The Gravy Train

12 February 2010 David Bolchover

In the United States the average CEO in 1980 earned 42 times the average blue-collar worker's pay. By 2000 that multiple had increased more than 12-fold to 531 times the average, and we're now at the point where around 10% of U.S. public company profits goes to the top five executives. Are today's executives really so much more talented? David Bolchover's new book, Pay check: Are Top Earners Really Worth It?, examines the evidence.

The arguments in defence of high corporate pay operate in three stages. First, we hear the argument that pay is an inevitable product of the market. This is an attempt to shut down the debate before it has started, by insinuating that people who dispute this statement are either childish naïfs, shameless populists or anti-business socialists.

If we probe a little deeper, the word 'talent' is usually called upon as the next line of defence. As we have seen, what 'talent' means is not adequately explained, and why it might be important (if we understood what it was) is not clear. But the intent, again, is to intimidate the curious-minded. "We, the insiders, value talented people, who happen, incidentally, to comprise our friends, people who pay us, and people who are like us. You, the outsiders, are not equipped with the experience and knowledge to know what we mean by talent."

That's where the defence of high pay normally stops. However, there are other arguments out there, articulated by those who are pushed a little further to justify their position.

Often they will take the form of a throwaway comment, such as "he's a big hitter, a serious player", "it's a top job, lots of pressure", "he brings in $200 million a year" or "he's got 500 people working for him". This article will look at all these arguments, both those openly expressed and those inferred from these casual remarks.

"'Competitive base pay' was a prime reason for joining a company, but it did not feature in the top 10 reasons for wanting to leave a company."

Money motive

We have seen how Royal Dutch Shell massively rewarded Jeroen van der Veer in 2008. The following year, as he was about to step down as chief executive, he made this intriguing comment: "You have to realise: if I had been paid 50% more, I would not have done it better. If I had been paid 50% less, then I would not have done it worse."

I have argued that Van der Veer received this fortune because the company that employed him operated in an environment that guaranteed huge revenue, and despite the fact that it failed to reach a minimum target when even the achievement of the maximum target would be hard to classify as exceptional. I have also argued that it would have been impossible, anyway, to attribute the company’s success (or failure) to him as an individual.

And then we learn from the man himself that the level of financial reward had little or no bearing on his own performance!

Is Van der Veer an exception? Does financial incentive encourage people to work harder, arguably making high pay justified on the basis that it promotes high performance?

Not according to the 2007 Towers Perrin Global Workforce Study, which interviewed 90,000 employees in 18 countries and is trumpeted as the largest such workplace survey.

"If the chief exec’s pay was reduced to the level of the U.S. President, he would leave for a rival or enter an industry where the rewards are thought to be higher."

The study measured which factors attract employees to join a company, what motivates them once working there, and what persuades them to stay. 'Competitive base pay' was indeed the prime reason why people joined a company, but it did not feature in the top 10 reasons for wanting to leave a company. Nor did it feature in the top 10 for 'engagement', or motivation, when actually performing the job itself.

One could argue, of course, that most employees are not particularly interested in financial reward because they feel they cannot earn that much more anyway. A rival company might offer them a relatively substantial percentage increase in their salary in order to entice them, but once recruited, the prospects for further substantial salary increases are remote. And most employees will not receive annual bonuses based on performance.

Senior executives and many finance workers, one may suggest, are in a different category. Not only will they earn a large salary, but they also often stand to earn life-transforming additional money if their performance is deemed excellent, and often a very nice moderately life-changing consolation if their performance is deemed average or below average. Surely that is all very motivating, despite what Van der Veer claims? Surely they would want to work extremely hard to retain their job and the accompanying large salary, and if possible, obtain an extremely large bonus, rather than a smaller large one?

Is it a question of executive effort?

Let’s take the chief executive in a large public company first, and assume that his influence on company performance is significant and that companies must therefore do everything in their power to ensure their maestro is highly motivated.

Perhaps we should begin with a couple of questions: is the very highly paid modern-day CEO more committed than chief executives pre-1980, the point at which their salaries started shooting up? Is he more committed than the chief executive of a smaller company where pay will tend to be much lower?

We can't answer these questions one way or the other with any certainty. These three groups (modern-day CEOs of large public companies, their predecessors pre-1980 and small company CEOs) are likely to be, or to have been, highly motivated by comparison to most workers. How would you be able to distinguish between the three in terms of effort?

"Senior executives are not paid so much in order to motivate them, but in order to compete in the market for perceived talent."

So, yet again, we are left to speculate. As Van der Veer's comment implies, you can't try any harder than your utmost – there is a limit. Even if money is a major motivation for chief executives, we might suppose that an individual who appears ambitious and hard-working enough to be considered for the top position in a large public company would try just as hard in an attempt to earn, say, 30 times the pay of the average worker in the United States, as he would to earn 364 times more, which is the actual ratio.

We might also suppose that an individual who seemed ambitious and hard-working enough to be considered for the top position pre-1980 expended just as much effort, once appointed, for much less money. And, finally, we might also suppose that a CEO of a small company, often its founder and owner, tries as hard as he possibly can to help to stave off the fierce competition that his company will usually face, competition no doubt considerably fiercer than that experienced by most large company CEOs.

We might also suggest that there will be other motivating factors, which together with a moderate financial incentive or perhaps even without any financial incentive, are likely to induce maximum effort from the large company CEO.

These factors might include the opportunity to make a personal impact (the will to make an impact is more important here than the eventual reality, which as we have seen is often extremely difficult to establish); to perform interesting work; to assume a position of high status and some power and influence; to gain the respect of his peers; to see his ideas reach fruition; to make a name for himself. We should note that the President of the United States earns substantially less than most large company CEOs (the base salary is $400,000) and there is no shortage of able aspirants for this role.

Of course, one might say that if the chief executive’s salary was to be reduced to the level of the President, both he and future aspirants would leave for a rival or enter an industry where the rewards are thought to be higher. And at this juncture, we come back, once more, to the talent ideology and reflect further on its pivotal role in maintaining high pay.

"The broader long-term risk of underpaying corporate executives," argue pay consultants Ira Kay and Steven van Putten, "is that top talent from colleges and business schools will enter other more lucrative, and arguably more interesting, professions, such as investment banking, venture capital, and management consulting. Private equity firms also recruit corporate executives for very lucrative pay packages. This puts upward pressure on corporate and CEO packages."

Herein lies the rub. Senior executives are not paid so much in order to motivate them, but in order to compete in the market for perceived talent. If we can motivate people to apply maximum effort for a lot less, we would only pay them a lot more if we believed that their ability to perform the job well is extremely rare and that to replace them would be a hugely onerous task. In my view, such a belief is ill-founded.

Pay Check: Are Top Earners Really Worth It? by David Bolchover is published by Coptic Publishing. UK Publication date: 22nd February 2010 - currently available at Amazon.