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 Everybody Knows the Game is Fixed: The Poor Stay Poor, the Rich Get Rich...
So sang Leonard Cohen in 1988's "Everybody Knows".
The game of executive compensation, this fascinating study of CEO pay demonstrates, is definitely fixed. In theory, executives are hired by a company's impartial board of directors, who negotiate with them at "arm's lengths". If the CEO of large public owned companies receive huge compensation - and they do - that's because they are worth it. Much of the compensation is tied to the firm and the CEO's performance. Thus the CEO has an incentive to ably serve shareholder's interests. As Gordon Gekko put it (Wall Street (20th Anniversary Edition)): "Greed is Good".
Or so goes the theory.
But everybody knows that the theory is nonsense; Lucian Bebchuk and Jesse Fried's study confirms that common sense perception: That CEO compensation is a game of insiders enriching themselves (and each other) at the outsiders' expense.
Far from being "arm's lengths" negotiators, the directors of a company are more or less stooges of the Firm's CEO. They don't quite serve at his pleasure, but he has ample control. Until the 2003 reforms, while the directors in the "compensation committee" had to be "independent" (that is, not part of the company), the directors on the "nominating committee" that picked the directors were not. Thus the CEO might have sat on, and maybe chaired, the nominating committee. After the Enron scandal and the 2003 reforms, the members of the "nominating committee" have to be independent. But that begs the question - who is an independent director? Well, Independent directors are people who may receive compensation from the CEO controlled company - but no more than 100,000 US dollars a year. And that does not include perks given to family members, donated to charities you favor (or work in), or, with some limitations, to companies you are involved in (p. 28). Director Independence is more of less a sham. And even if it weren't, Directors have little incentive to curb CEO compensation - many of them are or were CEOs themselves. Sometimes it's an "I'll rub your back and you'll rub mine" deal where the CEO of one company is a director of another company who's CEO is a director of his company. At any case, the atmosphere among the directors is friendly, collegial and non-confrontational - as one board member puts it, it's somewhat like a club (p. 32).
There are few effective checks on the powers of CEOs to feast on the shareholder's money. The CEO's compensation is not a large enough issue for the market to respond to, and the Courts generally refuse to intervene in decisions by professional executives and directors.
The best defense against CEO abuse is what Bebchuk and Fried call "outrage" - the bad publicity caused by the discovery of the executives' scandalous self dealing. Outrage does check some of the worst abuses. Fortunately for the CEOs, though, there is a way to give themselves large compensation that is not sensitive to their performance: camouflage. Executives and directors have found ingenious ways of devising gigantic rewards that are hard to recognize as rewards. Whether in the form of perks (such as unlimited use of the corporate jet long after retirement), fat consultancy fees (for which little actual consulting is done), or so-called "split dollar life insurance policies" (don't ask). But the worst offenders are probably the stock options. Until recently, chief executives would get options that were not indexed to the market or the sector -meaning that the executive would benefit from any increase in the company's stock price, even one that he had nothing to do with. And if the share's price went down - no worry, the option's target price would go down as well. "Heads, I win, Tails - I also win".
Fried and Bebchuk paint a gloomy picture of the current state of affairs. They acknowledge that their work is primarily descriptive rather than normative, but they still offer two chapters of solutions.
The first chapter focuses on various reforms, outlawing the most outrageous current schemes. That sounds to me like a good but essentially hopeless idea: No matter how many loopholes regulators would close, CEOs and their directors would always find new loopholes to exploit.
More promising is the final chapter, which focuses on ways to improve corporate democracy. Currently, the firm's directors are more or less immune from challenges by shareholders. Bebchuk and Fried offer reforms that could make them more accountable.
But to what end? The problem of collective action (one shareholder's actions serve the interests of non-active shareholders; this everyone has an incentive to do little) plagues corporations. Could better corporate governance really overcome it? I doubt it.
I wish Fried and Bebchuk would expand their watch to look at executive compensation outside the US, or even in different eras of US history. In The Conscience of a Liberal,Paul Krugman argues that the massive pay to US executives is not inevitable - it is the results of specific political and economic forces in US society. Maybe the US can learn from the experience of others.
Bebchuk and Fried's book is well written and very interesting, even if it is somewhat too detailed and technical for the casual reader. I recommend it if you want to know the nuts and Bolts of what "everybody knows".
 Author an academic and not experienced in actual day to day compensation matters
Jesse Fried is a corporate compensation grandstander who seems to show up at every scandal (recently the backdating scandal). Unfortunately it is obvious he has no "real world" management experience!
On Mr. Frieds allegation that stock option expenses are "hidden" by CEOs, corporate types in order to increase their bonus targets:
- CEO compensation (bonus targets etc) are almost NEVER based on non cash expenses, such as stock options expenses. Bonus targets are typically cash flow based only (meaning it doesn't matter to CEO bonus targets if stock options expenses are high or not) and anyone writing a book on executive compensation should KNOW THIS!
On Mr. Frieds allegation that the only possible reason for stock option backdating (without expensing) is to HIDE expenses to the company, presumably to increase the mysterious "bonus targets" above:
- Stock option backdating is used to give a hiring bonus that is only redeemable in 4 years and only if the company continues to perform (reflected in the stock price). The "locked in" and vesting aspects of stock options backdating are the reason they are used, resulting in significant value to company that cash hiring bonuses do not provide. These are not used to hide expenses and anyone who had ever seen these used in a real world setting would know this.
In my opinion, Mr. Fried needs to hire a management consultant who has actually PERFORMED AS A MANAGER before he writes anymore assessments on the state of executive pay.
 This Fascinating Read Will Leave You Thinking ...
Other reviewers have made many excellent points. I'll try to avoid duplicating their comments here...
- This book is written by two law school professors. They carefully and precisely make their case. Even as they make their points, they consider possible counter-arguments, and then cite further evidence to answer these objections. They clearly and methodically make their case.
- They start from a somewhat unique set of premises.
--> Whereas many critiques of executive compensation approach the large amounts as an egregious breach of egalitarian values, the authors are indifferent about the size of exec compensation.
--> On the flip side, while many would excuse large compensation packages as necessary to obtain top talent in a tight market, the authors come from a perspective of "if shareholders, as the *owners* of the company, can pay a lot for exec talent, but not get good returns, what's wrong with the market for executive talent?" This book challenges long held assumptions price always equals quality when shopping for top management talent.
- For a book that cites hard economic facts as often as they do, it also does a great job of analyzing the human element of this market to provide insights that seem missing in public debate about executive pay.
- Even as someone who is an outsider both to corporate governance and executive compenation, I found this book accessible and an enjoyable read. As a shareholder of a number of companies, I intend to take opportunities to reform this clearly corrupt system.
Highly recommend this book for everyone who owns shares in a publicly traded company, or works for one.
Fantastic Resource on Corporate Culture Run Amok
Superb exposé on the appalling lack of ethical fortitude amongst our country's business elite--namely the chief executives, their officers, and sadly those given the responsibility for representing the shareholders' interests, the directors. The adage "no one looks after your money like you do" is well-remembered by the reader of "Pay without Performance."
Primarily due to a phenomenon know as "interlocking" executives cross-pollinate their respective boards with a surprisingly shallow gene pool leaving the ordinary shareholder hardly independently represented at all.
Bebchuk and Fried do well by illustrating the mockery known as "independent compensation committees" when these committees are typically hired under the corporation's own HR department usually by CEO referral. Tough to place credence in any recommendation so biased from the outset!
Now only two years after the publication of this book, and several studies cited therein, the SEC has launched a sweeping probe into options timing--in particular boards who allowed their executives to cherry-pick the grant dates of options to take advantage of inside information to profit at the expense of shareholders at large. Criminal, yet condoned by far too many corporate "leaders."
Ultimately the question arises--Is the solution for shareholders to vote via increased legislation or with their wallet by only investing in corporations fully aligned with their interests? The authors make an excellent case for instituting a performance-based compensation system as well as supporting the role of making directors truly independent and not pawns of the CEO. Fantastic resource on corporate culture run amok--the elusive 5 Stars!
Excellent. The authors deliver a strong performance.
This is an excellent book. The authors have done extensive research from both a legal and economic standpoint to support their hypothesis that companies with better Board governance, more accountable CEOs, better structured CEO compensation packages perform much better than the others. They show better operating performance resulting in superior shareholder value creation over the long term.
Their diagnostic of what ales executive compensations are so well grounded they have become common knowledge for any readers of the financial press over the past couple of decades. Compensation of CEOs and other top officers has become insane. The structure of equity compensation has become so tilted in the CEOs favor that as the authors indicate they really don't have to perform. If they perform poorly they make a boatload of money. If their performance is about average they make an astronomical amount of money. What kind of pay-for-performance is this?
Other reviewers have had surprisingly strong reactions to the authors' proposals to redress the effectiveness of executive compensation. I found that surprising given that the authors' proposals are not that radical to begin with. They boil down to restructuring equity compensation so they reflect targets and vesting periods that make economic sense and align the economic interest of the executive with the long-term interest of shareholders. Their proposals also entails a massive shift of power from entrenched Board members plagued with serious conflict of interest to the shareholders of the companies who are the ones bearing the full brunt of the equity risk. In the days of the Enron, Tyco International, Arthur Andersen recent scandals, I find the authors recommendations rather sound. I do think a shift from Board to shareholder power would do a good deal to restore the integrity of certain executives, the transparency and the quality of accounting and financial disclosure.
Thus, I really think you will enjoy and learn a lot from this book. In a similar fashion, if you want to educate yourself regarding how movie stars are paid, and why just like CEOs they may be grossly overpaid I strongly recommend the recently released book "The Big Picture" by Edward Jay Epstein. This is another fascinating point that touches on the sensitive topic of a privilege group that earns a staggering amount of money hardly justifiable on any grounds.
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(based on 8 reviews)
