In the first three parts of this series we looked at how we got to this point of controversy over CEO pay. In this final part of this series, we’ll consider where things might go from here. But before we look ahead, a couple of observations about our current situation. First, in the early 1900s the members of the Jekyll Island Club were, I think, significantly more wealthy – relative to the general population – than today’s professional manager/ CEOs. We have entrepreneurs today similar to the Jekyll Island people who are perhaps equally wealthy – Bill Gates and the late Steve Jobs for example. These folks don’t seem to draw a lot of criticism. Because they started their companies and built them from small beginnings, they are seen as extremely innovative. People seem to feel that they earned their wealth and so it’s “OK”. The heart of the pay controversy seems to be a fairness issue based not so much on the individuals total wealth, but on how it was earned. Are they getting what they deserve? Some of these folks, Warren Buffet for example, don’t necessarily draw large salaries. But because they have a large ownership position in their companies, their annual income is drawn more from their investment. This income is not reported in proxy statements, and so isn’t particularly visible. That is, it isn’t until someone like Buffett makes an issue out of the tax take. But these situations are exceptions, tax data indicates that most people with incomes over $1 million, pay a higher percentage of their income in taxes than those with lower incomes. But the fairness issue is not going away. However, in a rational and objective look at how CEOs should be compensated, I think it should be secondary to other factors that we will discuss.
There are two primary factors which we will consider in thinking about CEO compensation and where it might (or should) be headed in the future. The first is the qualification questions and the selection process. How do we determine who has the ability to do the job and is the number of qualified candidates as limited as some seem to think? The second is after the person is hired, how do we keep him or her properly motivated?
The idea from the 70s and 80s that CEOs should have some significant amount of their compensation based on performance I think is valid. There is some validity to the assertion that CEOs had become caretakers. This is the motivation question. Entrepreneurs are, one thinks, motivated to build a successful company. The ones that are successful – like Bill Gates – are no doubt outnumbered by the ones who failed. But we don’t hear of the failures, even though they were all willing to take the risk of failing. Professional managers who succeed successful entrepreneurs may not be as willing to take risks. This should not be particularly surprising. Steve Jobs started out in his garage on a “shoestring”. It’s easier to take risk if one doesn’t have much to lose. Apple today is a much larger company with many employees, many customers and many stockholders. If mistakes are made there is much more at stake and many more people to potentially suffer. In the 1980s I had a chance to meet with An Wang who started Wang Laboratories in the 50s. We had about an hour in his office at Wang headquarters outside of Boston. Mr. Wang was a very nice and impressive individual who had built a well-known and successful company from scratch, but he missed a turn in the market, and within ten years after that his company was no longer with us. Had he become too conservative, or had he just mis-read where the technology was headed? There is also some validity to idea that successful companies often need a different type of leader than the entrepreneur who began it.
However, I believe that managers are better motivated to look after the interest of all the stakeholders if they have a significant amount of their wealth invested in the company. But there are some caveats. The motivation needs to be for the long-term, not next quarter or even next year. Five to ten years is not a bad planning horizon. So there need be restrictions to stock awards so that they can’t convert to cash too quickly. The motivation should not be simply to take risks, but to take necessary and considered actions which seem necessary to long-term survival. And there is more to their performance than simply where the stock price has gone in the last 12 or 24 months. Some of the best jobs have been done in down markets. If things go well, they should be rewarded for good performance, but it seems boards are reluctant to make cuts when performance goes the other way. The rewards need to go both ways. The good news about stock awards is that over time, it tends to automatically track results. If much of a CEO’s wealth is invested in the company, year-to-year adjustments should make less difference in their motivation. The good news about professional managers is that they should not be married to continuing strategies that got the company to a successful position. I think part of the problem with Wang may have been the Mr. Wang still believed that the things he did to make the company successful were what was still needed. Sometimes it’s necessary to make changes – sometimes not. But it’s always better to be open-minded.
The selection process became an issue when the best business minds concluded that leadership was different from management and no one was sure how to recognize or define “leadership”. Knowing that there were requirements for being qualified without knowing specifically what they were, or how to recognize them, has led to problems. But I think there is hope that we will work our way out of this situation. Considering that it took 50 years or so to develop the body of management knowledge that we had in the 70s, it should not be too surprising that it has taken awhile to development a body of knowledge on leadership. I think that there is reason to hope that the “body of knowledge” is catching up with the needs. To this end I will point out three books published in the last 20 years or so that indicate a change in thinking in a beneficial direction. (Note: I get no royalties out of sales of any of these.) The first of these is Stephen Covey’s Seven Habits of Highly Effective People. This book was on the best seller list for a number of years. The company I worked for used these ideas a basis for cultural change in the organization and I was impressed enough to volunteer to be certified as a Covey Leadership trainer/facilitator. I believe that these habits are leadership traits that work at all levels of an organization. But this book was not specifically aimed at CEOs and so was not immediately identified as a measure of CEO qualifications.
The second book is Real Change Leaders by Jon R. Katzenbach, et. al. the authors of this book were with the management consulting firm of McKinsey & Company which works with major corporations. In working with these clients, they concluded that CEOs should not receive all the credit for meaningful change large corporations. In the course of their work, they recognized that the succesful organizations also have middle management people who are ” a new breed of managers”. These folks have become change leaders, “because they have learned new skills and approaches for changing behaviors of people who generate better and better results for customers faster than the competition”. Again, this book is addressed more at how organizations improve and not solely at CEO skills. It also was not on best seller list so far as I know, so it may not be as widely read as some others. But it has the advantage of being written by people who have been actively involved in real world situations so it should have some credibility. On the other hand, because the authors were not from academia, some of their findings may not have made their way immediately back into business school curricula.
The last book that I will mention is Jim Collins book, Good to Great. Collins does a couple of things is this book. First, he explains why the Lee Iacocca model is not the best and final answer. The things we noticed about Iacocca – the celebrity CEO with a gargantuan ego – is not usually the best answer for building a lasting “great” organization. The “good-to-great” have a management team which together determine the best path forward and make it happen. In fact, some of the “good-to-great” CEOs may be people most of us have never heard of. If this begins to sound like a follow on to “Real Change Leaders”, it’s probably not accidental. Covey started with the traits that good leaders have; The “RCL” team found that it was not the CEO alone who was responsible for excellence in an organization, but teamwork; and Collins talked specifically about how the best CEO’s build a long-term effective management team. It would seem to me that many of these things – like the management skill being taught in the 50s and 60s can be learned. If so then the pool of potential CEO candidates is much larger than we have assumed it to be, and we now have some criteria for judging who might be qualified.
The popular public sentiment toward increasingly large CEO compensation has so far resulted mainly in longer explanations and logical rationalization in proxy statements. They have obviously gotten some attention of the Boards of Directors about public relations problems concerning executive compensation. But I believe that in most cases the Boards are doing what they need to do in order it ensure the continued survival of their companies. So real change will require a change in the key concepts underlying compensation practices, and the qualities and skills of qualified CEOs. (As a side note; Jim Collins quote on the book cover says, “Some of the key concepts in the study fly in the face of our modern business culture…”) The foundation for conceptual change has been laid, but it will likely take some time to see it reflected in practice. But a return to the practices of the 50s & 60s is probably not in the cards, nor should it be.
What will or should happen with College football and basketball coaches on the other hand, is much more problematic. But a discussion of that will have to wait for another time.