You have an employee whose job is
to produce boxes. However, this job is not as easy as it sounds. He
(the hypothetical employee is usually male, for some reason) sits in a
room with all types of materials of varying size and shape, but is
still responsible for creating boxes of a uniform size and shape. This
job requires both creativity and hard work. You decide to reward this
employee with a weekly salary, after you have a chance to evaluate how
many boxes he makes (although there are other factors, like how he gets
along with others and how much material he wastes, but you are
primarily interested in direct output). You give the employee $50 a
week, and he produces 50 boxes. "Alright," you say,
"Let's pay him $100 a week," and promptly your
employee produces 54 boxes. Okay, that's a little off, but you
increase his pay to $200 a week (these boxes are very profitable)
- and the next week your employee makes 35 boxes. What is going
on here? You decide to scale back his pay to $40 a week, and now he
makes 61 boxes. That seemed to work, so you try paying him $35 a week
and now you get 71 boxes.
Here's the question: What is
a fair wage for this employee?
The correct answer is, apparently, $10
This is the point at which you sigh
inwardly, realizing you're reading yet another editorial about
evils of executive compensation. Take heart, gentle reader, my goal is
not to shock or to anger, but to provide remedies and hopefully teach
In March, USA
Today released a compilation of the CEO pay for 150 of the S&P 500
and found a median compensation of $9.6M, with a mean of $10.9M. Of
course this led to the inevitable cavalcade of critics crying foul, but
I was interested in a separate question - did they earn that
As most defenders of executive
compensation could explain, the gains that a successful CEO can make
for a large company are enormous. A 4% increase in stock
price could be worth hundreds of millions, and so paying a third of
that to someone so responsible for that growth only makes sense.
This argument is odd though, as we
generally do not pay employees a percentage according to the yearly
profitability of the company, otherwise every worker at Tech
Data would be making over a million a year, and the employees at
Superconducter Technologies would
sadly only be making about $15,000 annually.
Generally, we pay people based on
expected performance, with a baseline dependent on rarity of the skill
set. Since there is some
that suggests performance might not always fall along a true bell
curve, the first step is to check to see if company performance
normally distributed - that is, are the majority of
one standard deviation of the average? With the data provided, and only
examining the stock price change for the 150 or so companies that both
reported CEO compensation data and had the same CEO all of last year, I
first looked to see if company performance is normally distributed,
which it is. Then I looked to see if CEO pay was normally distributed,
and that too was fairly bell-curved.
Where it gets weird is not the
percentage, or even the amount that CEOs
are making, it's that their
pay and company performance are not linked.
i4cp's researchers took the S&P 500 data and looked at it
way - we ran a correlation of CEO pay to company performance, and found
What you are seeing is the dreaded
SPSS output table sans
which is to say, there is no correlation. Higher paid CEOs are not
necessarily those whose stock price went up last year.
The counter-argument to this is that CEOs are often paid according to
how large the company is. The CEO at Boeing is naturally going to make
more than the CEO of International Flavors and Fragrances. Usefully,
the data also shows the percent change in compensation from 2010. So,
I checked to see if there was any correlation between compensation
increases in the last year and company performance. Again, no.
This is even more surprising when
you consider that a significant
percentage of the average CEO's
pay is in the form of stock options.
This anomaly is explainable by another component of CEO compensation,
which are bonuses given for hitting some particular goal (cf. debt
reduction, safety, cost management).
We aren't the only ones who
have failed to show a correlation between
CEO pay and company performance - in a paper out this month,
Manchester School found the same lack of relation in Norway.
With all that said, this is not a
treatise calling for a reform of CEO compensation; that's
Nor would we say the position of
CEO is meaningless, because CEOs can
have an effect on corporate performance. The point is that many
aren't aligned with business objectives. Their compensation
aligned in a meaningful way with the outcomes they are meant to
influence, so their financial results are independent of the
performance of the companies they work for. Note that this can work
both ways - there are examples on the list of CEOs who made
than last year, even though their company's stock value went up.
If not curtailed, CEO compensation
will continue on its untenable path
due to leapfrogging
and basic human greed. The first step in halting
this phenomenon is doing
a better job analyzing CEO performance, and
rewarding accordingly. The second is to steer clear of benchmarking CEO
pay, and avoiding
outside hiring firms.
Even if you aren't in a
position to influence CEO compensation at your
organization, this is a prominent example of methodology and
perspective. Such a strong disconnect between outcomes and rewards
would not fly for anyone else in the workplace, and is a glaring
reminder of why we need to focus on outcomes rather than outputs.
Employees should be performing activities that influence the business
(hopefully in a positive way), and we should find data that accurately
measures that influence so that employees can be evaluated and
compensated based upon their actual performance.
After all, these boxes aren't
going to make themselves.
is a senior researcher at i4cp, and believes his CEO is compensated
correctly, maybe even
a little underpaid.