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Pay For Performance Not What You Expected

I don’t begrudge the $15.3 million annual salary that Texas Rangers shortstop Elvis Andrus is knocking down this year, or even the $24 million that Rangers first baseman Prince Fielder will pocket.

The same goes for the $75 million that actor Robert Downey Jr. pocketed last year — more power to these gentlemen.

Indeed, all of them possess exceptional talents, and their agents negotiated the best money deals possible for them. These deals were struck in arm’s length transactions with rational, willing buyers of their talents — a professional baseball team and movie studio in these instances.

So big payouts such as those are fine by me. I don’t care.

But the same cannot be said for the exorbitant pay packages of corporate chief executive officers, which I find distasteful on two fronts.

First, the relationship between corporate boards of directors, who set compensation levels, and their CEOs is much too incestuous to resemble anything remotely akin to free market negotiations.

Secondly, an increasing number of academic studies has shown that paying large performance bonuses — mainly stock options — doesn’t increase a company’s stock price, earnings or any other measure of corporate success. I know it’s counterintuitive to think performance bonuses don’t improve performance, but at the CEO level, they don’t.

The median annual pay in 2014 for the top 200 CEOs of companies in the Standard & Poor’s 500 Index was $17.6 million compared with $7.2 million in 2010. In the 1980s, median pay for CEOs was $1.8 million and $4.1 million in the 1990s. Median compensation for D-FW executives in 2014 was $4.03 million.

I would much prefer that teachers, truckers and cancer researchers were paid like that, but as it turns out the market puts a higher premium on turning a double play and acting than curing cancer, hauling freight or teaching children to read.

Be that as it may, unfettered markets set the prices for those skills — not so with CEOs. As a practical matter, most boards of directors have accepted a subservient role to the corporation’s management team, writes Michael Dorff in his book Indispensable and Other Myths.

That’s because many directors are current or retired executives themselves, quite wealthy and move in the same circles as the CEOs they hired. They are going to “funnel as much corporate wealth as they can to their friend the CEO,” writes Dorff. They also don’t have the time to actively manage a corporation.

“Because directors have a monitoring rather than active managerial role in the corporation, they are culturally conditioned to defer to senior management,” Dorff says. “Just as they defer on issues of corporate strategy, they may also defer on compensation questions.”

Much of his book is devoted to explaining why gorging executives with performance bonuses doesn’t improve their performance. Space constraints prevent me from a complete explanation of all this, but blue-collar work is better suited for pay-for-performance than what Dorff calls the creative, analytical job of CEO.

“Motivational techniques that might work beautifully when the task is boring and repetitive — say, soldering a component to as many circuit boards as possible — can have perverse effects when the task is creative or analytical,” he writes.

Chief executives who have risen through the ranks of corporations are already highly motivated to succeed. Offering them big stock bonuses is like “using a treat to persuade a dog to leave the house when the dog is already impatient to go outside.” They may also view performance pay as controlling, even condescending, and it can distract them from focusing on their job.

CEOs are much like NFL quarterbacks who shoulder too much of the blame when their teams lose and receive too much credit when they win. Myriad factors other than the motivation of a CEO are involved in a company’s success or failure.

The costs of raw materials for a manufacturer may have changed. Rising and falling crude prices, interest rates, changing technology or economic growth are all important variables in the success or failure of companies.

In recent years, regulators have forced companies to be more open about CEO pay, and since the Dodd-Frank financial reform law was passed in 2010, shareholders vote on an executive’s pay. But the votes are nonbinding.

Individual shareholders typically have neither the time, information nor money to mount a proxy fight to alter a company’s board of directors. And even large institutional investors, such as pension funds, hedge funds and insurance companies, are often hesitant to spend the millions of dollars required to replace a corporate board.

As a practical matter, boards consistently have raised CEO pay over the years without much fear of shareholder reprisals.

“Questioning pay for performance is like questioning gravity,” Dorff says. “It’s hard to conceive that it might be steering us in the wrong direction.”

Courtesy of DallasMorningNews

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