CEO Pay

Yes I know, probably a very dull subject. We all know that CEOs are overpaid and we all know the arguments that are trotted out to justify pay levels by CEOs and boards. And of course we all know that boards are fundamentally conflicted because there are so many CEOs and ex-CEOs sitting on boards. But are CEOs actually overpaid and is that the real problem?

To begin with, let me state clearly that I have no problem with people earning lots of money. Indeed, they can earn whatever they like, although I think society as a whole is better off if people earn what they are worth rather than what they can get. So I don't blame CEOs for their pay, or their supposed "greed" - after all, how many of us would turn down $1 million a year plus a $10 million in bonus if we were offered? No, the people I find objectionable are firstly the boards of companies, and then, to a lesser extent, fund managers. Both of these groups are supposed to represent the shareholders, and in the case of fund managers, the ultimate investors - you and me.

The usual argument that boards of directors give when appointing a new CEO or increasing an existing CEO's salary is that there is global competition for talent. There is some truth to that, but it is in fact a pretty weak argument. For a start, CEO jobs in large companies don't come up that often. And if we assume that CEOs are reasonably specialised in terms of sector and experience, then the CEO jobs that potential or existing CEOs might be considered for are quite rare. Yet the number of people wanting to be a CEO is large. In every big company there must be at least two and more probably three or four senior manager who want to be CEO of the company they already work for, and who would be willing to change companies in order to move up to the CEO role (and if there aren't, then there should be). Then there are all the other existing CEOs, plus the CEOs in the next tier of companies down and their senior managers, plus a few outsiders in banking, accounting, private equity and so on. That's quite a large pool of hopefuls.

If there are lots of people who want to be CEOs and who are, on the face of it well-qualified, competing for a small number of jobs, why do we have to pay them so much? Boards make much of the unique experience and abilities of the people they pick to run their companies, but really this is sheer nonsense. The existing senior managers must know the business well and if the previous CEO and board have done their jobs, they should be CEO material. If the much-touted succession planning works, then each CEO job should be fought over by 2-3 internal candidates and perhaps 2-3 external candidates. The idea that only one of those possible CEOs is right for the company and none of the others could do a good job is plain ridiculous. It is also ridiculous to believe that the one "right" candidate would walk away from his or her perfect job unless offered a huge package.

Indeed, if you have 3-4 good candidates, why not offer it to the one who is willing to work for the lowest salary?  After all, it's obvious that most CEOs are not a great success, and a good many are failures. There is no correlation between what CEOs are paid and the performance of the companies they run. Nor is there any correlation between performance and selection criteria. So why do boards persist in using a system that does not work?

Moreover, in a modern large organisation, the CEO has very little real control over the business. He or she can set some sort of overall strategic direction, or undertake a large merger or acquisition, but in terms of the existing business, how much influence can they have? What a bank or an engineering or a mining or an IT or an oil company does, how it does it and where was worked out years ago. Every large company already has processes, procedures, strategies, managers, trained staff, products and so on. The CEO can set targets or demand cost cuts, but that's hardly worth so much money, and without competent mangers down the chain, nothing gets done anyway. 

In fact, the more you look at the role of a modern CEO in a large company, the more it becomes clear that their ability to succeed is extremely limited, because they can do so little to change the business. But their ability to mess up is very large - through grand gestures and strategic changes. And this is the key point - most CEOs should not be generals fighting large-scale campaigns, they should be engineers watching over a giant machine that somebody else built. They should be making sure that the machine runs smoothly and performs the functions for which it was designed, tweaking and improving where necessary. Of course, some companies need new strategies, new business models and restructuring. But then you want somebody really skilled and those skills really are rare.

Recruiting hot shot generals for boring jobs is a recipe for disaster. AIG is the classic example. A wonderful business to own, with massive market share, great products that will always be needed, good cost control and relatively low risk. But would I want to run it? No, because it must be very boring! In that sense, it's no wonder that AIG's management took it into new, exciting areas. And of course, that was its downfall. AIG needed a skilled engineer, not a want-to-be Sun Tzu itching to invade new territory.

What we have therefore is not just a system that significantly over-rewards CEOs, but one which also selects the wrong CEOs and then encourages them to act in ways that are detrimental to shareholder value. We have a system that has demonstrably failed, but which boards and fund managers seem completely unwilling to reform - presumably because of their own self-interest in perpetuating it.

And that is the real scandal.