The Association of U S West Retirees



Why Rules Can't Stop Executive Greed
By Daniel Akst
New York Times
Sunday, March 5, 2006

In the arena of executive compensation, two recent developments stand out against the backdrop of continuing looting.  First, the Securities and Exchange Commission announced plans to make corporations more fully disclose executive pay.  Second, a study by Mercer Human Resource Consulting found that more companies were imposing performance targets on the stock and options they granted to C.E.O.'s.

To the uninitiated, these events may suggest that some moderation is in the offing, but ultimately neither will help much.  Any benefit from shining the cleansing light of day on executive greed will probably be outweighed by the inflationary effect of additional disclosure, which will provide more ammunition for executives and consultants seeking to justify additional increases.  They have to keep up with the Joneses, they'll say.

Tying pay more firmly to performance won't help, either.  Boards will find ways around the requirements if performance isn't up to snuff, and they will continue to bid irrationally for unduly coveted executives.

As Rakesh Khurana showed in his insightful book, "Searching for a Corporate Savior:  The Irrational Quest for Charismatic C.E.O.'s" (Princeton University Press, 2002), there is a much wider pool of potential chief executives than soaring pay levels would seem to imply.  But companies insist on bidding for a savior, not a capable leader who knows the business at hand, which may be why typical C.E.O. tenures are now so short.  Even in the boardroom, charisma carries you only so far.

Indeed, linking pay to stock prices is liable to do more harm than good.  A stock price isn't much of a measure of executive performance, anyway.  A huge part of that price reflects industry conditions;  energy companies soared not because they were run by paragons of diligence or insight, but because of world events beyond any executive's control.  In hard times, moreover, a company's stock may take a hit, but those are precisely the times when good leadership is most difficult — and valuable.

Other performance metrics can be equally troublesome, encouraging executives to massage earnings, sacrifice long-term strength for higher short-term sales and profits and otherwise act in ways detrimental to everyone but the C.E.O., his family and a few lucky divorce lawyers.

Perverse incentives notwithstanding, this focus on metrics is a sad acknowledgment by corporate directors that they cannot control themselves or the pay they hand over to their top five executives.  In one study, two professors, Lucian A. Bebchuk of Harvard and Yaniv Grinstein of Cornell, found that from 2001 to 2003, such pay totaled roughly 10 percent of corporate profits at public companies.  It's a bizarre twist on the tradition of tithing, one that benefits the rich instead of the needy and conscripts America's shareholders as involuntary donors.

Although more disclosure and pay-for-performance requirements won't dampen runaway C.E.O. compensation, both are useful for illustrating a larger lesson:  that it's naοve to place too much faith in the power of rules to limit human behavior.  Indeed, the problem of C.E.O. compensation suggests that, as in many aspects of modern life, few mechanisms of constraint are as effective as one on which we relied so often in the past.  That mechanism was shame.

You'd think that more disclosure would produce more shame, and thus less pay, for C.E.O.'s and other top executives.  Unfortunately, disclosure of a few more million here and there won't fundamentally change a hiring system that actively recruits the most grasping and hubristic candidates.  Consider the incentives:  by offering lavish pay and perks that would make royalty blush, corporate directors today are perhaps unwittingly selecting C.E.O.'s for shamelessness and egotism rather than leadership.

History teaches that there is no ultimate solution to the so-called agency problem, or the tendency of those who merely work in an enterprise to act in their own interest rather than that of the owners.  Rules and incentives can help, of course, but they cannot take the place of an honest sense of obligation, duty and loyalty — values that ought to run in all directions in any decent corporate culture.

This web of mutual obligation is an invisible social safety net — a form of corporate social capital — which we've unfortunately allowed to fray.  Rapidly rising income inequality is a sign of the resulting imbalance.

Corporate chieftains may continue to enjoy unearned bounty, but they should not be surprised if someday they — and the hapless investors who employ them — reap the same brand of cynicism they are sowing.  If that happens, we'll all be poorer for it.

Daniel Akst is a journalist and novelist who writes often about business. E-mail: