Top managers in the US and Europe have been harshly criticized lately for their growing salaries and bonuses. Is the problem due to bad communication or greed?
— Stefan Eiselin, Zurich, Switzerland
You can be sure both bad communication and greed have something to do with the heated controversy over executive compensation. Some firms surely are not clear or candid enough in explaining why their top people earn what they do, and some top people probably want to earn more than they are worth. That said, we would actually suggest another reason for all the recent sound and fury over CEO pay. Clashing ideologies.
Jack and Suzy Welch
That’s right: We think the debate over executive compensation is exactly as it appears—a philosophical divide. On the one hand, you have activist shareholders (and a lot of regular people) who believe that many CEOs just make too much money compared with average workers and their relative value to the organization, and that someone — be it the shareholders themselves or government regulators — must close that gap. Outsized CEO pay, this group generally believes, is bad for society and morally wrong.
On the other hand, you have people who generally don’t say what they believe, because it is so politically incorrect. But allow us to step in, because we share their view. Yes, most CEOs make a tonne of money, and sometimes they make too much. But, in the market economy, salaries are set by supply and demand. The firms that field the best teams win and, because of global competition, the best teams tend to be expensive.
Now, is this free market system of pay perfect? Absolutely not, which is why it sometimes happens that underperforming CEOs end up getting paid huge sums of money just to go home. While such situations enrage many, given market dynamics, they can be hard to avoid. Some CEOs — former Hewlett-Packard Co. chairman and CEO Carly Fiorina, for example—get large severance deals because their boards, without an internal successor, guaranteed them at the front-end as an incentive to sign on. Others, such as former Citigroup Inc. chairman and CEO Charles Prince and Merrill Lynch’s former chairman and CEO Stanley O’Neal, left their troubled companies with more money than some people would have liked because of stock grants and compensation earned during more successful years.
Such endings look and feel wrong and, quite understandably, give critics a platform to stand on every time they occur. But from where we stand, no overall system of setting pay is better than the free market. Indeed, one of the best things about it is that it rewards companies that perform well, and those tend to be the talent magnets that pay everyone well, from the CEO to the front lines. Moreover, there’s just no better alternative.
Government involvement? Forget it! What a mess that would be, with grandstanding politicians vying to outdo each other with promises of putting CEOs in the poorhouse and CEOs (and their lawyers) appearing at Capitol Hill hearings every year to explain their business models, describe their competitive situations and defend their pay packages as they relate to both. Now, there’s a productive use of everyone’s time!
As for shareholders setting pay, the problem comes less in the ideology of it than the logistics. How can thousands of people formulate a company’s pay levels? The insurance firm Aflac recently agreed to let its shareholders vote annually on the compensation of its Top 5 managers. The vote is non-binding, but perhaps it will meet the needs of its supporters for some sense of input.
And a sense of input is actually about all that shareholders should have. Because it is ultimately their elected representatives, the board, that must set executive compensation, as its members are the closest to the company’s challenges and the top team’s performance, not to mention the cost and viability of replacing the CEO or other executives. They know, in other words, the free market’s human resource landscape. Sure, cronyism is always a worry when boards determine the top team’s pay. Luckily, there’s a check-and-balance in the company’s financial performance and stock price. A board can overpay a CEO, but not forever.
The debate over executive pay, by contrast, may last that long.
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