Corporations and their CEOs

[Geronimo]

Originally posted by One_more_turn
There are companies with people making 100K a year doing nothing other than surfing the web, engaging in office politics, and day-trading stocks.

There are companies with so many people in middle management that absolutely nothing gets done and all the best talents leave. IBM before Gerstner was a classic example.

Layoffs can scare unproductive people becoming more productive. It's not pretty, but it works in many instances.

The globalization has greatly expanded the supply of cheap labor ever since the 1980s, while the labor unions have stuck in the 19th century's nation state mindset. Unless you are in the top 20% of your profession, you are not gonna get much leverage against your employer these days.

Be lean be mean. so why can't this be applied to the CEOs (and the board of directors and other top tier staff) as well? seems to be a lot of rancid fat to cut away at those levels of many, maybe even most, large corporations. Yet the people at those levels appear to be immune to any of the sorts of trimming or cost saving remedys you described for other parts of a corporation.

[Patroklos]

Think of it this way, when your family's finances run into hard times do you fire you wife or the guy who mows your lawn? And when you get a raise do you ever decide to pay the guy who mows your lawn more just because you can? No, you give it all to your wife.

[Aeson]

Originally posted by Patroklos
Think of it this way, when your family's finances run into hard times do you fire you wife or the guy who mows your lawn? And when you get a raise do you ever decide to pay the guy who mows your lawn more just because you can? No, you give it all to your wife.

And when you want to get a new SO, the current one gets a big chunk of cash in the settlement.

[Kuciwalker]

Originally posted by Patroklos
Think of it this way, when your family's finances run into hard times do you fire you wife or the guy who mows your lawn? And when you get a raise do you ever decide to pay the guy who mows your lawn more just because you can? No, you give it all to your wife.

\

You make a convincing case that the boards are practically married to their CEO's.

[Zkribbler]

Originally posted by One_more_turn
There are companies with people making 100K a year doing nothing other than surfing the web, engaging in office politics, and day-trading stocks.

There are companies with so many people in middle management that absolutely nothing gets done and all the best talents leave. IBM before Gerstner was a classic example.

Layoffs can scare unproductive people becoming more productive. It's not pretty, but it works in many instances.

The globalization has greatly expanded the supply of cheap labor ever since the 1980s, while the labor unions have stuck in the 19th century's nation state mindset. Unless you are in the top 20% of your profession, you are not gonna get much leverage against your employer these days.

QFT

[One_more_turn]

Originally posted by Geronimo


Be lean be mean. so why can't this be applied to the CEOs (and the board of directors and other top tier staff) as well? seems to be a lot of rancid fat to cut away at those levels of many, maybe even most, large corporations. Yet the people at those levels appear to be immune to any of the sorts of trimming or cost saving remedys you described for other parts of a corporation.

That's because they have power. Low ranking employees do not have power over the management, only shareholders do. But shareholders are a fragmented lot. Usually when a company's stock is going up, they don't ask too many questions. Only when the stock begins to decline do shareholders begin to put the management under greater scrutiny. Even then, lousy management can hang on for years because mutual funds control most of the shares and cozy up to the management most of the time.

[One_more_turn]

After HP ousted Carly in early 2005, the stock has more than doubled since then. From what I heard, employees' morale also improved a lot despite an additional 15000 layoff.

[DanS]

Re: Corporations and their CEOs

Originally posted by Geronimo
Why do corporations always seem to pay their CEOs lavishly no matter how badly the company performs even when the CEOs make incompetant decisions?

Several CEOs were directly to blame for various bonehead blunders seen in Cronos_qc's thread regarding CNNs list of 101 dumbest moments in business.

Nonetheless Corporations usually lavish huge severance bonuses equivalent to the years salaries of thousands of employees to these boneheads when they leave.

We see that stockholders are generally thrilled if mere hundreds of employees are laid off even though it will cost the company hard won gains in experience and yet the same logic doesn't seem to allow them to play the same sort of hardball with their CEOs even though it is clear that CEO compensation exceeds that of thousands of other employees!

I've always assumed that the bottom line is the only real goal of any corporation so how in the hell does this double standard serve the bottom line?

CEOs sometimes get lavish bonuses in order to act nice when they're canned.

Regarding the ratio of pay for CEOs to pay for line employees, much of the problem stems from the fact that good executives are scarce. The market for executives is based on that scarcity, and has become something of a circular pay increase machine. Eventually, this will attract more talent to the executive ranks, and there will be a glut of good executives.

The best way that I can think of to stem these increases is by making it clearer who is a good executive and who is a bad executive. This will at least help to manage the flow of potential executives to the profession. In the past, for public corporations, the stock price has been an indication of the quality of the executive team. As it stands in our world today, there are too many ways to manipulate stock prices in the short term, such that this indicator is a bad one.

[pchang]

Shortage good executives?

That is not true. There are plenty of good executive candidates out there. The problem is that it is a closed fraternity. Any "shortages" are artificial.

[DanS]

If that were true, I would expect companies do well that are cheaters from the fraternity.

Can you identify those companies or industries?

[pchang]

Originally posted by DanS
If that were true, I would expect companies do well that are cheaters from the fraternity.

Can you identify those companies or industries?

Not exactly. Cheaters from the fraternity either do very well (if they pick a good exec from the non-exec ranks), or fail badly (if they pick a bad exec from the non-exec ranks).

Start up tech companies and small businesses are where you typically find cheaters from the fraternity.

[Lord Avalon]

NON SEQUITUR

[Drogue]

Re: Corporations and their CEOs

Originally posted by Geronimo
Why do corporations always seem to pay their CEOs lavishly no matter how badly the company performs even when the CEOs make incompetant decisions?

Several CEOs were directly to blame for various bonehead blunders seen in Cronos_qc's thread regarding CNNs list of 101 dumbest moments in business.

Nonetheless Corporations usually lavish huge severance bonuses equivalent to the years salaries of thousands of employees to these boneheads when they leave.

We see that stockholders are generally thrilled if mere hundreds of employees are laid off even though it will cost the company hard won gains in experience and yet the same logic doesn't seem to allow them to play the same sort of hardball with their CEOs even though it is clear that CEO compensation exceeds that of thousands of other employees!

I've always assumed that the bottom line is the only real goal of any corporation so how in the hell does this double standard serve the bottom line?

If you want a serious answer, the problem is risk aversion, and what we term the principle-agent problem:

Shareholders and CEOs have have a principle-agent problem, that is the shareholders own the firms, and wish to maximise their gains, however the CEOs make the actual decisions about the firms and may have other incentives (having time off, a large company to manage, etc.). This means the owners have to incentivize them towards the goal of maximising share price/profits. The way they do this is performance related pay, so the better a company does, the better the manager is paid. Seems ok so far.

The issue comes in that managers are risk averse, and thus to make their pay contingent on profits, you would have to pay them *vastly* more than if they had a set salary. Say if a normal CEO is paid $1m, if you were to make it solely based on profits, you'd have to pay them an average of maybe $3m or $4m for it to be the equivilent to them. People like having a high minimum amount that they can bank on getting - if you're mortgage is $200,000 a year, you'd rather have $1m for sure than somewhere between 0 and $10m, perhaps. This is compounded because profits are not a direct result, solely, of CEO performance. A great CEO may make a loss due to other factors, and vice versa. This makes performance related pay *very* expensive for a firm, on average. And thus firms choose to pay a large flat fee and a small performance bonus, meaning even badly performing CEOs get paid a lot.

Now add the fact that strategy is a very risky profession. What strategy will work is often unknown to anyone. This means ideas are either safe, or very different ideas that can either work brilliantly (Honda's small motorbikes, iPods, the Model T, etc.) or fall flat on their face (New Coke, the Edsel, etc.). If you want your CEO to play it safe, you have no problem, but also few profits. If you want your CEO to innovate, you need to make sure that even if it goes belly-up, which it may just because the product didn't work (most experts thought New Coke was a well tested and good idea), that their pay isn't too low. That's why CEOs have huge 'golden parachutes', as they have to be sacked if they fail, but need to be given enough incentives to make them take the risks.

Also, if you want to make pay really low when it goes wrong, you need to make it huge when it goes right, to provide the right level of incentives to innovate. Say playing it safe nets you between $750k and $1.5m. If you want someone to innovate, and thus if it goes wrong accept 0, you may need to pay them many many millions in order to induce risk-taking. And shareholders are like voters - partly uninformed and prone to take soundbites too far. Thus if you pay a CEO hundreds of millions when it goes right, unions are up in arms and shareholders think they're paying too much. Thus paying low high amounts is unfeasible, and you have to provide a high minimum in order to induce risk-taking.

A couple of key facts in this is that CEO pay used to increase by 27c for every extra dollar of profit, in the 1930s, as many firms were CEO-owned. Today, that's around 6c, due to the principle-agent problem above. Secondly, CEO pay has actually not altered that much from it's 1930 multiple of base salary. It used to be a CEO got paid, on average, 30 times the bottom-level worker did. Today it's around 50 (IIRC), although it hit 80 in the late 1980s. So far from equalling thousands of normal workers wages.


If you want to see how it should be done, there's a brilliant article by Jensen and Murphy "CEO Incentives - it's not how much you pay, but how" that argues for more performance-related pay and an acceptance of the extreme level it must be when companies do really well (ie. if you give a CEO 20% of profit, say, and the company makes $1bn, you pay him extreme amounts).

[Geronimo]

Re: Re: Corporations and their CEOs

Originally posted by Drogue

If you want a serious answer, the problem is risk aversion, and what we term the principle-agent problem:

Shareholders and CEOs have have a principle-agent problem, that is the shareholders own the firms, and wish to maximise their gains, however the CEOs make the actual decisions about the firms and may have other incentives (having time off, a large company to manage, etc.). This means the owners have to incentivize them towards the goal of maximising share price/profits. The way they do this is performance related pay, so the better a company does, the better the manager is paid. Seems ok so far.

The issue comes in that managers are risk averse, and thus to make their pay contingent on profits, you would have to pay them *vastly* more than if they had a set salary. Say if a normal CEO is paid $1m, if you were to make it solely based on profits, you'd have to pay them an average of maybe $3m or $4m for it to be the equivilent to them. People like having a high minimum amount that they can bank on getting - if you're mortgage is $200,000 a year, you'd rather have $1m for sure than somewhere between 0 and $10m, perhaps. This is compounded because profits are not a direct result, solely, of CEO performance. A great CEO may make a loss due to other factors, and vice versa. This makes performance related pay *very* expensive for a firm, on average. And thus firms choose to pay a large flat fee and a small performance bonus, meaning even badly performing CEOs get paid a lot.

Now add the fact that strategy is a very risky profession. What strategy will work is often unknown to anyone. This means ideas are either safe, or very different ideas that can either work brilliantly (Honda's small motorbikes, iPods, the Model T, etc.) or fall flat on their face (New Coke, the Edsel, etc.). If you want your CEO to play it safe, you have no problem, but also few profits. If you want your CEO to innovate, you need to make sure that even if it goes belly-up, which it may just because the product didn't work (most experts thought New Coke was a well tested and good idea), that their pay isn't too low. That's why CEOs have huge 'golden parachutes', as they have to be sacked if they fail, but need to be given enough incentives to make them take the risks.

Also, if you want to make pay really low when it goes wrong, you need to make it huge when it goes right, to provide the right level of incentives to innovate. Say playing it safe nets you between $750k and $1.5m. If you want someone to innovate, and thus if it goes wrong accept 0, you may need to pay them many many millions in order to induce risk-taking. And shareholders are like voters - partly uninformed and prone to take soundbites too far. Thus if you pay a CEO hundreds of millions when it goes right, unions are up in arms and shareholders think they're paying too much. Thus paying low high amounts is unfeasible, and you have to provide a high minimum in order to induce risk-taking.

A couple of key facts in this is that CEO pay used to increase by 27c for every extra dollar of profit, in the 1930s, as many firms were CEO-owned. Today, that's around 6c, due to the principle-agent problem above. Secondly, CEO pay has actually not altered that much from it's 1930 multiple of base salary. It used to be a CEO got paid, on average, 30 times the bottom-level worker did. Today it's around 50 (IIRC), although it hit 80 in the late 1980s. So far from equalling thousands of normal workers wages.

thank you for taking so much time to explain this!

Originally posted by Drogue
If you want to see how it should be done, there's a brilliant article by Jensen and Murphy "CEO Incentives - it's not how much you pay, but how" that argues for more performance-related pay and an acceptance of the extreme level it must be when companies do really well (ie. if you give a CEO 20% of profit, say, and the company makes $1bn, you pay him extreme amounts).

speaking of giving a CEO 200 million dollars, there just happens to be such a guy in the cnn bonehead list.

It would appear that the 30 times base salary average does not apply to the largest corporations if that and nearly all other examples of large corporation ceo compensation are like those I've seen previously.

Perhaps smaller corporations average something like 10 times lowest base pay while the big ones get thousands (literally) times base pay.

Too bad the big corporations seem just as likely to self destruct through bonehead ceo decisions as the little ones I guess you can't really buy that sort of talent.

[Drogue]

Re: Re: Re: Corporations and their CEOs

Originally posted by Geronimo
thank you for taking so much time to explain this!

No worries, it's good revision - very similar to a question I did an essay on a couple of years ago for my management course.

Originally posted by Geronimo
speaking of giving a CEO 200 million dollars, there just happens to be such a guy in the cnn bonehead list.

Well, he took $120m over 5 years, so an average of $24m a year. $210 was severence pay, designed to set someone up for life, so usually somewhere in the region of 5x average yearly pay. He did quite well though, almost 9x average pay is very high.

Originally posted by Geronimo
It would appear that the 30 times base salary average does not apply to the largest corporations if that and nearly all other examples of large corporation ceo compensation are like those I've seen previously.

Very true. The larger the corporation, the higher the person at the top gets. Look at it this way - if you're a middle manager responsible for a unit that employs 200 people, you tend to get paid only slightly less than a CEO who runs a company than employs 200 people. So if that original company employer 50 such units, employing 10,000 people in total, you get paid quite a bit more than the middle manager probably 2 or 3 levels below you.

Originally posted by Geronimo
Perhaps smaller corporations average something like 10 times lowest base pay while the big ones get thousands (literally) times base pay.

Exactlys. Although even base-level employees at large companies usually get $30,000+, so that would mean a CEO getting $30m+ to get 1000 times. There aren't that many CEOs paid more than that, per year.

Originally posted by Geronimo
Too bad the big corporations seem just as likely to self destruct through bonehead ceo decisions as the little ones I guess you can't really buy that sort of talent.

It's like many things, it's easier on a smaller scale. You can test things better for a start, as the size of the test compared to the size of the market is much closer. Growing an already dominant company is harder than growing a smaller one. And lastly, as Warren Buffet shows, larger companies tend to grow a good couple of percentage points faster than smaller ones. So on average, CEOs of larger companies do better than those of smaller ones.