Let’s Redesign Executive Pay

In Executive Compensation

lorschWhenever I find fault with the world of business, anyone who knows me could easily accuse the pot of calling the kettle black. I made my career, and continue to operate, within the corporate world. Yet, having retired more than a decade ago, my view of business has sharpened and cooled. I look at the conventions of business with an outsider’s skepticism now — even though, on balance, I’m still about as inside as someone can get.

I’ve been looking back a lot, partly because I tend to look forward toward a future that requires us to make radical changes now. One of the greatest crises we face is the growing gap between the rich and the rest. One element of what has driven this divide is the way in which we compensate those who govern our corporate world. I recently read The Future of Boards by Jay Lorsch, a professor at the Harvard Business School. His chapter on executive compensation seemed spot-on to me. In short: for many years, we have been rewarding our top executives in ways that have created a culture of avarice for short-term gain at the expense of long-term growth.

Here’s how he lays it out. Executives are simply paid too much. Current compensation policies often reward dysfunctional behavior rather than the sort of long-term strategic thinking which takes into consideration all stakeholders as well as nothing less than the survival of our social order. CEOs get paid more no matter how well they serve as leaders. Part of the problem is the assumption that a CEO is the only change agent who matters when a company radically improves what it’s doing. Companies that undergo a turnaround are the outcome of everyone’s performance, not simply the people at the top.

Meanwhile, CEOs are additionally insulated from the vagaries of a company’s actual health with pay schemes completely unlinked to a company’s fate. “Make whole” payments and “golden parachutes” protect executives by paying him or her anything they stand to lose by leaving another company early and guaranteeing that they will be rewarded even if the drive a company into a hostile takeover.

Legislation to change all this would seem sensible, but the wealthy easily find ways over, around and under the tax code. “Congress can change the tax code (as it did in 1993) so that salaries above $1 million would be taxed at an excess rate — but the dubious effect was to put more emphasis on incentive compensation (by other means, such as stock options).” There’s always a workaround to legislation. If you raise taxes on salaries, then compensation gets delivered in the form of stock options.

Lorsch is best when he asserts what ought to be the case. He asserts that companies once took all stakeholders into account, though the founders of the labor movement might disagree.

For most of the twentieth century, the large, public corporation was regarded as both an economic entity and a social institution. Shareholders were but one of several constituencies that stood in relation to the corporation. Corporate decisions were evaluated not only by their specific economic results but also with an eye toward their moral and political consequences.

Whether or not this is true in more than special cases, it’s a wonderful expression of what ought to become the truth of American business in the future.

“We need to change the terms of the conversation,” Lorsch writes, “to make room for a larger and more public discussion about the purpose of the corporation and larger moral and political considerations.”

You have to admire his courage in taking a shot at his current employer and his colleagues, but it’s a friendly and reasonable one.

At places like the Harvard Business School, the prevailing paradigm regards managers as relentless, self-interested free agents ready to make tracks out of their companies and to sacrifice the long-term for immediate gain. That view has largely displaced earlier views of managers as professionals with obligations to various “stakeholders” and to the broader society. The dominant ethos today also legitimizes the notion that human beings are relentless market maximizers who need literally to be bribed to focus solely on shareholder value — undermining other commitments managers might have to employees, customers, the community, or larger national and global concerns such as the environment or human rights.

His answer to all this?

1. Link incentives to areas executives actually influence.
2. Reward executives for organizing and fostering group behavior.
3. Tie lump-sum incentives to performance and a company’s fate.

These are great ideas. Yet America needs a sea change in leadership. Traditionally, those who succeed beyond everyone else’s wildest dreams undergo this change: look at Bill Gates now. He’s thinking of all the world’s stakeholders, its entire population. We need working CEO’s with that same mindset, not just those who’ve retired and run foundations. We urgently need to transform the perspective in the executive suite and on Wall Street. We need a shift away from our long-standing emphasis on short-term profit toward a vision that recognizes the perilous path we tread now toward social and economic division, if not collapse.