We hear an enduring myth: the "free market" decides who gets what in an efficient dance of allocation of resources through competition. Garbage. Especially when it comes to CEO pay--though apparently there are some who want to continue the myth of competition.
Over the weekend, I caught this in the NYTimes business section--an excerpt of "The Price of Everything" by a New York Times editorial writer, Eduardo Porter. Here is the relevant nonsense:
Top C.E.O.’s are not pop stars. But the pay for the most sought-after executives has risen for similar reasons. As corporations have increased in size, management decisions at the top have become that much more important, measured in terms of profits or losses. Top American companies have much higher sales and profits than they did 20 years ago. Banks and funds have more assets.
With so much more at stake, it has become that much more important for companies to put at the helm the "best" executive or banker or fund manager they can find. This has set off furious competition for top managerial talent, pushing the prices of top-rated managers way above the pay of those in the tier just below them. Two economists at New York University, Xavier Gabaix and Augustin Landier, published a study in 2006 estimating that the sixfold rise in the pay of chief executives in the United States over the last quarter century or so was attributable entirely to the sixfold rise in the market size of large American companies.
This is utter nonsense. The rise of CEO pay has very little to do with competition in the free market. And it has very little to do with the quality of people sought who have to make such...excuse me while I gag...momentous decisions and, then, therefore, demand such huge salaries.
It has everything to do with two things: cronyism and corruption, which are quite inter-related.
The CEO stocks the board of directors with his cronies and buddies. He pays them say $20,000 to attend each board meeting, along with first-class air travel and other perks. His buddies serve on the compensation committee. When the subject of pay and stock options arises, the buddies simply rubber stamp whatever the CEO wants or whatever the CEO candidate demands.
It is not actually competition or a "free market".
It's actually a monopoly--a monopoly controlled by a relatively small number of people.
Look at what Nell Minow says. Minow is one of the country's leading authorities on corporate governance:
I've given up on any other reform other than the ability to replace directors who do a bad job. Without that, as long as you still have this very cozy interlocked system of having CEOs control who is on their boards, you're going to have no incentive for directors to say no to bad pay. I mean, when Warren Buffett says that he has knowingly voted for excessive compensation because collegiality trumps independence, you know that there's something really wrong with the system. [emphasis added]
And this is nothing new at all. As part of the research for my book "The Audacity of Greed", I interviewed Graef "Bud" Crystal. Now semi-retired and living north of San Francisco, Crystal was once one of the country’s premier compensation consultants—the outside fixers that CEOs and their boards bring in to give their robbery of shareholders a veneer of respectability.
Here is what he told me in 2009:
According to Crystal, the original notion of CEO compensation was simple: you pitched your pay level to that of other CEOs. But that notion didn’t last long. "In 1970, one CEO hired me and said, ‘we don’t have a bonus plan and do we need one?’" recalls Crystal. "I did the study and I went back to the CEO and said ‘yes you do need a bonus plan. But we have a problem area. You are making $150,000-a year and the problem is that the $150,000 is equal to the salary and the bonus to what your competitors are paying so we have to cut your pay to $100,000-a-year and then we can put in a bonus.’" Crystal laughs. "It was like a scene from The Exorcist where ice formed on the windows...he started arguing about the findings and he finally said ‘let me say this to you this way: who do you think is paying your bills anyway?’ I replied, ‘If I recall correctly the checks were drawn on the corporate account, not your personal account so the shareholders are paying me, not you.’ The meeting ended quite quickly."
If we have learned anything from the last couple of years, and the last 30 years actually, it is that most CEOs are not particularly smart. They are not particularly gifted. They are not particularly endowed with special skills to manage companies.
What they have learned--and I suppose this is a skill--is how to manipulate the system, particularly in the financial sector. They have learned that when Wall Street analysts say "cut your labor costs", they go ahead and slash thousands of jobs--not because it necessarily helps the company's overall performance but because the stock price will improve because they have responded to Wall Street.
And, then, when the compensation committee looks at the gargantuan pay packages being demanded, the CEO can lay on the table a Wall Street analyst's report praising the CEO for "making the tough decisions"--which, then, boosted the share price.
It's all a sham. It has nothing to do with competition for the best talent.