Wall Street Journal
CBS chief executive Leslie Moonves. PHOTO: BLOOMBERG NEWS
In 1978 the average chief executive at a large company was paid 26 times more than the average worker. By 2014, depending on your method of calculation, he was paid 300 to 700 times more. It has become standard for a CEO to make more than $10 million a year, and a few make more than $100 million. These aren’t founders or major shareholders but hired guns, managers playing with house money.
It is not like this everywhere. In the U.K., the fifth largest economy in the world, the pay ratio of CEO to average worker is 84 to 1. In Japan, the third largest, it’s 16 to 1.
So what happened in America that so much is now lavished on the executive class? And does it matter? To the second question Steven Clifford, a former chief executive at King Broadcasting and now the author of “The CEO Pay Machine,” responds with an emphatic “yes.” The outsize income, he thinks, feeds inequality and mistrust in our democracy. In response to the first question he argues that a system of compensation has emerged over the past four decades that rewards mediocre executives by stiffing shareholders, employees and society at large.
The CEO “pay machine” works like this: When a chief executive is hired, a company will also hire one of a handful of compensation consultants to establish a benchmark for his pay. The consultant will look at a bunch of companies in different industries and then propose that the CEO be paid at the 75th percentile. (No company wants to think it is paying its CEO at the 25th percentile.) The consultant is out to please the future CEO, since the real money will come if he is hired to design the company’s pension or health-care plans. Charlie Munger, Warren Buffett’s business partner, once said that he would “rather throw a viper down my shirtfront than hire a compensation consultant.”
But salary is just the beginning. Next come the short- and long-term incentive plans. Short-term plans contain bonuses for meeting annual targets or for simply accomplishing the tasks one expects of a senior manager. In 2014 Les Moonves, the CEO of CBS, received a cash bonus of $25 million. Roughly half of that was reportedly paid to recognize Mr. Moonves’s “leadership and direction in the creation of premium content.” In other words, doing his job.
PHOTO: WSJ
THE CEO PAY MACHINE
By Steven Clifford
Blue Rider, 277 pages, $23
Blue Rider, 277 pages, $23
The marvelous thing about bonuses at this level, Mr. Clifford notes, is that they aren’t binary. If you fail to meet your targets, you don’t lose your bonus; you just get less of it. If you have a $1 million bonus target, chances are that the board will shave maybe 10% off if you underperform. And $900,000 for failure isn’t bad. Of course, there are also long-term incentives: the stock options and the restricted stock that vests over time.
Mr. Clifford blames the emergence of the CEO pay machine on three people: Michael Jensen, Milton Rock and Bill Clinton. Mr. Jensen is the Harvard Business School professor who argued that the single best measure for managerial performance is a company’s stock price. He wrote that the CEO’s main job is to maximize shareholder value, and the way to ensure that the CEO does that is to give him shares so he acts more like a “value-maximizing entrepreneur” than a bureaucrat. It turns out, though, that stock awards and bonuses often don’t align the interests of managers and shareholders; they encourage short-term boosts to earnings rather than investing for long-term growth.
Milton Rock was the godfather of compensation consultants. His firm, the Hay Group, pioneered the practice of comparing executive pay between companies. This method created what Mr. Clifford says is a bogus market for managerial talent. Few executives can transfer their talents from one company to another, let alone from one industry to another, and yet they are paid as if they are basketball free agents.
In 1993, President Clinton and a Democratic Congress pushed through a bill intended to cap executive pay and link it to performance. Salary in excess of $1 million would no longer be tax deductible for the company, but there would be no limit on the deductibility of performance-linked pay. Not surprisingly, the performance-linked component exploded, with the approval of corporate boards often cozily linked to chief executives.
“Apart from aliens from the galaxy Zork-El, corporate directors are the only sentient group who think that CEO pay levels today are justified,” Mr. Clifford writes. Board members—and no doubt well-heeled CEOs—suffer from several delusions, in Mr. Clifford’s view. Among them, that the CEO is as important to the performance of a company as a quarterback is to a football team. Not true, he says. Many are no more significant than the water boy. Another delusion is that bonuses motivate. In fact, other measures of accomplishment and status matter more for executives already swimming in money. Then there is the question of whether you can really measure executive performance. In Mr. Clifford’s view, there are far too many variables in a vast organization to gauge the effect of one leader’s pixie dust.
Mr. Clifford targets specific CEOs whose middling performance and exorbitant pay merit ridicule. It would have been interesting to read him on CEOs like Bob Iger of Disney or Jamie Dimon of JPMorgan Chase who have done hard jobs well over many years. Not all executive talent is as easily replicable and overpaid as he believes.
Mr. Clifford’s answer to the CEO pay machine, though, is a compelling one: a simple combination of salary and restricted stock. “No pay for specific performance, no short-term bonus, no stock options.” If company boards had the guts to implement his idea, it would bring much needed clarity and integrity to an invidious system.
Mr. Delves Broughton is the author of, among other books, “The Art of the Sale: Learning From the Masters About the Business of Life.”
