Executives and sales professionals of large corporations are paid too much and paid too soon so that they are incentivized for results they don’t produce and are encouraged to make decisions which show immediate profits but put their organizations at strategic risk. The relationships between these people and their corporations are parasitic rather than symbiotic and the tragic consequences obvious in AIG and General Motors. These people are overpaid for the same reasons that male dogs lick their genitals: they can do it, all their peers do it, they are comforted by it, and occasionally stimulated to do something useful.
In the real world it normally takes at least 3 years for the consequences of executive level actions and major financial transactions to become measurable with any degree of confidence; the larger the corporation, the longer the delay. If incentives and bonuses were rational or mutually beneficial, they would pay for strategic consequences as they became measurable.
A CEO’s job includes: hiring and managing top executives, establishing and implementing corporate policies including establishing the level of R&D expenses, investing in modernization, resolving intrinsic resource allocation conflicts between departments and divisions of the corporation, selecting products and markets, making the final decisions on mergers and acquisitions, and dealing with key stakeholders outside the organization such as the Board of Directors, banks, investors, and key customers. The process of finding, recruiting, hiring and bringing top executives up to speed takes at least 1 to 2 years and even their contributions aren’t reliably measurable for some years. Mergers or acquisitions and new product lines likewise take years to prove as wise or foolish. So it seems strange that top executives are incentivized in the current year for this year’s performance, as measured by profits or stock valuation. At best, CEOs and other executives, should be measured and receive such compensation several years down the road; whether or not they remain in the employ of the corporation.
The primary reason for these chronically unhealthy relationships is cultural rather than rational. The culture took decades to develop. It probably started from the incestuous relationships between CEO’s and their Boards of Directors. Boards picked CEOs then, after the CEO’s assumed power, they played dominant roles in choosing new board members. Naturally, they tended to select board members who were favorably biased towards them rather than ones who would critically evaluate their performance. Boards determined CEOs’ compensation packages and some boards chose packages which favored the CEO’s at the expense of the corporations in ways that were generally small, diffuse and difficult to measure. However, once a few companies began paying their executives too much and too soon, other Boards began to follow suit for “competitive reasons” and a compensation race ensued until excessive pay for immediate profits became the usual thing to do.
Overpaid CEOs usually overpay their subordinates to encourage personal loyalty, to minimize tough personnel decisions and to reinforce the “rightness” of the CEO’s own compensation. Although these costs hurt bottom lines, growing companies can afford them, everyone is doing it and it keeps people happy. Growth and economic prosperity mask the parasitic effects of executive genital licking.
Incentive compensation for executives and sales professionals thus degenerated from symbiotic to parasitic. A symbiotic relationship is an interdependence in which two or more parties provide vital services to one another to the mutual benefit of all concerned. A parasite, (tapeworm, pinworm, hookworm, tick, leech, head lice, flea, etc.) takes nourishment from its host but provides little or nothing in return and may even introduce a pathogen or two.
Grossly overpaid executives and commissioned sales people are parasites to their corporate hosts. Parasites, individually and collectively don’t usually kill their hosts but systematically weaken them, making them more vulnerable. Corporations, like animals or humans, tend to accumulate parasitic loads over their lifetimes. Nature reduces the average parasitic load on each species by building in term limits for its individuals. The species “corporation” initially had such term limits: corporate and bank charters were limited to 21 years, subject to deliberate renewal by governments. With the help of corporate lobbying, the term limits were removed and parasitic loads enabled to reach dangerous levels.
Excessive compensation for executives is only one kind of parasitic load. Other kinds include contractual agreements that commit the company to pay future benefits without fully funding those commitments from the work of those who receive them; i.e. defined benefit agreements instead of defined contribution agreements. They also include outmoded policies, procedures and corporate operating myths. For example, the accumulation of excessive salaries, bonuses, underfunded benefits and unprofitable dealer contracts have so weakened GM, Ford and Chrysler that they have become uncompetitive in the struggle to compete with younger auto manufacturers who don’t have comparable parasitic loads. Some of the parasitic agreements which brought these companies to their knees were entered into decades ago by executive who found it easier to make parasitic commitments than to negotiate “pay for measurable results” agreements. Such agreements dug holes in the futures of these corporations, while the executives who dug the holes were applauded, and received their personal salaries, stock options and bonuses based on current results. By the time the negative consequences became obvious, the perpetrators were long gone and safe from accountability. By 2007, GM, a dominant competitor in earlier decades, had accumulated benefit liabilities for retired workers of well over $1500 per vehicle. This put them at a distinct competitive disadvantage to newer companies without this parasitic load. They postponed the consequences of this weakness by marketing large gas-guzzlers with high profit margins and by lobbying the Federal Government to avoid clean air regulations to keep their companies limping along. In 2008 they were bankrupt.
Major employment agreements with guaranteed but unfunded or underfunded benefits are other CEO decisions whose overall benefits or liabilities to the Corporations are not obvious for several years, perhaps even for decades. Yet the CEOs and other executives who make these decisions receive, at best, compensation based on the immediate impacts of those agreements and on the results of their predecessors’ actions. Out of whack executive compensation has thus systematically encouraged short-term decisions and short-term thinking.
I suggest that society would benefit by reinstituting year term limits of 80 years or less on all corporate charters; by which time any corporation would have had to systematically dissolve itself, satisfy its contractual obligations, dispose of its assets and pay off its investors. This is a serious suggestion, the result of deep consideration of all the trade-offs that such a legal change would produce. The initial reactions to this suggestion will most likely be intensely negative, and fatal flaws will seem overwhelmingly obvious. I encourage you to think about the idea and its ramifications; the strategic and pro-active benefits are worth considering and may well be essential. I will write more about this proposal in a month or two after I document a broader basis for it.
It’s remarkable that the consequences of parasitic relationships are not worse than they are. Some CEOs, a very few to be sure, have tried to make wise long-term decisions in spite of the fact that short-term results are negative to their own compensation. For example, launching a new product line may be unprofitable for several years. It takes courage to maintain a high level of R&D and to introduce new products, particularly those which cannibalize existing product lines, when the alternative of reducing R&D expenses or delaying new products improves this year’s bottom line and jacks up personal compensation.
When it comes to excessive compensation, the parasites who receive it are cheered on by other parasites that live off their excrement. Rudolph Giuliani, formerly mayor of New York City, recently defended the excessive bonuses given members of Wall Street firms on the basis that the city’s budget benefitted from the freewheeling expenses of highly paid executives.
It should be clear, in hindsight, that the banking crisis was encouraged by out of whack compensation up and down the line in banks, brokerage houses, home mortgage companies, hedge-funds, etc. The people who committed their organizations to strategic risks, such as credit default swaps that brought tactical “profits,” collected their out of whack compensation before the shit hit the fan. The executives who enabled these disasters are, for the most part, still in place, protected by subservient boards and Golden Parachutes. The banking and business behemoths are now so weak they can only be salvaged by firm, curative actions from outside regulators. Unfortunately for our economic system, many of those regulators have also been emasculated by the parasites over the previous decades. ________________
Related posts:
Economic over-centralization driven by tactics and weak executives!
Management Bottlenecks: primary source of institutional failures
Bank bailout yields Collateral Damage, Double Standards, Poor Solutions
How Tribalism has undermined Wall Street reforms
Mr. President: Break up the financial behemoths now
I’m guessing you never made it very far up the corporate ladder?
KH:
Guess again!
Ed Lee