In part I, we addressed the college coaches high salary growth over the last 30 years or so. In this we will address the large growth in Corporate CEO compensation over the approximately same time period.
This past June, columnist Robert Samuelson addressed this subject in his syndicated column. He dates the rise from 1980 and gives us some valid reasons for the changes. In the 1970’s I was a member of the corporate planning group of a Fortune top 100 sized company. In that role, I was a part of several internal discussions about what needed to be done to address the increased competition from Japanese manufacturing. CEO compensation was a part of this. And I believe Samuelson is right, the late 1970’s and early 1980’s saw a change in thinking in a number of ways. I think he got it mostly right, but there are a few things that are significant that he didn’t mention. So herewith is my version.
At the end of WWII, the US was the premier manufacturing nation in the world. We had been giver much credit by historians for our ability to manufacture the goods necessary to win the war. After the war we changed to manufacturing peace time goods: cars, dishwashers, radios, TV sets, etc. Much of the worlds manufacturing capability had been destroyed by the war, but even as they rebuilt, we still were the premier manufacturer in quantity, quality, and price. That lasted for a good 25 years after the war ended – a generation. We thought it would last forever. But in the 1970’s the Japanese product invasion started. First it was motorcycles, then cars and TV sets, etc. The products were innovative, high quality and relatively inexpensive. By the late 1970’s, Japanese products had made serious in-roads into manufacturing areas at which we thought we were the world’s best. People started asking what was wrong? Were we going to lose our lead in industry and industrial management. There was a lot of gnashing of teeth, questions and suggestions of what we might do to regain or retain our leadership. We thought we knew how to manage companies and industries, but all of that came under question.
Prior to WWII, much of American industry was still run by company founders. By the time the war ended and in the 50’s and 60’s, many, if not most, of the senior positions had been turned over to “professional managers” These managers had come up through the ranks, and their pay scales were tied to the company “professional/ job ladders” which were widely implemented after WWII as a way to help companies be fair and consistent with their pay levels. Typically, these started at the bottom tier of jobs and went through the CEO position. CEO pay was tied to the rest of the organization. CEO annual pay raises were reasonably modest. Increases in poor years of company results may have matched inflation (say 3-5%). In good years, they may have been 7-10%. Unlike the company founders, these CEO’s had come up through the ranks and did not own a large percentage of company stock. So they did not get a proportionate benefit from significant increase in corporate income. The thought in the late 70’s was that the CEO’s had become “caretakers”. If they attempted to institute change and it didn’t work, they could be fired, If it worked, they would get very little reward. So they were “risk averse”. Why take the risk of making significant change if you were not going to see substantial reward if it worked, and if it didn’t, you could lose your job along with its “comfortable” salary? One suggested fix for this was for corporate CEO’s to have a greater stake in company earnings – i.e. more ownership. This could be accomplished by having a significant part of their compensation being stock or stock options. So if the company did better, they would get a meaningful reward and if it did worse, they would be penalized by having lower income.
In the meantime, in the 1950’s, in prestigious schools of business, there had developed a body of knowledge on what it took to be a successful manager. This was based on some work done in the 1930’s and before, the experiences of WWII, and the academic wisdom of the times. When I was in graduate business school in the late 60’s, the functions of a manager were summed into 5 functions – plan, organize, staff, direct, and control. The belief in much of academia was that management had become a science in which most of us could be trained. This would include principle corporate leaders even if they had not had previous training or experience. “Advanced Management Programs” offered by many major universities and other sources could fill in any gaps in knowledge. By the late 1970’s some of this came under question, and by the 1980’s the thought was that the senior executive needed more than just a grasp of the management functions, the person needed “leadership” ability. The poster boy for this new type of CEO was probably Lee Iacocca who was given credit for turning Chrysler around. The idea was that Leadership was different from management and a good CEO needed both. The problem? There was no settled idea on what constituted specific leadership skills or how to train someone in these. Consequently there was also no agreement on how to recognize who had these skill until they had actually been in the job that required them, i.e. the CEO job.
So two things changed. First the compensation structure changed to provide a higher compensation to the CEO in company stock (to cause him to act more like an owner than just an employee). The real difficulty with this may have been that the original salary level wasn’t adjusted, but rather the stock awards were added to the existing salary. The second thing that happened, was that companies began to look more outside their ranks for people who had already held CEO positions and had demonstrated leadership abilities. So like football coaches, in order to get someone to leave one position and move, they were offered increases in salary. Some of this has no doubt worked, because the drain in industry and jobs experienced in the 70’s was abated in the 80’s and 90’s. However with the resulting run of economic growth and increasing corporate earnings, the total compensation increased significantly. And like football coaches , there is a fear that someone will try to hire our CEO away from us, so we have to keep them at least up with, if not ahead of the pack. As Samuelson points out, we are now left with a system that has a continuing upward bias.
The ideas that started this are not irrational. Ownership and a risk/reward system that encourages innovation and change is no doubt important. And there is a difference I think, between management and leadership. But like a lot of human activities, we have gone overboard. The unintended consequences of some of these changes is that things have gone too far. We need some better balance. I’m not sure what the answer is, but I will share some thoughts in the next installment.