Tuesday, April 19, 2016

Reining in CEO Pay: Market Discipline at the Top

This is a phenomena that i saw emerge during the past fifty year and all driven by short term thinking at the corporate level.  The universal idea out there is that brokers should dictate corporate strategy.  That inevitably means taking risks to juice near term performance and running when failure looms.  Supposedly short term results are an indicator of long term performance when it is nothing of the kind.

All Kodak had to do was to bet the farm on electronic photography.  All AT&T had to do was to accept price cutting and lead the pack to eliminate competition while rapidly adopting the new products.  Both strategies demanded diverting current profits and management bonuses.  It was never done except under duress.  These were not stupid people.  By doing nothing they allowed their corporations to be substantially looted while they accepted the juice.

The key point is that corporate governance is broken and has become corporate looting of the leading pillars of the global economy.  We need something better and this needs to be rethought completely.  Plausibly leading corporations do need to also employ a corporate version of the rule of twelve to staff their board of directors drawn from both shareholders at large and employees.  This is naturally self selecting and also plausibly impossible to manipulate...
Reining in CEO Pay: Market Discipline at the Top

Monday, 11 April 2016 00:00 Carly Fiorina speaking with attendees at the 2016 First in the Nation Town Hall in Nashua, New Hampshire. (Photo: Gage Skidmore)


Ever wonder how top executives like former Republican presidential candidate Carly Fiorina can walk away with $100 million after nearly wrecking a major corporation? The answer is that the market doesn't work the same way at the top as it does for the rest of us. While most of us expect our pay to bear some relationship to our performance, at the top it's mostly a story of play money among friends.

Corporate executives get patted on the back when they announce plant closings, layoffs and pay cuts. This is seen as good news for corporate profits and stock prices. But there is no one to applaud when the CEO gets their pay cut because they are not worth the money. That would be a decision of corporate boards, and these boards tend to have more loyalty to CEOs and top management than to the shareholders they ostensibly represent.

After all, top management often played a role in getting the directors their job. And being a director is a very good job. Typically it means getting paid several hundred thousand dollars a year for showing up at 6-10 meetings. Many corporate directors find the time to sit on three or four boards while still holding down full time positions of their own.

In that environment, why would a director ever want to make a fuss over a CEO getting $5 million, $10 million or $20 million more than they are worth? The rewards from successfully leading a difficult battle are minimal. And, corporate directors tend not to be the sort of people who do things for the greater good; they want money in their pocket. And the best way to keep getting a cushy stipend as a corporate director is to smile and go along with every CEO pay hike.

Excessive CEO pay has an impact on the economy that extends far beyond a few thousand CEOs at major corporations. It also means excessive pay for their underlings, after all, if the CEO gets $20 million, then the second and third in line are also likely to get pay packages well into the millions.

CEO pay also affects pay scales outside of the corporate sector. Presidents of universities, nonprofit hospitals and even charities often now earn more than $1 million a year. They argue, correctly, that they could make far money if they were operating a private corporation of the same size. In short, the bloated CEO pay is major factor shifting pay upward throughout the economy. For this reason it is important to bring some market discipline to CEO pay.

The cesspool of failure corporate governance will be on display next month at the annual shareholder meeting for Blackrock, the investment management company. Blackrock is by far the largest investment management company in the world with more than $4 trillion in assets under management. These assets include many of the mutual funds or exchange traded funds that middle-class people hold in their retirement accounts.

This matters when it comes to CEO pay, since most middle-class workers probably think that they should pay the CEOs of the companies whose stock they hold as little as possible. That way more money can be used either to build up the company or be paid to stockholders. But Blackrock's CEO Larry Fink doesn't see things that way. Blackrock has supported 99 percent of the CEO pay packages, voting against them just 1 percent of the time. By comparison, the average fund votes no 10 percent of the time, and the leading investment advisory service recommends no votes 15 percent of the time.

One reason that Mr. Fink may be so willing to turn over shareholder money to CEOs is a sense of solidarity. His pay last year was $24 million, which he just had increased to $26 million this year, in spite of weak growth for Blackrock in both profits and assets under management. In this context, it perhaps shouldn't be surprising that Fink might feel more solidarity with his fellow CEOs than the shareholders he is supposed to represent.

There will be a resolution at Blackrock's May 25th shareholder meeting which would instruct the company to re-evaluate its practices on voting shareholder proxies on CEO pay. (The originator is Steve Silberstein, a friend and supporter of the Center for Economic and Policy Research.) This resolution won't by itself reverse the explosion of CEO pay over the last four decades, but it will be a big step in the right direction. Shareholders shouldn't be forced to give Mr. Fink's friends money for nothing.

As progressives are starting to learn, market discipline can be a beautiful sight when it is applied to those at the top. This resolution will be a big step toward bringing market forces into the CEOs' suite.

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