Corporate Boards: Act on Executive Pay Or Congress Will
LIKE most Americans, this economist gets upset when he reads about the "retired" business leader who earns $750,000 annually plus bonuses for chairing two meetings a year. My hackles rise when I hear about the $70 million a year executive who heads a company with deteriorating performance.Skip to next paragraph
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This situation did not exist several decades ago, when the typical corporate board of directors consisted primarily of "insiders." Board members were mainly officers of the company plus friendly commercial and investment bankers, lawyers, large customers, and suppliers. This cozy arrangement kept dividends just high enough to pacify the shareholders, but their desires did not get high priority. The executives didn't have the nerve to pay themselves extraordinary salaries.
More recently, boards and corporate goals have undergone fundamental change. Most board members of larger corporations are independent "outside" directors. They are neither employees of the company nor are their businesses dependent on the companies on whose boards they serve. Simultaneously, corporations now emphasize the needs of the owners - "maximizing shareholder value."
The new approach focuses on incentives to management. The compensation package of the chief executive officer is often based in large part on the performance of the company's common stock. As an outside director, I gulped hard the first time that a board on which I served approved a $1 million annual package for a CEO. I now see that such generous compensation can be a bargain for the company, depending on a variety of critical factors.
The person at the top does make a profound difference. A $2 million a year CEO who raises the profits of a $10 billion company by 5 percent earns that compensation many times over. People with such capability are in short supply; the bidding for them is spirited. The dedication of the best of American CEOs is truly impressive. A tale is told of one CEO who, when he took his son to the ballpark, bought three seats - the third was for his two briefcases.
It is false economy, regardless of what the Japanese or Germans are paying, not to encourage such dedication to the task. Moreover, we must discount the usual invidious comparisons of United States business executives with the Japanese. Japanese managements are paid a far smaller multiple of the salary of the average employee. But fringe benefits are extremely generous.
There is an important, but often neglected, flip side to the executive pay question. In the face of poor performance, compensation should decline - substantially. Otherwise, it becomes a matter of heads, the management wins, and tails, the owners lose. Of course, it is painful for a board to replace a CEO. Nevertheless, that is the ultimate, and appropriate, sanction for unsatisfactory performance.
Given the failure of some corporate boards to take these tough actions, it is not surprising that many have urged the federal government to "do something" to deal with the executive pay issue. Some would put a dollar ceiling on CEO salaries, $1 million being frequently cited. Others would limit the CEO's pay to 16 times that of the average worker, the ratio reported for Japan.
Given the awful track record of economic regulation of industry, it is hard to get enthusiastic about these proposals. The side-effects of government regulation are powerful and often negative. This is likely to be the case with executive pay limits because these proposals ignore the performance of the enterprise.
There is no shortage of media attention to CEO pay, but the focus is on the wrong target - the executives who receive those outsized compensation packages. Public outrage should aim at the complaisant board members who vote for these sweet deals. Either the corporate boards tackle the executive pay issue head on or Congress, goaded by the public, will do it for them.