It’s simply astonishing how often the myth of shareholder rule is parroted by the business press. Let’s see, average CEO pay was 49 times average worker pay in 1980. As of the most recent tabulation, 2008, it was 319 times average worker pay. And since that was the worst year of the crisis, and top level pay was therefore a tad subdued, one can expect the gap to have widened since then.
Tell me: do you really think the CEOs of 2008 are more than five times better, on average, than their 1980s counterparts? Do you even believe that pay for performance works at the CEO level? The evidence suggests the opposite. In IT, CEO pay is inversely correlated with performance. Pay being correlated with underperformance is particularly strong with particularly well paid CEOs. From a 2009 study:
Compensation, status, and press coverage of managers in the U.S. follow a highly skewed distribution: a small number of ‘superstars’ enjoy the bulk of the rewards. We evaluate the impact of CEOs achieving superstar status on the performance of their firms, using prestigious business awards to measure shocks to CEO status. We find that award-winning CEOs subsequently underperform, both relative to their prior performance and relative to a matched sample of non-winning CEOs. At the same time, they extract more compensation following the award, both in absolute amounts and relative to other top executives in their firms. They also spend more time on public and private activities outside their companies, such as assuming board seats or writing books. The incidence of earnings management increases after winning awards. The effects are strongest in firms with weak corporate governance. Our results suggest that the ex-post consequences of media-induced superstar status for shareholders are negative.
Similarly, Jim Collins’ classic Good to Great found that the CEOs of sustained outperformers were modestly paid (and perhaps more important, appeared temperamentally not terribly oriented towards getting big bucks). Various small scale analyses (see here for instance) confirm this finding.
But why should pay have anything to do with performance? After all, compliant boards keep resetting benchmarks to make sure no CEO is discomfited when stock markets go down, for instance, by lowering hurdles for equity-related incentive awards.
In 1994, Amar Bhide, in a Harvard Business School article, described how efficient equity markets led inevitably to deficient corporate governance. A public share is a very ambiguous promise: you have vote which can and usually eventually is diluted, and the company will pay you a dividend when it earns money and is in the mood. Promises like that are not suitable to be traded on an arm’s length basis, and historically, equity investors typically played a venture capital type relationship: they knew the owners personally and were involved in the company’s affairs. The securities laws of 1933 and 1934 tried to make it safe for shareholders at a remove to participate by providing for timely, audited financial reports, disclosure of information about top executives and board members, and prohibiting insider trading and various forms of market manipulation.
But that turns out to be inadequate. No outsider can know enough to make an informed judement about a company’s prospects; critical information, like merger and new product development plans, must be kept secret until well advanced because they are competitively sensitive. Boards are shielded from liability by directors’ and officers’ insurance (and on top of that, it seems hardly anyone even bothers pursuing board members. For instance, have any Lehman board members been sued?). Moreover, only a comparatively small number of people are deemed public-company-board worthy, and their incentives are to make nice in their community and not rock the boat, which means not making life difficult for the CEOs, since a nominating committee (of the current board) is responsible for nominating directors, which makes the entire process incestuous.
This system has proven to be fairly impervious to outside challenge. Once in a while, a company is so abysmally run that an activist investor will engage in the pitched battle of a proxy fight. But the dog seldom catches the car; instead, they might get a bad CEO to exit or force a restructuring. The stock trades up and the rabble-rousers take their winnings. More polite efforts, even by large, powerful shareholders, are much less effective. For instance, some major institutional investors met with Goldman last year to object to the idea that the firm would pay lavish bonuses for 2009. The session appears to have had no impact.
So the SEC is expected to pass rules that would allow effectively disenfranchised shareholders the opportunity to throw a rope over the castle walls in the hope of gaining entre and hence some influence. Per the Financial Times:
The proposal allowing investors to put their own nominees for board seats alongside the company’s nominees is expected to be approved by the Securities and Exchange Commission…
The new power is expected to be restricted to investors with a 3 per cent or greater stake in the company who have held the shares for at least two or three years, people close to the situation said. The SEC commissioners have the power to exempt smaller companies from the rule, should they wish to do so.
Note that this is a severely restricted form of access; only very big and longstanding investors can put up director nominees. A much bigger number of shares held by a group of equally longsuffering investors has no such privileges, when by any common-sense notion of democracy, all shares should be equally influential, and any group that in aggregate met the 3% threshold and the length of ownership test should be granted the same power. And note this is merely the right to put candidates up for a vote of all shareholders; there is no guarantee any outsider candidates will prevail.
Not surprisingly, the leaders of the CEO/board club responded as if this proposal represented a mortal threat to capitalism:
Corporate America senses a revolution in the offing on Wednesday – and one it finds deeply alarming.
“The implications of [Wednesday’s] decision will be far-reaching and likely will have a major impact on how all US publicly traded companies are governed,” the Business Roundtable, which represents chief executives of the biggest US companies, said in a letter last week to the White House. It warned of “a major threat to the ability of US companies to grow and create jobs”.
Ten senators, led by Richard Shelby, senior Republican on the Senate banking committee, urged the head of the Securities and Exchange Commission to be “particularly careful” to ensure that Wednesday’s planned change did not impose unnecessary requirements on companies “at a time when capital formation and job creation are in jeopardy”.
Yves here. The Ministry of Truth speaks. There is so much nonsense in this salvo that it is hard to know where to begin. First, big public companies weren’t in the job creation business in the last expansion, and aren’t anticipated to be this cycle (if and when we have something that can credibly be called a recovery). Second, big companies hardly ever tap the public markets for equity, so the idea that (first) having an outside nominee which might (second, horrors!) be elected which would (third) would be bad for share prices (very questionable, why the hell would they have won a majority?) and then (fourth) the resulting poor share price would hurt the ability of said company to raise needed equity capital to grow. The reality is the converse for big public companies; in aggregate, they’ve been net savers (which means they are shrinking rather than growing). In general, they fund themselves first from cash flow and retained earnings and second, from debt. The equity markets have perilous little to do with the funding needs of major corporations.
So what additional scare tactic do CEOs and boards that might have their imperial right to loot curtailed? They invoke rule by the modern equivalent of commies, namely, unions:
Their concern centres on fears that the new investor right will be hijacked by unions and other special interest groups to force boards to accede on particular issues. The Business Roundtable asserted that the threat of a director election contest could “place unnecessary pressure on a company to improve short-term financial performance” at the expense of long-term growth.
Yves here. So get this: the business lobby is trying to rebrand highly respected institutional investors like CALPERS and TIA-CREFF as “union” pension funds. And in complete through-the-looking-glass nuttiness (projection is too weak a term), they act as if UNIONS or evil activists of other unnamed types might produce more short-term orientation than already exists? The current order has led to a near-complete breakdown of pursuit of long-term objectives (and this is not based on a reading of the media; I hear it consistently from all sorts of advisors to big companies, from attorneys to consultants to marketing specialists. Expedience and cost cutting are the order of the day).
Fortunately, pretty much anyone with an operating brain cell can see through these patently phony arguments:
Investors on Tuesday rejected these assertions. Kurt Schacht of the CFA Institute, which represents investment professionals, dismissed the industry warnings as “complete and utter camouflage”. Mr Schacht, who sits on the SEC’s investor advisory committee, said it was “insulting” to shareholders to suggest that they would not be able to recognise if a fellow investor, such as a hedge fund, was trying to misuse the new power.
Yves here. The real shocker is that some of the defenders of the failing corporate oligarchy (well, failing at anything other than increasing bottom lines by starving top lines, disinvestment, and squeezing pay to workers, both in job additions and pay levels) is that they are pathologically unable to see that they have enriched themselves to the detriment of shareholders. The pretty looking earnings were at the expense of future prospects. As one savvy investor friend said, circa 2006, “Why should I invest in these companies if they aren’t investing?” They cannot conceive that investors as whole (when the proxy vote DOES require a majority) would vote against them. No, it has to be a pinko plot against their rights as anointed members of the elite. Only peasants would want to storm the castle.