Is your boss overpaid?
It is not that they are overpaid it is that they are badly paid.
Their interests are not aligned with the customers and the stakeholders. Therefore they do not act with their customers or stakeholders in mind.
Last September, The Economist argued against the conventional wisdom that American bosses are grossly overpaid. We mulled that one.
The Economist was not talking about owners of their own businesses or about managers of businesses. They were surveying the CEO’s of the S&P 500 and firms of that nature. Forbes, which likes to survey things about the rich and powerful, fretted last year: “our report on executive compensation will only fuel the outrage over corporate greed.”
The complaints are based on three propositions:
- CEO pay just keeps on going up;
- that it is not tied to performance;
- that boards are not doing their jobs
To be fair, the CEO is holding many of the cards, and that means he can influence how the board gets selected and paid. These facts make it difficult for the board to fulfill their monitoring functions.
Steven Kaplan of Chicago’s Booth School of Business distinguishes, for example, between “estimated” and “realised” pay. Estimated pay is the estimated value of the CEO’s pay, including stock options, when the board does the hiring. Realised pay is what the CEO actually makes when he exercises his options.
The captains of the corner office are hardly going short. In 2010 the average package for an S&P 500 CEO was $10m and the median CEO took home $8.5m.
What about the relationship between pay and performance?
Mr. Kaplan argues that CEOs are clearly paid for improving the performance of their company’s stock. But should the improvement of stock be the prime objective?
Stocks can go up by:
- Hyping
- Sexy mergers, acquisitions or divestitures
- Short term profit boosters like cost cutting or closures
- Share buy backs
- Dividend increases
None of the above items, in and of themselves, make for stronger businesses if they are not sustainable.
They can all be short sighted. But if a CEO’s pay and stock options are geared in such a way, why should the CEO care if they are short sighted?
Today CEOs are with their companies for six years on average. That is not an overly long time to implement long term planning (3 to 7 years).
This all fuels short-termism. The solution? Pay CEO’s a good salary, but pay most compensation and bonuses in restricted stock. Get rid of stock options!
Make the restricted stock taxable only when “sold.” Treat it like capital gains if held long term. Restrict sales to 5 to 10% per year, even after they resign, are fired or retire from their position. Then the CEOs would become investors in the companies that they are leading.
The CEOs interest would be aligned with shareholders. The CEOs interest would be aligned with the customers since the compensation would be long term in nature. The CEO would have to believe that the company was financially sound to take the position and the package. Revolutionary!
Governments could stay out of regulating pay. They could pass rules on reducing the number of stock options available from 10% of a companies float to 2%. They could restrict the amount of options that any individual gets. They could adopt restricted shares rules that were tax and regulatory friendly and they could stand back and watch capitalism and ownership work.
Companies could continue to compete for scarce talent. The talent could become choosier. The benefits would be felt across the economy.
That is how it should work.
- Bonuses or goals that are approved by BOD’s and shareholders
- Base salaries that are respectful of the public trusts
- Shares that can make them wealthy…if they do so for all shareholders
These types of rules should apply to Banks and financial institutions as well.
Why does it matter?
When trying to hire talent, we should not compete with the excesses of the “options” market.
We are the consumers! We matter!
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