Robber barons

Congress is currently considering legislation that will change the way executives in the United States are compensated. Even in these formative stages of the legislation there is tremendous hue and cry from executives of BIG corporations. The gist of their message is: without high pay they cannot attract talent and therefore their businesses are not managed well and ultimately that shareholders do not earn returns as high as they would with high executive pay.

Enter research done by a Harvard corporate governance expert, Lucian Bebchuk. He looked at more than 2,000 firms and identified what share the CEO’s pay was of the top 5 highest paid executives at a firm – they refer to this as the “CEO pay slice.” If the pay was allocated equally, it would be 20%, but Bebchuk found that the average CEO pay slice was 35%. That is a full 75% higher than an equally sized slice. This is calculated as:

***** 35% average CEO pay slice – 20% equally sized pay slice = 15% excess pay over equally sized pay slice; 15% excess pay / 20% equally sized pay slice = 75%

Just through simple reasoning we should expect CEOs to receive a bigger pay slice because they have greater responsibilities. However, the research goes further. Lucian Bebchuk found that the higher the CEO slice of the pay pie the lower a company’s future profitability and market valuation (!). Wow!

Now to those of us standing on the sidelines this seems to be a very logical result. For me personally I have long understood that big CEO pay packages have nothing to do with executive talent but have to do with unabashed, ugly, greed. Yet to the average U.S. executive and his/her compensation consultant this result is likely awesomely shocking.

As regular readers of the blog know I have been saying that corporations don’t simply want to attract people motivated by money. Instead the ideal is to attract people who are motivated to do a great job and whose reward is commensurate with long-term performance and satisfaction of (at least) the majority of a corporation’s many constituencies (e.g. employees, environmental groups, shareholders, etc.). So thank God for this study which confirms what I have long believed to be true: greed is just greed and greedy CEOs have no interest in improving a business for the benefit of its owners, just themselves.

Commentators of the study have rightly pointed out the complications of statistically “proving” causality in the data. In other words, I have inferred that greedy CEOs cause low shareholder returns. Yet, statistically this inference is hard to make. It may simply be a statistical artifact. So the hard, analytical data make discerning causality difficult. But, the soft intuitive observation strongly suggests that greedy people (that we all have encountered in life) have a singularly focused mentality on that greatest of central points: themselves.

When I was a highly paid investment professional one of the things I paid very close attention to was the level of executive pay. I steadfastly avoided firms that ignored shareholders and awarded executives willy nilly. The one exception to this rule was a company called International Rectifier (IRF) that handsomely rewarded its executives and that I consider to be one of the greater investment mistakes of my career. IRF shares perpetually went sideways and never up.

Food for thought!

Jason