Fantasize with me for a moment that you are part of a very special group of peers. You and your friends have a special deal with your employers. Here’s the deal:
- If you do a good job, you get paid spectacularly well.
- If no one is sure whether or not you, personally, did a good job, you get paid equally handsomely.
- If you do not do such a good job, that’s fine! Gracious hands slide your multi-million dollar compensation package to you across a conference room table.
It’s in your contract. I forgot to mention you and your friends have contracts, like all executives of American publicly traded corporations.
What has accounted for the contemporary business rules and historical developments that have lead to stratospheric growth in American executive pay? Between 1980 and 2009, the average CEO to worker pay ratio in the United States increased from 42 to 263 times, peaking at 525 times in 2000 and leveling off since the end of what I’ll call the ‘tech-housing boom-bubble.’ (1)
And not only is the average difference in pay between the top tier and the everyday worker two hundred and sixty three times apart, but these very rich fall into a plutocratic class that perches far above the ‘lower upper class’ of lawyers, physicians, and some media and financial professionals that make up what most other Americans describe in homespun terms as “the rich.” Such ‘lower upper’ professionals earn sums that afford a lifestyle almost everyone else on earth would describe as princely, but they tend to regard themselves as “merely” middle class, or upper middle class, and sometimes with resentment. CEOs, and others at the uppermost level of American economic life, earn so much more than they do, that even they – rich as they are (and they are) – feel dwarfed.(2)
James Suroweicki in a 2010 New Yorker column pointed out that “at the same time that the rich have been pulling away from the middle class, the very rich have been pulling away from the pretty rich, and the very, very rich have been pulling away from the very rich”:
“Between 2002 and 2007….the bottom ninety-nine percent of incomes grew 1.3 percent a year in real terms, while the incomes of the top one per cent grew ten percent a year. …Even within the top one per cent, income is getting more concentrated: The top 0.1 per cent of earners have seen their shares of national income triple over the same period. All by themselves, they earn as much as the bottom hundred and twenty million people.”(3)
The plutocratic class to which you and your friends belong – remember, we’re fantasizing here – not only commands salaries inconceivable to most of the planet’s inhabitants, it also benefits from the premiums that its wealth attracts in the way of dividends from and growth in equities and other financial instruments; these are the capital gains that the investing classes enjoy.
But you deserve it, don’t you? You’re experienced “talent” after all. It took a long executive search and tens of difficult interviews with lots of smart, crafty people to land you in your position. They had to battle you like a glittering prize trout from your previous employer, where you were being paid handsomely too. It was so inconvenient, losing the company jet, for instance. That’s why you insisted on a “make whole” clause in your new contract to replace the perks you left behind. No need for anyone to get miffed about it; such clauses are now standard in CEO hiring contracts. Of course, it didn’t hurt that some of your golfing pals were on the board of Widget Corp., your new employer. You worked with some of them back in the day. A few had become equally successful as CEOs of related firms. They would not dream of paying you less than the last guy at Widget, or even much less than they themselves got. And what would it say to the public about your new employer if – in its annual 10-K report – it noted that your total compensation was actually at or below the average for an executive of your class, (as reported by this year’s eagerly awaited Towers-Watson annual executive compensation survey)? It would look bad – really – it might make shareholders think we were not doing so well, like, we were just cheap, or that Widget did not have the cash on hand, or, heaven forbid, there was some doubt in the inner circle about the ongoing profitability of the firm. No, they had to pay you as much as Bob Thrum, the CEO of Widget’s nearest competitor. Hell, they had to pay you more.
After all, Talent is a scare commodity, traded on a tight market, right? We go out there: We roll up our sleeves, and we compete for the best guy – (or gal, no sexism at Widget!) – for the job. OK, so the last executive, Zelda Moore, was discovered having a clandestine affair with the Director of Operations, both married (at the time!), but that’s so beside the point. Zelda was a team player, an inspirational leader. She began those daily motivation meetings every morning at 7:30 am; she had the balls to innovate, to tighten the ship, to take the market by storm with bold new ideas, to cut expenses, et cetera, you know? And there’s just not much CEO material like that to go around. They chose you, by gosh; you were handed that gold baton and you ran and will run. You will run for the money, partner, because, as the global business world now understands, the primary bullseye for us is wealth. Oh, not just our personal wealth, but the wealth of the shareholders! The shareholders are primary in every decision. Clients, customers, employees, suppliers – yes, they’re important too, but only insofar as they help enrich the shareholders – the real owners of Widget Corporation. And Mr. Shareholder – you’ll want to say that to him - Mr. Shareholder, I want to say to you that if you hold Widget Corp for only a week, nay, a day, I want you to get the return on investment you deserve! As the CEO is enriched, thus are the shareholders are enriched – it demonstrates that we’re all coming up together. So relax, pat yourself on the back, have a sip of this rare, single-malt scotch sent over last Christmas by Bob Thrum. You deserve it, cowboy.
In the spring of 2010, Harvard Business School professors Jay Lorsch and Rakesh Khurana published an article unpacking the history of and assumptions behind contemporary executive compensation. (4) What most normal people intuit as excessive CEO compensation they explained by a series of faulty and unexamined assumptions about and structural changes in American business practice. More importantly, the authors examine what these trends say about the relation of business to and its purpose in our society. For example, most Americans are at least concerned about and at most horrified by the 2010 Supreme Court “Citizen’s United” decision that gave corporations almost unlimited ability to donate money to influence public elections. (5) The decision is simply the most recent in the high court’s long history of serially affording ever more ‘individual personal rights’ to corporations. So we and they want to know: What kind of guy are you, Mr. Corporation?
Lorsch and Khurana identify several trends that have helped to smack executive compensation out of the ballpark in the last twenty-five years. The widespread use of compensation consultants for executive searches and public executive compensation surveys published by high profile consulting firms annually have crafted a mini-industry around the ‘pay game’ in high-stake business. Compensation consultants, standing on ceremonial ‘scientific management’ canards often stand to gain from the lucrative packages they help secure for the CEO pool in the form of further business awarded to them in the network of relationships they help create, This is analogous to how ratings agencies, neutral in theory, stood to gain from the genteel, mindlessly high bond ratings awarded to the mortgage-backed securities that helped crash the housing market in 2008. Consultants with complex networks of patronage often see the CEO as part of their client network and are happy to secure him or her with the highest pay possible else risk future contracts in the same patronage network. Too, boards of directors hiring a CEO are often current or former CEOs themselves, and the entire process approaches a class-insulated, backslap operation. After all, business is nothing if not a network of carefully cultivated relationships and personas that follow the businessperson throughout his or her professional life. Each work-related activity can be understood as inevitably influencing the next. “Never burn your bridges behind you,” the saying goes, “as you never know whose help you might need down the line.” In this way, cultivated roles and hierarchies take the place of actual ethical and even sometimes practical directives. Business executives will come to think of themselves as doing their “best by the business” even though what might actually be happening is that they are doing their best for the network of peers, superiors, consultants and patronage networks they’ve developed over time and which they hope might play a role in their future successes. (6)
And so personal gain becomes a convincing proxy for corporate success: “If I am being paid well, the company is successful,” when what might more likely be happening is that “What I am being paid is simply being withheld from the larger pool of my reports and their workers below me.” My hefty slice of the pie simply reduces the remaining portions for other stakeholders – employees, investors and clients. Yet the board has no choice but to pay me my stated gambit, else be seen as endangering themselves in the leadership “marketplace.”
As Lorsch and Khurana note, the near-totalistic transfer of corporate success predicated on “shareholder value” in the last twenty years has helped to bolster the illusion of “I win – we win.” For example, since corporations report executive compensation in the annual “Compensation Discussion and Analysis” (CDA) section of the annual 10-K report to the Securities and Exchange Commission (SEC), should it be shown hovering in a lower quartile, it might imply to the shareholders and public at large that the company cannot compete on salary and might not be doing so well. “As a result,” they write, “American senior executives are like the children of Lake Wobegon – all above average.” (7)
It was not always this way. The Gilded Age, obscene for its class ostentation, established the mythos and practice of mahogany-and-leather-chair capitalism that led to the mistakes of the Great Depression. Following it, a vast expansion of the American middle class was built on a massive scale-up of a new economy brought to you by plentiful and easily accessible fossil fuels wedded to World War II’s hefty economic stimulus. Whereas the Gilded Age was ruled by the legend of the ‘Millionaire’, the nineteen-forties through the sixties evolved newish, haute bourgeoise concepts of “traditional values” wherein ‘citizenship’ began to trump ‘wealth.’ The flourishing middle class congratulated itself on its broad desire for the equalization of fellows, all aiming for a sweet future – including a home, car, appliances, the good life – and it was all nearly in view. Paranoid anticommunism, jingoism, pervasive racism – these remained firmly in place but the society was rapidly on the move with new social and economic realities, and many really were more egalitarian.
In keeping with the new esprit de temps, in the fifties and sixties so-called “captains of business and industry” were routinely profiled as “Regular Joes,” responsible, predictable and loyal to employer and customers. Even top dog executives longed to be seen as everyday guys; the American dream – they seemed to say – could be yours, just as it has been mine. Executives in this era were not paid audaciously for their services or to sign up with a new firm. They were, one might say, first among equals.(8)
Malcom Gladwell in a 2010 New Yorker article on paying for talent quotes a 1959 Ladies’ Home Journal article:
“In 1959, the Ladies’ Home Journal dispatched a writer to the suburban Chicago home of “Mr O’Rourke,” one of the country’s “most successful executives.” …(T)he country had undergone extraordinary growth. But Mr. O’Rourke’s life was no more extravagant than that of his counterpart a dozen years earlier. He lived in an ivy-covered Georgian, with ten rooms. Mrs. O’Rourke, “a slim blonde in a tweed suit and loafers,” gave the writer a tour. “For our neighborhood this is not a large place,” she said. “You can see that we’ve made do with rugs from our old home and that this room has never seen the services of an interior decorator…”…”I’m president of one of the larger companies in the U.S.,” Mr. O’Rourke said, “yet chances are I’ll never become a millionaire.”(9)
Now, say Lorsch and Khurana, “the existing approach to compensation offers a poignant commentary are the kind of society we have become.” (10) That is, a society in which the means and ends are not related; one in which business, rather than a societal sub-system shot through with meaningful relationships both commercial and personal, has become a mansion of self-referential cabals controlled by greed and poorly disguised fantasies of self-importance. A simple contract or wage still governs the relationship between employee and employer but many are ‘at will’ and can be voided at any time. The contract between the executive and the corporate board is a more rarified instrument that affords this special employee and stockholder orders of magnitude more, but not necessarily for good reason. In my small businessman father’s day, a handshake and a personal pledge were all that was needed to engender trust among gentlemen in commerce, and in everyday practice, people working at corporations will behave as if within family-like societies, forming meaningful relationships with their co-workers and forming loyalties, sometimes ambivalent, to the employer. It often does not take all that much to make them happy. And yet though the corporate office will go to great lengths to generate this employee loyalty to the firm’s “persona,” it’s common knowledge now that this is a marketing message crafted to be sold to employees, its promise abandoned as soon as it is no longer in the corporate “person’s” interest. Employees, cognizant of this decades-in-the-making shift, regard themselves increasingly as free agents and some have gradually abandoned the loyalty they once reserved for employers. They understand the game as it applies to high-level people is not the same game being played with them, and they are trying to equal the playing field by withdrawing their services until or unless the game is fairer. In reality, their withdrawal has only cheapened their labor by creating a class of contractors and consultants, free agents regarded as easily secured, plentiful and cheaply gotten – even if the corporation has to find them in poorly paid developing countries, while the “free agency” of high level executives is overvalued and recompensed.
Free agency, in fact, is an apt metaphor for how executives see their roles in companies, and also how they expect to be paid. The underlying fiction is that there is a ‘market’ in which talent circulates. Boards of directors must make their packages attractive to competing ‘wannabe’ CEOs. This market assumption underlies many of the practices driving the increase in executive pay. Note a competing opinion that this is not a true market driven by a limited pool of resources/buyers, but rather a series of practices and negotiations on behalf of a group of powerful individuals driven to maximize their own personal profit. The only real restraints on the system in practice have been those required by the so-called “outrage constraint,” the predictable public firestorm generated when someone’s colossal compensation package goes public.
The compensation negotiation between the ‘free agent’ CEO, the compensation consultants and the board is supposed to be driven only by considering the company’s need to compete for marketplace talent for the good of the shareholders, as mentioned above. But the actual negotiation of egos goes something like this:
The board does not want to piss off the potential CEO or make her look bad in front of her peers. If she gets pissed off, a director might end up kicked off the board in the sort of hissy-fit drama that we see in Silicon Valley from time to time. Board directors can receive fabulous perks, and no one wants to give those up. CEOs and boards often have intertwined relationships, and in that manner alone, the “market” is certainly not “free.” Neither does the board want to make itself look bad or unprofitable to shareholders, so although boards must mind their ethics and reputations, this does not generally get in the way of a salary negotiation that will favor highly the CEO with little heed to what may happen to shareholders. In fact, certain pay-for-performance perks have led to disastrous results in CEO risk-taking. This has been especially evident in shenanigans of large financial firms that, by underestimating risk and overestimating their own brilliance, managed to created a profound mess in US financial markets. To put it mildly, this did not maximize shareholder value. (11)
So, senior executives think of themselves as free agents because they think of themselves as rare talent in a marketplace, but this would not have become axiomatic except for the development in the nineteen-seventies of the practice of paying for talent rather than for role. Lawyers, unions, agents and consultants had to apply threat to an insular managerial and often heredity elite that contractually exploited and routinely hoodwinked its talent professionals. This was a good thing and it began to secure for writers, singers, actors, musicians and athletes – all ‘talent professionals’, a fair share of pay and rewards from their ex-masters. Malcom Gladwell asks if it has since gone too far:
“A negotiation in which a man can get paid twenty-two million dollars for hitting a baseball is not really a negotiation. It is a capitulation, and the lingering question…is whether the scales ended up being tilted too far in the direction of Talent — whether what Talent did with its newfound power was simply create a new authority ranking, this time with itself at the top. A few years ago, a group of economists looked at more than a hundred Fortune 500 firms, trying to figure out what predicted how much money the C.E.O. made. Compensation, it turned out, was only weakly related to the size and profitability of the company. What really mattered was how much money the members of the compensation committee of the board of directors made in their job. Pay is…determined horizontally, according to the characteristics of the executive’s peers. They decide, amongst themselves, what the right amount is. This is not a market.”(12)
In fact, there is little indication that executive pay has anything to do with corporate performance, which depends on complex systems and not on one VIP. There is little truth to the notion that most CEOs are marvelously talented. One cannot compare the average CEO, talented in business though he may be, to a first violinist in a crack orchestra, a Cy Young award-winning pitcher, a star quarterback or even an author or actor. In these cases, there really is some consensual/critical yardstick for individual talent beside even cultural popularity or crowd appeal. An actor might shine above the performances of his fellows in a mediocre movie, but the success of senior executives always depends on the talent in the trenches below them as much as it depends on their own ‘vision.’ Vision is carried out by committees and delegated throughout an organization. Moreover, when an organization gets large enough, the vision of the senior executives is frequently nipped, tucked, undermined or ignored in practice by departmental or division heads when it seems to contradict their own successful but divergent practices. This is well camouflaged but hardly uncommon. In the end, who can say who or what actually created the conditions for success? Of course we also know by now – if we did not know before 2008 – that market forces beyond anyone’s control are as critical in a company’s success as is any bright idea offered by a single executive.(13)
Let’s return to our reverie for a moment, a place where we can be blessedly sure – based on the data – that our executive compensation will be plentiful no matter what sort of job we do. We have trust in our own abilities, in our vision for where we can take the company. We will not undersell ourselves; we know that we deserve as much as we can negotiate from our sympathetic and trusted peers on the board and in the widget industry at large; I mean, these guys know each other and are keeping tabs. Perhaps then we feel some – sympathy? – with the University of California top executives that recently threatened to sue the state unless it “agrees to spend tens of millions of dollars to dramatically increase retirement benefits for employees earning more than $245,000″ in accordance with an agreement made in better economic times. (14)
Here’s a good example of how an insular perception of self-importance among a managerial class can deflect any shot at cooperation or community enterprise. The gist is that, in 1994, the IRS created a rule that pensions can be calculated only on the first $245,000 of someone’s earnings. That means that if you take home, say, a million bucks a year, your employer can’t calculate your pension using that million; there’s a cap of $245,000 that you can be awarded for your annual pension. In 1999, high-level University of California executives requested that UC make a special request to the IRS to lift the cap and calculate pensions based on their total salaries. This was likely thought to incentivize the retention of executives, who could easily make more in the private sector, and lifting such caps is occasionally done by the Feds for non-profit or educational institutions like UC. Still, it took almost eight years for a waiver to be granted (2007), though no action was ever taken and the waiver ‘just sat there’, if you will. When UC Chancellor Mark Yudof along with the UC Regents began to mention revoking these caps in order to help save UC’s core mission (educating students and doing research, in case we’d forgotten), the executives fired off their portentous missive.
With federal and state funding at record lows, California’s budget in dire straits, pervasive layoffs at UC, pay cuts and freezes literally piled upon staff for years and years, large tuition increases for students now making it impossible for many to attend college, this bomb threat by UC execs finally struck the public’s “outrage constraint” button and created a very vocal backlash. Such citizen anger, apparent in op-eds, letters to the editor, blog posts, etc (and I did not see one in favor of the increases), may have been made more bitter by other recent disclosures of large secret “perks” and extra pay awarded “under the table” to UC executives in violation of policy that led to the resignation of University President Robert Dynes in 2007 (and figured in the suicide of Denise Denton, a UC Chancellor, in 2006).(15) In fact, in January, 2011, the California Assembly heeded the torch-toting mob and introduced a bill that would limit pension benefits paid to any highly paid workers in publicly funded retirement programs.(16)
In a case like this, it’s hard not to visualize the “lower upper” UC executives doing symbolic battle with their class betters at the top of the University administration and in the private sector: No one is more important than the executive is to himself in times like this because personal reputation and interpersonal power are at stake. Is this group preparing a lawsuit because it might be truly underpaid when retiring on “only” $245,000, quite apart from any defined contribution (401K, 403b) and/or private savings and investments? Or is it more likely that it feels cheated and devalued, ready to go to battle over the letter of the law and its sense of self-importance or wounded honor, with no thought for anyone else in the fabric of the educational-medical system it is part of: Students, professors, doctors, researchers, or the army of support staff? How would you handle that, Widget Corp. executive? Do you know how lucky you are, punk?
I’d warrant that there are talented people in the pipeline right now who could be groomed to do the jobs these executives are doing and would do them not only well, but would be untroubled by existing IRS pension caps. To paraphrase one peeved newspaper letter-writer, if remuneration equivalent to the private sector – which unlike the public system no longer offers old school pension plans – is more important to them than the overall health and public educational mission of their employers, then why don’t they go work there? As New Yorkers would say, “Don’t let the door hit you in the ass on the way out.”
There are executives that are truly talented Renaissance individuals, über-competent visionaries that fundamentally changed the cultural game. There are also storied CEOs, who, like celebrities, become American legends. And like celebrities, they are sometimes paid out of proportion to the societal value they really create, if one does not define water cooler gossip as societal value. But this is not to disparage the great laurels placed on those that have added value – in incalculable ways – to the culture and the economy. Andrew Carnegie, Mary Kay Ash, Steve Jobs, Bill Gates, Jack Welch, Warren Buffett, the Google guys – all these people and hundreds more have helped construct legends in American business. Some hundreds are legitimately venerated, while some rather resemble celebutantes: Like Paris Hilton and Kim Kardashian they were merely lovely and lucky at the right time. Many geniuses, scientists, engineers, systematicians and artists, have done much more than they to create and maintain the things we value, yet remain unrecognized and are paid much less. As long as we consent to pay people for playing a role, or in deference to an imaginary market that traffics more in hearsay than substance, we devalue the millions of everyday working Americans whose phenomenal growth in productivity over the last twenty five years is the number one contributor to our fast-slipping affluence.
Perhaps spurred by the grievous missteps of the recent financial meltdown and severe recession, legislative and regulatory agencies are catching on: Just this month, the SEC introduced new “say on pay” rules that give institutional investors an opportunity to scrutinize, and a non-binding vote on, executive compensation and “golden parachutes,” contractual agreements that guarantee a package of benefits, such as cash payments, stock options or other perks, to the executive upon severance.(17) Rules like this are a step towards greater scrutiny of executive pay norms by a wider circle of stakeholders. Involving more interested parties can move the debate from its solipsistic closet out into the sunlight. Such corrections notwithstanding, there are other ways to do good business: Not all companies are run as linear, hierarchical inheritances, for instance; some are run as worker-owned collectives. Some recognize the creative fluidity of a flatter hierarchy, where the people on the ground have more input and can contribute innovative ideas. A participatory organization that recognizes input from and rewards all its stakeholders, like a flexible organism, is more likely to survive, thrive, and – when hurt – heal to live another day. Come to think of it, creative fluidity, flexibility, responsibility, relatedness, openness – those sound just generally like good qualities for people to have, don’t they? Those are the kind of friends I want.
(1) Figures from AFL-CIO: http://www.aflcio.org/corporatewatch/paywatch/pay/
A more comprehensive article can be found at the US Santa Cruz sociology website: http://sociology.ucsc.edu/whorulesamerica/power/wealth.html
(2) Journalist Matt Miller on the “lower upper class”: http://www.washingtonpost.com/wp-dyn/content/article/2010/04/21/AR2010042102508.html
(3) James Surowiecki, “Soak The Very, Very Rich,” The New Yorker, 16-23 August 2010, 33.
(4) Jay Lorsch and Rakesh Khurana, “The Pay Problem,” Harvard Magazine, May-June 2010, 30-35. (Online access at: http://harvardmagazine.com/2010/05/the-pay-problem)
(5) For more information about the “Citizens United” decision, see Wikipedia entry: http://en.wikipedia.org/wiki/Citizens_United_v._Federal_Election_Commission
(6) Such self-interest acting as proxy, consciously or unconsciously, for the public interest may have been a workable ideal in 1776, when social philosopher Adam’s Smith’s “The Wealth of Nations” was published and most commerce was made between single person or family proprietorships or chartered companies in a much smaller and more intimate world. But that world and its power balance has changed radically and the abuses once merely inherently potential and that Smith himself warned against have become everywhere apparent. Such a discussion is relevant but beyond the scope of this article. You don’t want to have to read one hundred pages of this, do you?
(7) Lorsch and Khurana, 33.
(8) For a wonderful period portrait of America’s self-image in business and corporate matters, see Frederick Lewis Allen, “What Have We Got Here?,” Life, 5 Jan 1953, 46-57. (This can be accessed at the Life Magazine archives at Google Books:
(9) Malcom Gladwell, “Talent Grab – Why do we pay our stars so much money?,” The New Yorker, 11 October 2010, 84-93.
(10) Lorsch and Khurana, 34.
(11) There is an interesting discussion on boards and pay in Michael S. Weisbach, “Optimal Executive Compensation vs. Managerial Power: A Review of Lucian Bebchuk and Jesse Fried’s Pay without Performance: The Unfulfilled Promise of Executive Compensation.” Unpublished paper, 21 Nov 2006, available from http://fisher.osu.edu/fin/faculty/weisbach/bebchukfried.pdf; Internet, accessed 10 Feb 2011.
(12) Gladwell, 93.
(13) One of the foundational texts on pay and executive performance is widely quoted as: Lucian Bebchuck and Jesse Fried, Pay Without Performance. Cambridge, MA : Harvard University Press, 2004.
(14) Nanette Asimov, “Highest-paid UC execs demand millions in benefits.” San Francisco Chronicle, 29 Dec 2010, 1.
(15) For information about the Denton suicide, see: http://www.usatoday.com/news/nation/2006-06-24-chancellors-death_x.htm
(16) Laurel Rosenhall, “Assembly bill would limit pension benefits for UC executives — and others .” Sacramento Bee, 8 Jan 2011, 3A.
(17) See discussion in the Reuters blog article: http://blogs.reuters.com/financial-regulatory-forum/2011/02/02/u-s-corporate-shareholders-gain-more-frequent-say-on-pay-westlaw-business/.