CEO compensation II

Profpaj left a comment to my post yesterday on CEO compensation in which he said:

Page 32 of the Jan. 22, 2007, issue of The New Yorker describes a study done by University of Texas professors that shows high CEO compensation is not related to better company performance. Instead high CEO pay is related to the connectedness of board members (caused by individuals being on several boards).

which prompts me to share a bit more of that New Yorker article with you:

Unfortunately, the more connected board members are, the likelier they are to overpay for executive talent. In some cases, which economists call “interlocking” directorates, this is straightforward: I sit on your board and you sit on mine, and we both have an incentive to be generous. Sure enough, several studies have found that companies with interlocking directors pay C.E.O.s significantly more. Surprisingly, though, connectedness remains important even when the links are not direct. A study of S. & P. 500 companies, by Amir Barnea and Ilan Guedj, finance professors at the University of Texas, found that, even after other factors were accounted for, C.E.O.s at companies whose directors sat on a number of other boards were paid thirteen per cent more than C.E.O.s at companies whose directors were not.

...It’s tempting to wonder if the sheer prevalence of enormous C.E.O. compensation packages means that they have some beneficial effect. But academics have found little evidence that higher executive pay leads to better company performance, and the recent study of three thousand companies actually found that the firms whose directors were the most well connected—and which paid their C.E.O.s most lavishly—in fact underperformed the market. Markets work best when people make independent decisions about how much a commodity—in this case, the C.E.O.—is worth. They stop working well when people simply imitate what others are doing, or when non-market factors (like how well you get along with the boss) intrude. In the end, the very things that make people likely to join a board—connections, business experience, sociability—are also the things that make them less effective once they do.

I have little doubt that these guys all think they're worth the grossly inflated compensation packages they have, but there's really very little reason to believe they are.

Furthermore, in my experience many of them tend to neglect the actual inner workings of their businesses -- the nuts and bolts of the shop foremen, the plant managers, the sales folks on the road, the new product designers, or the capital investments needed to compete in the future. For the most part, these activities tend to be rather tedious as compared to the excitement of wheeling and dealing in the mergers and acquisitions markets, and it is these activities that many of the highest paid CEOs devote almost all of their time to.

Much of the resulting churning of companies -- consolidating them first and spinning them off later only to re-consolidate them still later -- may tend to be exciting for the CEOs and (although I suspect it is more the exception than the rule) may even help the market adjust to the more extreme over- and under-valuations, but it has almost nothing to do with the efficiency with which the underlying businesses are run. In that sense it is merely wealth transfer rather than wealth creation.

More importantly, almost no one pays any attention to the real purpose for having industry in an economy, which is not wealth creation, per se, but job creation. After all, what good is industry to an economy if it fails to create jobs? Wealth creation was merely the incentive that was expected to lead to job creation, but that link seems to have become broken in the modern global economy.