
Focus: Executive pay and performance  - stfu
http://www.economist.com/blogs/graphicdetail/2012/02/focus-0?fsrc=scn/tw/te/dc/executivepayandperformance
======
forgotAgain
It's interesting that the cause for spiraling CEOs salary is similar to the
cause of spiraling Civil Service salaries over the past 30 years. In both
cases compensation is not based on performance but rather on what others in
similar positions are receiving and control of the compensation process.

In corporations there will be board compensation committees that hire outside
compensation consultants. The consultants will come back with a suggested
salary that is the current standard for similar companies plus an additional
amount to insure that they "get the best". There are only a small group of
such consulting companies and it is in their self interest to inflate
executive salaries. Suggesting lower salaries would mean a loss of future
business because it is the very same executives that hire them.

For civil service contracts their will be independent government boards set up
to negotiate salaries. To insure that the boards are independent they are
usually constituted using a political process. As a baseline for salaries they
will use formulas based on what other unions make plus a little something
extra because "well everyone deserves a raise". As with the executive
compensation committee, it is in the self interest of the government
compensation boards to be generous. The government boards are appointed
positions based on the party in power. Given the capabilities of unions in
voter organization, it is fair to say that they at least indirectly hire the
compensation board members.

The net result in both cases is spiraling salaries that have no relation to
performance.

~~~
api
The right likes to scream about this phenomenon in civil service. The left
likes to scream about it in the private sector.

Incredibly good point... it's the same phenomenon.

We need -- collectively -- in all spheres -- to take a good look at some
people and start asking questions like "what exactly is it that you do here?
what value do you create that is commensurate with your salary?"

In government this has to happen at the management or political level. In the
private sector this needs to happen via shareholder pressure. If shareholders
had a brain, they would start agitating for long-term merit-based CEO pay.

~~~
maratd
The best solution, in both the government and private sector, is to keep
things small. Smaller governments and smaller companies.

On the small scale, it's very easy to ask "what exactly is it that you do
here?" to everyone involved in the entity.

~~~
jtbigwoo
Small companies don't generally change the world until they become big
companies.

~~~
maratd
Wrong order. Small companies change the world and as a result, become big
companies. Such is the nature of the beast.

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brianlouisw
Paying CEOs for 'performance' may not be a significant improvement
unfortunately.

Daniel Kahneman, and Nassim Taleb have spoken about this - essentially that
there's no good reason to think CEOs of large companys have any significant
control over their company's outcomes. Our judgement is clouded by a
combination of hindsight and narrative biases along with a significant
underestimation of 'luck'. Kahneman quotes something like a .6 correlation
IIRC. So, it CEO performance exists, it's just overestimated.

Kahneman's new book - Thinking Fast and Slow - is an excellent read.

[http://www.smh.com.au/opinion/in-dumb-luck-we-can-
trust-2012...](http://www.smh.com.au/opinion/in-dumb-luck-we-can-
trust-20120127-1qldb.html?skin=text-only)

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jbooth
I really don't understand why people think any amount of pay over, say, a few
million, for any position, makes any difference to anyone.

Think about the people you know who are good at their job. Do they give a fuck
about money if you give them enough that they're taken care of? No, they
probably care a lot more about prestige, interesting problems, other ego-
feeders besides a silly 8-digit number.

Of course, CEOs are bound to be good negotiators and will negotiate themselves
a higher number because why not. But is anyone going to argue that there's a
serious quality of life difference between 20 and 100 million?

~~~
JumpCrisscross
Because I want to have enough money to say hey, people should go to Mars and
so I'll start a company that does that. I want to pursue social, medical
research, and technological policy on my own terms which needs my own capital.

Because I want that apartment on One Central Park that costs $17 million and I
want a chauffeur at 50k a year and a PA at 100k a year and someone to take
care of my kids for 100k a year (no sketchies). I also want to be able to hire
a plane when I want to do I can zoom out to Tripoli or Nigeria when
interesting things happen and no private charter will go.

Maybe I'm being the stereotypical New Yorker, but I can see 30, 50, even 100
million dollars whisking away rather fast. You know what traders call $100
million of personal income? A unit. It's the starting point.

Note: CEO pay is not, when done sensibly, where the Board goes "Mark, you look
damn handsome today - here is a hundred million. Go wild." It is a structured
pay where you try and align incentives, that is, give the CEO upside when he
does well and some downside when he doesn't. You want to encourage sensible
risk-taking, remove principal-agent issues, and deal with moral hazard. Most
pay for CEOs comes in stock grants or via other non-cash instruments. It is
also usually not guaranteed up front.

~~~
jbooth
So, corporations should pay CEOs bigger salaries, because it's the most
effective way to boost human space travel?

This is the highest voted counter-argument?

~~~
JumpCrisscross
It's a broad metaphor for companies giving executives incentives to earn
income that comports with the value they produced for shareholders. The
incentives drive these executives far beyond where it has material
significance for them because there are things beyond the material which money
can increase the probability of attaining and that many people aspire towards.

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byrneseyeview
Zero correlation is a surprising number. That seems to imply that CEOs are
paid fairly; I had thought they were overpaid.

If they're underpaid, there should be a positive correlation between CEO pay
and corporate performance (i.e. the companies that pay the most can hire the
best people). If they're overpaid, there should be an inverse correlation
(i.e. the companies that pay the most are likely to overpay the most, and thus
waste the most money). So the exact middle ground implies--the exact middle
ground. I didn't realize the market was so efficient.

The other possibility is that CEO pay or market performance are totally
random. But all you need to do is identify a few very effective and very well-
paid CEOs to argue that this is false. Just look at e.g. JCP's new CEO (they
nabbed him from Apple thanks to, in part, a generous options package).

This might be clearer in another context: it wouldn't surprise me to find out
that your average hunger in a given day has no correlation to your daily
caloric intake. That wouldn't imply that calories don't satiate hunger; it
would imply that most of us eat something close to our daily calorie
requirement.

~~~
monkeyfacebag
> all you need to do is identify a few very effective and very well-paid CEOs
> to argue that this is false

No. If there's no correlation between CEO-pay and performance/market cap,
finding a few interesting counter-cases doesn't further your argument.
Inherent randomness and lack of accounting for other factors are far more
likely to be the culprits here than market efficiency.

EDIT: Further, zero correlation isn't a "middle-ground" between positive and
negative correlation. If it implies anything it's that one variable
(performance/market cap) doesn't depend on another. If there's _no_
correlation, CEOs can still be overpaid, they just can't do worse for their
companies as pay increases.

~~~
byrneseyeview
I'm presenting two possibilities:

1\. There's an efficient market, and CEO pay reflects the extra value they
create. In other words, a $100 million CEO is worth $50 million more than a
$50 million CEO, so your economic outcome is the same regardless of which one
you hire--except that larger companies will extract more value out of a given
level of managerial talent, since they can amortize it over more
underlings/revenue/whatever.

or

2\. CEO pay and company performance are totally random. But for that to be the
case, you'd have to deny that there's any such thing as being able to identify
and pay for a talented CEO. Maybe! But every time I've interacted with large
company CEOs, I've noticed that they tend to be very bright, and they work
extremely hard. People who are in the 10th percentile of public company CEOs--
the kinds of people who bankrupt companies--still seem to be in about the 90th
percentile of smarts and energy.

I don't know of another theory that could explain the data as presented.
Either the process is random, or it selects for people with certain valuable
skills. If the system tends to promote skilled people, you'd expect the
companies they run to have a higher return. Unless, of course, they capture
that value for themselves.

~~~
vannevar
_[CEOs] tend to be very bright, and they work extremely hard._

You can be extremely bright and work extremely hard and yet fail to produce a
desired outcome due to forces beyond your control or understanding. It's human
nature to overestimate our degree of control over events, and indeed, CEOs are
probably selected for this trait more than other professions. Who wants a CEO
who admits he really doesn't have much influence over the fate of a $100B
enterprise? No, you want someone who is self-confident to the point of
delusion.

~~~
byrneseyeview
I'm not sure if this is deliberately obtuse, but: all else being equal, the
smarter and harder-working person will win, right? The existence of some
randomness doesn't mean that skill and judgement are immaterial--if you
disagree with that, let's play poker some time.

~~~
vannevar
_[A]ll else being equal, the smarter and harder-working person will win,
right?_

But in actuality, all else is _never_ equal. Then we use the outcome of that
unequal scenario to judge _after the fact_ who was the smarter and harder-
working. In poker you have a very regular, controlled game. Imagine a
tournament where some players were randomly given extra aces, then try and
figure out who the best players really are. _That's_ the corporate CEO market.

------
vsl2
Conflict of interest where the CEO (or his friends on the board) decide how
much to pay him? Say it isn't so.

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cynicalkane
The headline is probably true in the statistical sense. The sample size is
undoubtedly small and economic data are often tainted by the efficiency effect
--the 'experiment' is uncontrolled and actors might already be choosing the
results that are best for them, dramatically reducing the apparent statistical
effects of their decisions. Finally, CEO pay is often negotiated before
performance becomes apparent, and for something like CEO I'd imagine it's
really hard to tell how well they'll do in advance, even if you're trying to
pick the best people for the job. It's not like there's a CEO aptitude test,
it's not like the skills picked up being CEO of Pepsi are necessarily
transferable to being CEO of Apple Computer (for example).

The headline might also be true in the economic sense. I'm not especially
qualified to judge this.

The article, however, is quoting the apparently private data of one obscure
financial research firm. So I'm filing it under Not News.

(I also just noticed that they call Warren Buffet 'underpaid'. The guy earned
fifty billion dollars being CEO of Berkshire Hathaway. Calling him 'underpaid'
seems like a bit of a technicality.)

~~~
JumpCrisscross
I think the point is the board should structure pay so that when the company
does well the CEO automatically earns more and when it doesn't he doesn't.

~~~
cynicalkane
CEO pay is frequently structured like this already. CEOs will often get half
or more of their pay in restricted stock and options, and it's not unheard of
for their salary to be a token value like $100 or $1. They also have the
incentive of not being fired, and being re-signed if they're on contract.

The alleged problem is that the vesting/restriction periods for these stock
and options is too short, like a few years. I have a pet idea that CEO pay
should be mostly in stock that vests quickly but is restricted for a very long
mean time, like 20 years. But that's just a pet idea and I bet it would be a
very hard sell to potential CEOs.

I also think pay for performance is overrated. It won't help if you have the
wrong guy in the first place.

~~~
jandrewrogers
You are forgetting that this compensation is then discounted for time. And 20
years would incur a very substantial discount. Every CEO knows how to do that
math.

Radically increasing the vesting time means that you would need to grant
several times the number of options that you would need to grant for shorter
vesting terms, just to maintain parity. The potential dilutive effect for
other shareholders (including employees) would be rather large.

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polyfractal
There is an interesting podcast with Steven Kaplan about the same issue. His
research showed a similar result: CEOs are paid fairly and have had wage
growth similar to other highly skilled fields (doctors, lawyers, etc).

Conversely, he found that hedge fund managers have absolutely skyrocketed past
everyone else. They have totally blown past any type of normal wage growth and
are the real culprit for the "1%" phenomenon.

[http://www.econtalk.org/archives/2011/11/kaplan_on_the_i.htm...](http://www.econtalk.org/archives/2011/11/kaplan_on_the_i.html)

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verelo
This makes me think back to the TED talk that discusses that higher pay
actually decreased performance and employee motivation when innovation is
required.

Interesting that the overpaid industries are those that i would consider to be
less innovative and those that are considered underpaid are the move
innovative industries and companies. That is just my opinion however.

<http://blog.ted.com/2009/08/24/the_surprising/>

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Gustomaximus
I recall a study some years back on Australian CEO's of public companies and
they found a negative relationship between pay and company performance.

I tried to find the article to no avail. This article says no relationship
between pay/performance but mentions many previous studies have found a
negative correlation: [http://www.sef.hku.hk/upload/faculty/42/officer-
remuneration...](http://www.sef.hku.hk/upload/faculty/42/officer-
remuneration.pdf)

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tocomment
I wonder if they would find a correlation between board members not getting
voted out and CEO pay. Maybe shareholders tend to be pleased if boards hire
big name CEO's?

~~~
jtbigwoo
Many companies have what basically amounts to a board exchange where a high-
ranking official from company A serves on the board of company B which has an
official on company C's board and company C has an official on company A's
board. In the end, it has the potential to be an "I'll scratch your back, you
scratch mine" arrangement.

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thelonecabbage
And how would the company have performed if they hired a less expensive CEO?

Fantanomics.

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7952
I would love to know the break down by type of business. Surely a CEO is more
important at a product lead company than a service company?

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talmand
And this is a surprise? I didn't need research to determine this, I just kept
up with the news.

~~~
scott_s
<http://lesswrong.com/lw/im/hindsight_devalues_science/>

~~~
talmand
It's not hindsight as I'm reading the news article that day.

~~~
scott_s
Yes, it's hindsight because you're reading the conclusions of a study and
saying "I could have guessed that." But you didn't _know_ that, you
_suspected_ it. The point of doing such studies is to _know_. I also suspect,
but obviously can't demonstrate, that someone would have said the same thing
("I could have told you that") were the conclusion the opposite.

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outside1234
i don't know how you could possibly say Steve Ballmer is underpaid for his
performance.

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michaelochurch
It's actually a steep negative correlation if you take a historical context.
In the 1970s, CEO pay was much lower and companies were well run. Now, CEO pay
is very high and the results are awful. I explained this "paradox" in a blog
post a year and a half ago:

[http://michaelochurch.wordpress.com/2010/11/22/pay-more-
get-...](http://michaelochurch.wordpress.com/2010/11/22/pay-more-get-less/)

~~~
thelonecabbage
They also wore more hats. Or the market was different, or they weren't dealing
with labor shortages, or their predecessors set the stage differently, or
inflation has increased 580% since 1970....

It's not possible to tease out the cause and effect.

Fortunately there is an easier way to figure it out; if the businesses are
hiring idiots, at far to much money the easy way to tell they are doing it is
their stock price will plummet and they will go out of business.

~~~
CWuestefeld
_Or the market was different, or they..._

A really significant difference that I rarely see acknowledged in these
discussions is that the _means of compensation_ has changed drastically in the
last few decades.

It used to be that executives got part of their compensation through perks
like generous expense accounts, or country club memberships, or keys to the
executive washroom. Changes in tax laws and other cultural norms have
eliminated these _as such_. But the corporations still need to be able to
compete for the same pool of executives, and so the money that had been going
into those perks now surfaces as monetary compensation.

In other words, much of the apparent increase in salaries is actually just
that part of the old-days compensation wasn't reflected as income.

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dustingetz
my gut reaction was "so what?" the article doesn't attempt to explain. why
does this stat matter?

