Why, Indeed?
‘It’s all about the Benjamins, man.’
That’s a line from a pretty old movie, I think, but damned if I can remember which one.
Anyway –
This morning’s WSJ had an opinion piece in it titled ‘Why CEOs Get Paid So Much’, with the sub-headline – ‘Doug McMillon’s success at Walmart shows the value of corporate leadership’.
It’s not a long piece, and the gist of it is easy to lay out. McMillon took over as CEO of Walmart in 2014, and is about to step down and retire. In that time, according to the article:
“Walmart’s annual revenue has grown on his watch from nearly $486 billion to $681 billion in its latest fiscal year. Walmart’s shares have risen some 310% in his tenure, while the company has increased wages and benefits for Walmart’s 2.1 million employees.”
Now, as a number of the WSJ readers who commented on this piece point out, the fact that one CEO of one company did well (assuming that those numbers indeed imply ‘doing well’, as no comparisons with other retailers are offered) does not constitute an answer to the question that is implicit in the article’s title.
One commenter on the piece also made the very astute observation that McMillon’s actual compensation is never stated in the article. Sources tell me it was $US27million last year.
So, the implicit claim the article is making is that, given how well Walmart did during his term, McMillon’s pay package was perfectly reasonable. In a phrase, he was worth it. Again, hardly a proof that CEO pay is reasonable in general; I do expect better arguments from the WSJ.
However, I write mostly to say that this whole discussion goes against the way (most) economists think about pay. The only answer economics can give to the question ‘What is that employee worth?’ is the same as they give to the question ‘What is my house worth?’. It is worth whatever someone is willing to pay for it.
That is not a normative, or ethical, claim. Rather, it follows from the belief that there simply does not exist any notion of objective, intrinsic value for, well, anything. ‘One man’s trash is another man’s treasure.’ I am well aware that this attitude flies in the face of much common sense and/or talk about such things, including often my own. I, too, wonder how Vlad Guerrero Jr’s prowess in baseball (much as I love watching him play) can possibly be ‘worth’ paying him a half billion (big US) dollars over the life of his contract.
A friend of mine pointed out during the World Series that, based on the claimed average price the Jays were getting per seat during the WS, they were raking in close to $100million per game, thus going a long way toward paying for Vlad. But of course, Vlad did not get them to the WS on his own, and there are all the other costs the Jays had to pay and…..
To an economist, that is all beside the point. The Jays org agreed to that contract, therefore he is worth it – to them – and they are the ones paying him.
This attitude also runs against any number of progressive slogans about workplace justice, like, ‘Equal pay for work of equal value’.
The economist’s objection to that slogan is ‘how does one assess what work is of ‘equal value’. Well, lots of bureaucracies do try to do that, and one way it often shakes out is to insist that people with the same job title must be paid the same. Anyone who has spent more than five minutes in the world of work knows that not all people with the same job title (first baseman, assistant professor, millwright, on and on) are providing ‘equal value’ to their employer – or to their fellow employees.
On top of that, there is no way to assess what ‘value’ any particular employee has to his employer, as economists insist that it is all ‘team production’ and quite impossible to separate out the contributions of the different team members. That holds for CEO McMillon, too. However well or badly Walmart did over his term, there is no way to determine how much of that is due to him and how much to other team members, not to mention everything that happened outside the company over which he had zero control.
All of the above could be taken to imply that no matter what or how anyone is paid, in any company, there is no way to improve the situation. It should not. In particular, there are aspects of how CEOs (and others) are selected and paid that do bear scrutiny, imho.
First, there are some incentive structures that are often built into CEOs’ (and others’) pay that seem to me to be clearly counterproductive.
Economists think incentives matter, although they do not believe that only financial incentives matter. Consider the occupation of restaurant server. It is typical that they are tipped by the customers. (I know there are those who think tipping is an awful practice, but I am much in favour of it, a topic for another post). The idea is that if the server does a better job the tip gets bigger; that is certainly how I approach tipping. However, a restaurant is still a team operation, so the server can only do a good job if the bar staff and kitchen do their job well, too. So, in recognition of this, many restaurants require servers to turn over some proportion of their tips to be divided between the bar, kitchen and busboy staff. This isn’t perfect, but it is a recognition of the fact that it is a team effort, and that still, incentives matter.
[Aside on the non-financial incentives in the workplace. One of my university-era summer jobs was as a short-order cook on the breakfast and lunch shift in a diner along I-75. The servers did not tip out to me in those days, but they sure let me know if I was doing my bit to help them keep customers happy, both when I did well and when I did not. Those incentives matter too, the question is whether the employer can augment them in some way.]
Not all incentive structures seem productive to me, however. In Ontario labour law, if an employee is terminated by an employer whose payroll is greater than a stated minimum, they are entitled to severance pay, unless they ‘are guilty of wilful misconduct, disobedience or wilful neglect of duty that is not trivial and was not condoned by the employer’.
Fair enough. However, it seems that many CEOs hired by large companies (like Walmart, etc) have negotiated into their contract some kind of ‘golden parachute’ that pays them a large sum in the event the Board of Directors fires them. Now, if a Board fires a CEO, it is invariably because they are not happy about the company’s performance. So, why should said CEO then get paid some amount that dwarfs any statutory severance pay when they have just been fired?
The answer is almost always said to be that the company could not have hired said CEO in the first place without including such a parachute in their contract. In other words, the market standard is that such clauses are always offered to new CEOs, so the only thing to negotiate over is its size.
Sorry. It seems to me a winning strategy here is to say to a potential CEO ‘If you are confident of your ability to run this company, such a clause won’t matter to you, because we are going to build into your contract all kinds of good things that you will get if the company does well’. A CEO candidate who turns that down is maybe not the person you want to run your company.
I admit that this has come to mind in no small part because of my awareness that this golden parachute infection is spreading.
Two cases in point.
a) Our local city council recently entertained a resolution that city councillors who lost their re-election bids should be paid some amount (I forget how much) of severance pay. Jeezus, Mary and Yosef. As if not being re-elected is not the ultimate dismissal with cause. In the end the Council voted itself a 30% raise in salary (J,M & Y again!), but did not approve severance for themselves.
b) NCAA football coaches with big-time multi-hundred-million-dollar programs now routinely have such clauses in their contracts.
You can read the whole sorry story here, I will give you just the last three lines of it:
“This season, LSU leads the way with a $53 million buyout for firing Brian Kelly, followed by Penn State’s $49.7 million buyout of James Franklin. The largest buyout ever remains the $77 million Texas A&M agreed to pay Jimbo Fisher in 2023.”
Yes, those are the payouts given to those three fired football coaches by those three (try not to laugh) non-profit, state-supported institutions.
By the way, Texas A&M’s football team this year, two years after firing the coach who they could not possibly have hired without that $77M clause, has a 10-0 record and is ranked 3rd in the country. Wonder what the new coach’s severance package looks like?
Ok, I’m being a smart-ass here, but I have a real point: such clauses seem to me like an incentive to fail. CEOs and football coaches get a big payment if things go badly enough that the Board/Athletic Director fire them. I get why you would want such a clause if you are the CEO or coach, but not why it is agreed to by the other side(s).
My second concern is not about an incentive problem per se, but rather about something that has crept into hiring all kinds of high-level people.
To illustrate, here is another quote from the WSJ opinion piece regarding Mr. McMillon:
“He’s spent more than 40 years at the company, rising from a part-timer in a Bentonville, Ark., Walmart garden center to the C-suite.”
That, my friends is a rare thing, so far as I can tell. Very few CEOs of major companies these days actually worked at that company at all before becoming CEO, let alone for 40 years. They are mostly ‘headhunted’ by professionals who are paid by the hiring company to find and vet potential hires.
So, here’s an idea the WSJ article never considers: maybe the reason for Walmart’s success is that they had as CEO someone who knew the firm from the ground up over a career of 40 years.
Suppose you are such a CEO, and the Board decides you are not doing the job, the company is not thriving, so they fire you. Having worked there for many years, and being paid very handsomely as CEO, you would quite naturally be entitled to a considerable severance package in that case. Seems sane and fair to me.
Another observation based on my own career. It has become common practice to do the very same thing at universities in both Canada and the US, in the following sense.
The two highest level positions at a university are that of President and Provost. The former is the CEO, the guy at the top, and the latter is the person in charge of academics, which is, of course, what a U is supposed to be about. Both positions are always held by people who started out as professors, doing what I did for 42 years.
My former employer did not have a President who had risen from its own professorial ranks for the entire time I worked there. And, during my career, we had, so far as I can tell, exactly two Provosts who were appointed to that position from the institution’s own professoriate.
Early in my career, when I had been around long enough to be known outside of UWO, I would occasionally get correspondence from colleagues at other institutions saying they were looking for a new Chair/Dean/Whatever and asking me if there was anyone I knew who might be a suitable candidate. In later years, when I got such emails they were always from a headhunter firm.
So, we have universities that are run by people who neither know nor give a shit about the institution’s history, strengths and weaknesses. They are all on the ‘administrative career ladder’, not having done a regular professor’s job in perhaps twenty years. All the head-hunted Provosts are hoping to be appointed President somewhere else one day, and the Presidents are all hoping to be appointed President at some more prestigious university. They are all looking ahead, and not to the university’s future, but to their own.
Much that is wrong with today’s PSE institutions can be laid at the feet of that simple fact, and I cannot see that it is any different for profit-making companies. To deny it is to deny that knowledge of the institution you are running is important for running it well.