How is a CEO being paid $10M per year and running the company into the ground different from an employee being paid $6/hour and alienating 10 customers?
In both cases the shareholders were harmed. In both cases, the company made a bad hiring decision.
If a CEO has the market power to demand a golden parachute and happens to be paid after she's fired, that's a byproduct of her initial market power, not corruption.
Unless you idealize a world in which all employees have equal market power then some employees are going to be able to extract better perks, severance, etc.
To expand on this, hiring the CEO and giving them a golden parachute might still be a good thing.
Suppose Nokia's chances of survival were 10% without Stephen Elop and 20% with him. That means he is worth 0.1 x value of Nokia if Nokia survives.
If you pay Elop based directly on the performance of Nokia (i.e., he only gets paid if Nokia does well), he'll stay at Microsoft. Why leave MS for an 80% chance of getting paid nothing? Obviously Elop demands some cash up front, a golden parachute, or something of that nature, and a rational board of directors will give it to him.
In 80% of situations like this, the CEO gets paid well for running the company into the ground. But that's a better situation than the alternative, i.e. 90% of similarly situated companies crashing and burning.
> Suppose Nokia's chances of survival were 10% without Stephen Elop and 20% with him. That means he is worth 0.1 x value of Nokia if Nokia survives.
With respect, this is complete nonsense. It would only be true if there were no replacement for Elop who could not produce similar returns for a lower cost.
With respect, this is complete nonsense. It would only be true if there were no replacement for Elop who could not produce similar returns for a lower cost.
I realize Elop's pay is set by supply and demand, and if Nokia could find a cheaper person with the same qualities, they would and should hire him.
I'm just pointing out that it is in Nokia's best interest to pay significant amounts of cash comp to a good executive even if that executive "runs the company into the ground".
In other words, you're agreeing with me; Elop is benefiting from a windfall of lack of information. This lack of information forces companies to make inefficient choices of leaders and waste lots of money on leadership.
So Nokia has a lack of information but you don't ? What decision should have been made? And whose responsibility is it to make that decision?
Sure there are problems with corporate governance but ultimately we're talking about the risk of misallocating capital belonging to investors, whose job it is to oversee the allocation.
Not to nitpick, but since we're on the topic of corporate governance... Hopefully this will make it a bit more clear on why the governance issues are so murky: At least in Canada, and I'm fairly sure the United States as well it's actually not investors' job to oversee the allocation. The board of directors manages the company. Investors merely get to vote for who gets to be on the board of directors.
Sooo, it's the job of the board of directors to select who the CEO (an officer in Corporate Law-speak) is.
That's a good question (not sarcasm, it might come off that way). I actually do have a small investment yet I never planned on exercising any control and only control a trivial number of shares. There's a fair bit of academic debate on these theories of control and how shareholders relate to companies.
Personally I think there's a lot of freeloading off the small group of big players that do exercise control. I have a certain amount of faith that they won't vote in a way that's seriously adverse to my interests as a little fish.
Then shouldn't part of their job also be researching and coming up with a larger pool of candidates for a position of that importance? Not saying Nokia didn't necessarily do that, but I suspect in a lot of cases, there tends to be a short list that people choose from initially. Expanding out from that short list and spending more time gathering more info might take more time, but would ultimately be in the shareholders' interest.
How exactly do you establish the %likelihood that a particular CEO will save your company to the degree of precision that you could actually meaningfully incorporate it into a business model?
Seeing as Elop's $6M pay is orders of magnitude smaller than Nokia's $25B market cap, you don't need to be very accurate. Say my 10% was wrong, even wildly so. As long as Elop gives Nokia more than 0.024% improved odds over his next best alternative, he is still worth $6M.
(Yes, I'm ignoring the time value of money, risk, etc, to simplify.)
You're just pretending you can calculate inherently incalculable probabilities. How do you determine the probability a company will fail under a variety of potential CEOs so that you could even get a mathematically-justifiable rank order? You can't run trials, you can't really extrapolate from past performance, you're subject to all kinds of confounding variables, you can't actually treat 'failure' as '$0 market cap', etc, etc, etc.
The best you could ever hope to do is "CEO candidates with this kind of background tend to have this kind of record when taking over this kind of company", which I'm sure is quite an illuminating sample.
You are correct - the board's estimate is merely the best approximation they can come up with based on incomplete information and a subjective set of priors (yes, "subjective prior" is redundant). So what?
I really don't get the point you are making. Are you telling me that a struggling company shouldn't try to get what they believe is the best possible CEO, provided his pay package is vastly smaller than the variance in possible outcomes for the company?
My point is that it's ridiculous to try to justify golden parachutes for bad CEOs using fake math, and the fact that the market bears these kinds of contracts isn't evidence on its own that they are good.
The fact that most business decisions are made by gut feeling implies that post-hoc pseudo-mathematical rationalization shouldn't be called out as bullshit?
The problem with this is that the CEO gets the same payout if he does a good job and things don't work out or if he fantastically mismanages the company.
I think a lot of the problem with CEO failure come from risk adverse boards being unwilling to try someone new as opposed to the accepted stable of CEO candidates. Small pool equals big compensation even for failure.
There's more to it than that. Board members of large corporations tend to be CEOs of other large corporations. Not only do they see each other at charity events and such, they have a vested interest in not being too hard-nosed about compensation.
The question is why the shareholders put up with it, and I don't have an answer to that question.
Because it sounds like the safe, experienced play. It does work for a lot of companies (says something about the companies more than the CEO), and I would suppose it is easier to make deals to keep the company going when you have all the "club" contacts. When it fails, it fails in amazing spectacular ways.
I guess many should be sorta happy since it allows untried upstarts to disrupt the market and truly well run companies to expand. I feel sorry for all the people caught up in the fail.
The board of directors decides if a CEO gets hired, and for how much money. Often this board consists of presidents and CEOs of other companies. Is it very far-fetched to suspect that there may be non-market forces at work when this compensation is determined? Quid pro quo? I don't have a chart handy, but I think the pay of a CEO in relation to the average employee of a company has been rising dramatically over the past decades. Are CEOs orders of magnitude more important today than they were 30 years ago? I don't think so.
I think you have to define market forces. The market force is simple:
"You want me. If you don't pay me enough, I will go somewhere else that will!"
In other words, as Adam Smith correctly noted, it is a question of who has power in coercive negotiations. Consequently CEO's get paid so much because they are so much more powerful than workers in that negotiation process, not because they are worth that much more.
But a lot of market forces boil down to this sort of power difference analysis. We think of a free market where the consumer has the power and the company does not, but I wonder how often that is really true.
But a lot of this boils down to the reason I think folks should try to be able to be self-employed-- it means you negotiate with companies from a position of greater power. I suspect if 60% of the population was self-employed doing everything from janitorial services through database engineering, we'd have no need of minimum wage laws because anyone anywhere could turn down a job offer.
By market forces I mean supply and demand. And you have correctly noted that these have a secondary role in CEO pay negotiations. Instead, it's a question of power and indifference. Where does this power come from? It stems from the fact that the board with which the future CEO is negotiating consists of inside and outside officers. This means that he is negotiating with future subordinates (inside officers) and executives who might want to become the CEO of a company where this future CEO has a seat on the board. Who would openly try to lower the salary of their future boss, the same person they will have to talk to about their own pay raises? So, the board does not really have an incentive to push for the true market rate of the CEO, unless they are major shareholders, but usually lots of incentives not to do so.
> We'd have no need of minimum wage laws because anyone anywhere could turn down a job offer.
And right now janitors can't turn down job offers? I don't understand. How does a self-employed janitor have more power? I think you greatly overestimate the advantages of being self-employed, and underestimate the downsides.
Right now, only 20% of the US workforce are self-employed, and a quarter of them are professionals (lawyers and doctors mostly). That means 16% of the population are running a business which is not expected to be a medical or legal business.
Most people esp. in the current economy, are not in a position to turn down a job offer. This means they want work more than the company wants to hire them. This is a major source of a power differential. If, on the other hand, the boundary between employment and self-employment is porous, this means that companies not only have to compete with eachother to hire said janitor, but they also have to compete with the fact that they could hire said janitor's ability to be self-employed.
The point is it is a clear shift.
Right now minimum wage laws are too low. We should at least set them high enough that people have no need of welfare when having a minimum wage job. As it is they are a nice way to tell us we are protecting the worker when in fact we are doing no such thing. When you combine it with welfare, you have solid incentives for low-paid workers not to become self-employed and thus the welfare and minimum wage scheme we have right now are actual tools in the class war by the wealthy against everyone else.
"If a CEO has the market power to demand a golden parachute and happens to be paid after she's fired, that's a byproduct of her initial market power, not corruption."
Adam Smith made the same point. Wages are a result of power differential in negotiations, not value to the organization. This is why being able to be self-employed is so important. If you do decide to take a job, you can negotiate from a much greater position of power than if you can't be self-employed.
Isn't it possible for the market itself to be screwed up? There is no such thing as The Market, there are many different markets with different rules and contexts. We can alter these rules and contexts, and they change on their own over time through technology and other things.
The question is whether the market we have right now is serving us well, or if we could alter it to serve us better.
Market prices just reflect supply and demand. If there are insufficient numbers of people qualified to act as CEO of a struggling fortune 500 company, and such people are paid very well, then there's a strong incentive for anyone remotely qualified to do whatever possible to appear qualified, so that he/she might receive that high level of compensation.
This isn't true. One example off the top of my head, good looking people get paid more. They aren't more qualified, yet they get paid more. Even at the executive level.
> How is a CEO being paid $10M per year and running the company into the ground different from an employee being paid $6/hour and alienating 10 customers?
Clearly the former is orders of magnitude worse (in every respect) than the latter, no?
> If a CEO has the market power to demand a golden parachute and happens to be paid after she's fired, that's a byproduct of her initial market power, not corruption.
The system need not be corrupt, just broken. In the sense that (I think) we're discussing the merits of modern american capitalism, your comment begs the question.
Orders of magnitude worse each time, but likely to happen far less often. Arguably hiring a bad low wage employee, if repeated a lot of times, is way worse.
Wage inequality is not necessarily a sign of corruption.
Think of how it must look to a third-worlder who has trouble scoring a dollar a day to see that lavishly paid slackard mistreating customers despite being paid so very much.
think of how it must be to be on the edge of starving in the US to realize that you can eat out at a restaurant and get a good meal for a dollar in many parts of the world.
In both cases the shareholders were harmed. In both cases, the company made a bad hiring decision.
If a CEO has the market power to demand a golden parachute and happens to be paid after she's fired, that's a byproduct of her initial market power, not corruption.
Unless you idealize a world in which all employees have equal market power then some employees are going to be able to extract better perks, severance, etc.