Steven Clifford thinks CEO pay at large companies is outrageous.
Boards are throwing away money in an act of collective delusion, overpaying chief executive officers for reasons that don't make any sense.
Most people would agree with him. "Corporate directors are the only sentient group who think that CEO pay levels today are justified," he says. But where he stands out is that he is a member of that tribe – a retired CEO and active board member at three companies. Yet, as he started to look into the matter he decided current practice is crazy and took dead aim in a new book, The CEO Pay Machine.
Some time around the 1980s, that pay machine started. There are advisers to boards – Mr. Clifford calls them "the consulting mafia" – with metrics and analyses supporting the current system, with its large bonus payouts. Board members are supposed to be hard-headed and skeptical. But there is safety in numbers – if every other company is buying into The CEO Pay Machine, he says in an interview, why should you dissent? And there is no upside to questioning the system. That will just anger the CEO and compensation committee.
Since the system took hold, Mr. Clifford notes, CEO pay has skyrocketed and economic growth rates have gone down. He doesn't think that's accidental, since the system overvalues the CEO; undervalues everyone else, reducing morale and productivity; and focuses the CEO on short-term actions to increase his stock options rather than long-term growth for the company. As one example, share buybacks are the rage these days. A company interested in growing for the future will invest money in research and innovation. A CEO interested in his remuneration – aware that the average CEO lasts less than five years at Fortune 500 companies – knows that when he buys back shares that can immediately increase earnings per share and thus goose the stock and his bonus.
He lists these delusions boards succumb to:
The importance delusion: The CEO is thought to be primarily responsible for the performance of the company, so if the company does well the CEO should get most of the credit and rewards. But the CEO is not the corporation. Mr. Clifford figures a CEO may be responsible for 10 per cent of the performance, the high end of research estimates, and thus a different CEO might manage a few percentage points more or less growth. "Most of a CEO's success is blind luck, being in the right place at the right time, or fit, having the skills needed now," he says.
The market delusion: There's supposedly a competitive market for CEOs, driven by supply and demand – high compensation reflects the low supply of good CEOs and the large number of companies bidding for them. In fact, bidding is rare and most CEOs come up the ranks in their own company, so a more fitting compensation would focus on internal equity and comparisons to other levels in the firm hierarchy. A CEO is not like LeBron James, able to shift to another basketball team and carry it to the championship. Usually the training and skills fit only a certain company or industry.
The motivation delusion: Bonuses are supposedly the best way to motivate CEOs to do their jobs. But CEOs should want to do a good job because that's the way they are wired. Studies show financial incentives only work for simple tasks. For CEOs, incentives are unnecessary if not counterproductive.
The performance delusion: Corporate boards can supposedly measure and reward CEO performance effectively. But Mr. Clifford insists they actually can't – business is too complex and random. However, knowing the goals, the CEO can skew performance to hit the numbers, not always in the company's real interest.
The alignment delusion: Stock options and measurable bonus goals align the interests of the CEOs and shareholders. But CEOs only have an upside – they cash in if stock goes up but don't see their fortunes plunge down as can happen for shareholders. "They aren't aligned at all," he says.
Mr. Clifford recommends keeping CEO compensation to salary and restricted stock – stock that might only become available in chunks over a five-year period and that they can only cash in on retirement. But he figures boards won't do that so governments must act: For every dollar a company pays a CEO over $6-million, it should pay $1 in tax. It can still pay the CEO $40-million but then owes the government $34-million.
It's a radical proposal, but he insists "there is absolutely no justification for today's CEO pay in America and it hurts the economy and the companies."
Harvey Schachter is a Kingston, Ont.-based writer specializing in management issues. He writes Monday Morning Manager and management book reviews for the print edition of Report on Business and an online column, Power Points. E-mail Harvey Schachter