Just after an outstanding article (subscription required) on the real brains behind Voltaire (his lover, Emilie du Châtelet), the Economist chimes in (subscription required) on executive pay. The article outlines the perils of stock option based pay (stock prices badly correlated with executive performance and the evil this does, e.g., rewarding poor bosses who happen to preside over the firm during a general stock market boom) and notes some of the various performance based packages that seem to be all the rage. Pay "inflation," seems now to be in full effect, in Britain at least, with the Economist noting the impact of some of the typical scapegoats:
But pay moderation among British executives may now be coming to an end. Hedge funds and private-equity deals are proliferating, bringing with them rewards that make the offerings from public companies look stingy. So remuneration committees are approving more generous schemes to retain their best executives.
I've touched on CEO compensation before, more than once actually. So have the Economist (subscription required), Gary Becker, Richard Posner, and Financial Rounds. This most recent Economist article makes three interesting points, one implicitly and two directly.
First and implicitly, the article suggests there is an active market for managerial talent, at least in Britain, with the passage I cite above. That senior management pay floats with supply and demand is, and please do forgive me for being a capitalist, a good thing. I expect that enumerating the arguments for such a system would be beneath the notice of Going Private readers.
Second, the Economist points out that there has been a move to "absolute" metrics to trigger incentive pay (bonuses, etc.) and away from "relative" metrics, based, for example, on the firm's performance relative to the competition. The Economist notes that payouts under relative systems that could, for example, require the firm to beat the average for the industry in, say, earnings growth, have a particular effect. Quoth the Economist: "Indeed, if all companies used them, only half of all bosses would get a payout in any given year." That great sucking sound you hear is the slurping draw of managerial expertise to the far higher pay packages offered by private equity and hedge funds. Absolute metrics, that might even be set quite arbitrarily low or split into two severable targets, tend to increase the frequency of payouts and keep public firms competitive in an inflationary compensation environment.
Finally, the Economist comments:
Transplanting pay plans from private-equity firms to public companies is dangerous, not least because doing so confuses two quite separate issues: how much executives ought to be paid and what their incentives should be. Managers involved in buy-outs are usually expected to put some of their own money at risk. And it is far easier to fire an executive in a private company than in a public one. Big rewards in private-equity firms are in part supposed to compensate for bigger risk. But more important, private-equity investors typically have direct control of the companies they manage and are able to set targets and structure incentives that align managers' interests with their own.
I have some issues with this analysis. First, insofar as executive compensation is being moved from salary to incentive based pay, executives do have their own money at risk. Second, I'm not sure how one can argue that the compensation committee of the board of directors of a public firm doesn't have similarly "direct control of the companies they manage..." with respect to "[setting targets and structure incentives that align managers' interests with [the shareholders]."
Of course, this silliness about executive pay has caused all sorts of regulation and calls for regulation on the issue. Section 162(m) of the internal revenue code limits deductions for executive pay to $1,000,000- unless it is "incentive based." At least one article I caught the other day wondered in print if options backdating, the latest scandal, isn't just a means to avoid these deduction issues by giving an option grant with a built in cash certainty. Looks just like a bonus, when you think about it.