Executive Pay: Is “I’ll Have What He’s Having” Really the Best Approach?

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Anyone who’s ever watched When Harry Met Sally will remember the line “I’ll have what she’s having” as the perfect punchline to that memorably obscene deli scene. As a justification for CEO pay, though, the “I’ll have what she (or, more often, he) is having” approach is a lot less hilarious in its effects, contributing to the ratcheting up of CEO pay regardless of CEO performance.

A new study funded by the Investor Responsibility Research Center Institute shows that “peer group compensation benchmarking,” an approach that’s become the de facto standard for how executive pay is determined, perversely rewards mediocre CEOs for the performance (and the sky-high) pay of a few CEO superstars. “A formulaic reliance on peer grouping,” the study warns, “will lead to spiraling executive compensation.”

The idea behind “peer group” benchmarking is simple enough: When corporate boards attempt to determine what’s appropriate to pay a company’s CEO, they look to see what other companies pay their CEOs – and thus reduce the temptation of the CEO to jump ship to head up another company willing to pay more.

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But the IRRCi study, prepared by Charles M. Elson and Craig K. Ferrere of the John L. Weinberg Center for Corporate Governance at the University of Delaware, argues that this approach is based on some dubious logic, and one big false assumption. Consider what we might call the “Lake Wobegon Paradox.” As longtime listeners to Garrison Keillor’s Prairie Home Companion know, Lake Wobegon is the mythical Minnesota town where “where all the women are strong, all the men are good looking, and all the children are above average.”

In the real world outside of the imaginary Lake Wobegon, it’s obviously impossible for all the kids to be above average. In the real world, it’s also impossible for all CEOs to be average or above average. By adopting the stance that CEOs should be paid what their “peers” are paid, the “peer benchmarking” approach puts pressure on boards to compensate below-average CEOs as if they were at least average. What’s more, since the average pay can be inflated by the gargantuan compensation packages of a few superstars, CEOs can end up being rewarded for the performance of other CEOs rather than their own performance, which may have been something less-than-super .

The study also pokes holes in the notion that CEOs unhappy with their pay packages can simply say “see ya” and head to a company with a more generous board. This approach, the study argues, essentially conjures up “a model of a competitive market for executives” that wouldn’t otherwise exist. In reality, CEO talent isn’t so readily transferable from firm to firm. As CEO of Apple, Steve Jobs was a visionary. Would he have done as well heading up a chain of grocery stores? Would people really wait in line for days to pick up some new and improved iEggs and iMilk?

The folk at the IRRCi offer what is apparently now considered a radical strategy for setting executive pay: boards should judge individual CEOs on their own merits and their own accomplishments. “[C]orporate boards need to de-emphasize peer grouping, and increase the emphasis on their company and executive accomplishments,” explains Jon Lukomnik, IRRCi executive director, in a statement. “Companies are better served when directors use discretion – both up and down – in setting compensation structures and levels.”

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Will the IRRCi study have any effect on the way execs get paid? It’s hard to tell, but it seems unlikely that most boards will be willing to hear its arguments. Instead of cutting back on too-high executive pay, some companies are simply trying to make it look as though they pay their executives less. As the Wall Street Journal recently reported, some companies are starting to disclose executive pay in their proxy statements in a way that minimizes their total compensation.

In filings with regulators, companies are required to disclose things like stocks and stock options granted to execs. But in their proxy statements, where they have more discretion, hundreds of firms report “realizable” or “realized” pay instead – that is, what the exec actually took home that year and ignoring the value of unvested options, pensions and the like, which of course are a major part of most executives’ compensation packages. As the Journal notes, this can make a big difference: General Electric’s proxy states that CEO Jeffrey Immelt took home “only” $7.82 million in taxable income; the more complete figures given to regulators put his total compensation at $21.6 million.

Nice pay, if you can get it.

7 comments
jessiecruz111
jessiecruz111

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Talendria
Talendria

When did top-tier salaries get so ridiculously high?  Movie stars, athletes, CEOs... these people make stupid money for doing jobs that are no more demanding than the average American worker's job.  Why do they get paid so much?

Nonaffiliated
Nonaffiliated

Because the average American worker can't do their job.  Can you hit .250 in the big leagues?  Can you act well enough to star in a major motion picture?  If anyone could do it (like checkout at the 7-11) then the pay would be minimal.

Talendria
Talendria

I'm actually asking a deeper philosophical question about how worth is determined in our society. Why do we assign such importance to a batting average or to an actor's dimples? How does that advance the species or improve anyone's lot in life? You may argue that those skills are rare and therefore valuable, but in a world with seven billion people, there are probably thousands of individuals who could perform any given feat with equal aplomb. And is there an upper limit on the amount of money we will throw at these supermen? Why stop at 20 or 30 million? How about 100 million? I find it interesting that people complain about CEOs without mentioning these other disproportionately rewarded members of society. Whereas athletes and celebrities merely amuse us in two-hour increments, the CEOs actually have the power to make our lives better through employment, technology, and credit. If Karl Marx were alive today, he'd probably say that entertainment is the opiate of the masses.

Nonaffiliated
Nonaffiliated

How do we assign importance?  Everyone makes that decision as an individual.  When you watch a baseball game (and its advertisements) or buy a movie ticket, you are saying that this product provides the best value for your money.  The people who provide that product (entertainment) compete with each other to provide a better product for a lower price.  If they could sell tickets with John Doe instead of Denzell Washington, they would. 

You may say that this is a waste of resources.  That's your opinion and you're entitled to it.  However, the opinions of baseball and movie fans are just as valid as yours.  You aren't forced to buy baseball tickets and they aren't forced to go to the opera. 

So, the answer is "No".  There is no upper limit on what any person should be allowed to earn.  If the next Elvis Presley brings so much joy to so many people that they reward him with millions of album purchases, that should be their choice.  Not yours or mine.

qdiscqus
qdiscqus

This is the real travesty of our so called "job creators". When the guy who sets your salary is your buddy, and whose salary you will set one day, the system is no longer capitalism.

There was a study a few months back that looked at the ratio of the lowest paid to the highest paid in firms in the US and in Sweden. They found, as expected, that the Swedes do not rip as much out of their companies as the US CEOs do. And yet the study found that the Swedish companies gave greater shareholder value than the US companies do.