One of the hot topics among corporate directors and their constituents is executive pay. It’s been a hot topic for years and years. For some reason, each time it comes up in the public’s awareness, people react to it like it’s the first time. If that weren’t puzzling enough, so is the fact that what would appear to be a simple issue becomes a centerpiece for complex research and expensive consulting.
The debate is, as always, how much CEOs and other executives should be paid, and secondarily, for what. The “what” really hasn’t mattered all that much, if you measure what matters by the impact those measures have on compensation. One of the things that the complex research has actually provided of value is demonstrating that, on average, there isn’t much correlation between executives’ pay and the operating performance of the companies they ostensibly lead.
Legislators want to change that, arguing that private businesses haven’t protected the public interests and can’t be relied upon to make sound judgments in their public organizations. The damage done to the entire country, even the world, has been too great, to allow executives to continue to pad their own nest at the expense of everyone else.
Viewing the issue like regulated areas of commerce which affect public health, their argument is that we can’t afford to let a financial infection become an epidemic again. The assumption is that the creation of legislation and spending the money on enforcement of new regulations will prevent singularly terrible troughs like the one we’re in.
“Free market” proponents say that nothing is amiss. The poorly led companies have lost billions for their shareholders and so those shareholders won’t invest in such companies in the future, thereby punishing the bad actors. The people resisting regulations on executive pay say that artificial limits imposed from government will only serve to reduce the quality of people who want to perform the role of CEO. And after all, wasn’t this country built upon the freedom to make as much money as you can?
Both arguments are flawed. The problem is that both sides refuse to acknowledge the chinks in their own armor. Each is building up a good case of righteous indignation, which, as we know, is the altar upon which solutions are sacrificed.
So what are those chinks? Regulation proponents erroneously assume that controlled pay will make a difference in protecting shareholder value, ensuring that critical industries which can have a dramatic and broad impact are run well. As I said earlier, there is little evidence that pay and performance relate to each other. Until they actually do relate, limitations on executive pay will have similarly little to do with achieving the objective.
For free-market proponents, the chink is their stubborn faith in the “efficiency” of an unregulated market. There is no such thing as an unregulated market that is based on the exchange of symbolic value, i.e., money. Once people started using money, and moved away from barter, we had to impose commonly accepted rules, like denominations, exchange rates between currencies, basis of confidence in the negotiability of the currency, etc., in order to be able to use money at all.
Personally, I like what SEC Commissioner Troy Paredes said when he spoke to the Corporate Directors Forum a few years ago. He said that the role of the Securities and Exchange Commission is to be a magnifying glass. That role is based on the legislation that created the Commission, which established that its purpose is to ensure transparency to shareholders of public companies. One can debate the degree of success and the wisdom of the methods, but I think that mission seems appropriate.
If shareholders knew that large bonuses were composed on formulas that may not include factors the shareholders preferred, then they could vote with their money while they still had some left. Government’s contribution is ensuring that the crime of stealing is prevented. Stealing was likely one of the first problems that people had to solve in groups. A successful individual response to theft was historically dependent upon how many friends and relatives one had. When communities decided to band together for strength, laws and police and judges and prisons were invented. These don’t work perfectly, of course, but think of the criminal incidence rate without them.
People have been complaining about the elite getting richer and the poor getting poorer for literally ages. Well, most people. The top 5% complain about a rampant entitlement attitude robbing the populace of self-reliance and motivation. Both camps are right, of course. Rich people do hang out with each other, trade favors on deals, support each others’ businesses and personal objectives, etc. If rich people hung out with the homeless more often, maybe we’d see a change there, eh? And there does seem to be an entitlement culture we are mired in, spending way too much time rationalizing why we can’t win, and why someone else ought to make up for that.
Each side of this argument on executive pay would do well to step back, look in the mirror first, and ask the underlying question, i.e., what is the problem we’re trying to solve and what evidence do we have that regulatory approaches to solving the problem will result in the desired solution? With every new law comes unintended consequences.
Perhaps the solution is for the investment community to determine what it wants in terms of executive compensation and invest in those where results and pay correlate.