Executive Excess Part 2
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JIM LEHRER: Now, part two of our series on executive pay and performance. Last night, our business correspondent Paul Solman of WGBH-Boston looked at the causes of the growth in CEO pay. Tonight: How free is the marketplace that determines that pay? Here again, Paul Solman.
PAUL SOLMAN: Earlier this year at Babson College, a business school outside Boston — a discussion of the $100 million-a-year pay package of former Tyco CEO Dennis Kozlowski.
PAUL SOLMAN: How many of you think the contract Kozlowski had was over the top, unreasonable, unethical in the sense of what he deserved to make? How many of you think it was not unethically high, that it was reasonable what he was getting?
MAN: I don’t want to say he makes too much money, because then I cut myself off. I’d love to make that amount of money.
PAUL SOLMAN: This attitude helps explain the ambivalence afoot in America these days. In the past few decades, most of us have experienced modest pay raises at best, and they are put off and, if not shocked, by the huge CEO pay packages of recent years: Oracle’s Larry Ellison and his $3/4 billion in 2001; Apple’s Steve Jobs, nearly $400 million in the year 2000; Michael Eisner’s roughly $1 billion take since becoming CEO of Disney. Nobel Prize-Winning economist George Akerlof puts it bluntly.
GEORGE AKERLOF, University of California, Berkeley: This is very bad behavior, just to pay yourself out a large amount. The public is very angry about such behavior, and in fact, rightly so.
PAUL SOLMAN: But many members of the public also feel, like these business students, that CEO mega-pay is justified.
WOMAN: I think that’s one of the things that’s really great about our culture is that we believe that we all can rise to the top, and we all can be CEO’s that have this kind of compensation plan, and so therefore when somebody negotiates a plan like that for themselves, we’re completely behind it.
PAUL SOLMAN: Now, this was early June, before Kozlowski’s indictment for stealing $600 million in company funds. Still, at the time of our Babson College taping, he’d already been indicted for evading sales taxes on 19th century paintings, and had resigned. But to the Babson students, that didn’t change the basic principle of economics.
MAN: It’s laissez-faire, meaning that if the market was willing to pay him five gazillion… then he deserves to be paid that amount to do something.
PAUL SOLMAN: Six.
MAN: Six gazillion, whatever.
PAUL SOLMAN: A gazillion, a gazillion. The students were voicing an old theme in economics that’s been revived, even revered, in recent years: Laissez-faire– let the market be free, and those who deserve to, will get their just rewards. That’s become the standard explanation for why CEO pay has shot up in their lifetimes, from 40 times the average worker’s pay in 1970 to more than 100 times in 1990 to some 500 times today. Laissez-faire is even used to justify lavish retirement packages, like Jack Welch’s from GE. Lifetime tickets to New York’s Yankee stadium and Boston’s Fenway Park, a Manhattan penthouse, and numerous other perks that came to light in his divorce case, and that critics like Graef Crystal now mock.
GRAEF CRYSTAL: When this thing broke, I think you had… you had Queen Elizabeth II checking into a local London hospital with a severe case of perk envy.
PAUL SOLMAN: Jack Welch’s response? The free market was just doing its thing.
JACK WELCH: Do shortstops over here deserve that much? Do anchors on television deserve that much? Free markets aren’t perfect. Capitalism isn’t perfect. But it’s the best system we have.
PAUL SOLMAN: CEO pay consultant Joseph Bachelder agrees.
JOSEPH BACHELDER: There aren’t that many outstanding professional athletes, and not that many outstanding executives to lead major U.S. corporations.
PAUL SOLMAN: But is the market for CEOs as free as the market for athletes? We put the question to the pioneer of free market bargaining in sports, former baseball union lawyer Marvin Miller.
PAUL SOLMAN: A number of people say that CEO compensation is the same as the high salaries that are paid to, for example, baseball players. Is that true? False? Ridiculous?
MARVIN MILLER, Retired Baseball Union Lawyer: I choose ridiculous. (Laughs) You have to consider how salaries are set and by whom in each case.
PAUL SOLMAN: In baseball, salaries are set by owners spending their own money. And even the richest of them, like the guy who owns the Yankees, have an interest in keeping salaries down. CEO pay expert Graef Crystal.
GRAEF CRYSTAL: George Steinbrenner isn’t going to give you a nickel, if he can avoid it. He’s the owner and it’s his money, and he doesn’t want to pay those baseball players any more than he has to. And I’m sure he just agonizes over what he does pay them.
PAUL SOLMAN: But who pays the CEO? A board of directors, usually hand-picked by the CEO.
MARVIN MILLER: When your salary is determined by people who are beholden to you, as is the case of CEO’s, then there’s no…there are no brakes. The sky is the limit.
PAUL SOLMAN: The key point is that in free market, laissez-faire economics, you’re paid for performance. And with some exceptions, that’s how it works in sports: The best performers make the most money. But are the CEO’s who make the most money, like Michael Eisner of Disney, which owns the world- champion Anaheim Angels, the best performers on their playing field?
SPOKESMAN: Congratulations to Disney, to Michael Eisner.
PAUL SOLMAN: Well, Disney’s stock’s been under siege, and hundreds of studies show little if any correlation between CEO pay and company performance, as measured by profits or stock price.
So in economic terms, perhaps this is a bigger story than just the advent of CEO mega-pay. Indeed, critics like Robert Kuttner charge that it shows one thing: the forces necessary to make free markets fair have lost their grip.
ROBERT KUTTNER, Editor, The American Prospect: Unions have gotten weaker. Government regulation has gotten weaker. SEC disclosure has gotten weaker. So there’s nobody shining lights on this. And the ability of insiders to have conflicts of interest has gotten stronger. That’s why CEO compensation completely unrelated to whether the company is doing well or badly has exploded.
PAUL SOLMAN: In fact, more and more economists are wondering if the CEO pay market is free, or rigged. Case in point: The windfalls CEO’s have been making in stock options. Harvard Business School’s Brian Hall explains.
BRIAN HALL, Harvard Business School: A stock option is the right to purchase the stock at a particular price that’s set in advance. So for example, if the current stock price is at $50, most executives will receive a stock option with an exercise price of $50. So obviously, if the stock price rises to $70 or $100, or $570, they make the profit between the new price and the old price.
PAUL SOLMAN: The theory, says Hall, was that options would align CEO pay with performance. If the stock shot up, the CEOs options would be worth big money for having enriched the shareholders. But instead, says Berkeley’s George Akerlof, CEOs had an unfair advantage, could persuade investors to be bullish, even about a firm with bearish prospects.
GEORGE AKERLOF: They have a very big incentive to see that their stock price goes up. Well, what determines whether the stock price goes up?
PAUL SOLMAN: Perception, says Akerlof — how well buyers of stock think firms are performing.
GEORGE AKERLOF: And how well the buyers think that the firms are doing depends of course upon the information they have, the accounting. Instead of being an incentive for CEOs to do well, these stock options have been a very big incentive for CEOs to do badly.
PAUL SOLMAN: In other words, says Akerlof, CEOs can manipulate financial information to boost the stock price, so they can cash in their options. We’ve seen illegal examples of this at Enron, for example, known as the crooked “E.” But George Akerlof won his Nobel Prize for pointing out, in his paper on lemons in the used car business, that unequal information can give anyone the incentive to trade on it, which in turn can corrupt a market, like that for used cars, or CEO’s.
GEORGE AKERLOF: The public thinks that this is an issue of left versus right. We should have either free markets or regulated markets.
PAUL SOLMAN: But Akerlof thinks freedom and regulation go hand in hand. After all, it took the so-called lemon laws to restore confidence in the used car market.
GEORGE AKERLOF: So let’s have free markets. But when you have the free markets, you also have to watch over them.
PAUL SOLMAN: That’s why Akerlof thinks a more vigilant, well- funded SEC is so important, why the current disarray at the Commission has him so concerned. But free market enthusiasts, for their part, aren’t worried. The market itself will adjust, they say — is already doing so. After all, the stocks of firms with manipulative CEO’s seem have plummeted. Moreover, some big institutional money managers are now putting pressure on boards to become more independent and reign in CEO pay.
KURT VONNEGUT (television commercial): I have always depended on the kindness of fiduciaries.
PAUL SOLMAN: — institutions like TIAA-CREF, which represents Kurt Vonnegut, Jr., It’s ads boast, and millions of current and future retirees. TIAA-CREF will be henceforth voting its shares to eliminate stock options for CEO’s, says VP Peter Clapman.
PETER CLAPMAN, TIAA-CREF: We want them to have stock. We want them to buy stock. We want them to have significant equity holdings where they will feel the pain of a loss the same way we, you and I, feel the pain of a loss.
PAUL SOLMAN: In the end, then, for those who believe in laissez-faire markets, Clapman’s shareholder activism is an example of inevitable self-correction, that stays true to the spirit of free market capitalism. Pay consultant Joe Bachelder puts it somewhat differently.
JOSEPH BACHELDER: You want to get a certain price for your house. You want to get a certain price for your stock. Why shouldn’t a CEO seek to get the price that he or she wants for his or her services?
PAUL SOLMAN: But to those who think this market needs plenty of help, it may be a case of too little, too late.
ROBERT KUTTNER: But if you take a long enough view, the country eventually recovered from the great depression. The market worked. But in the meantime, there was a lot of pain and suffering that was unnecessary. You shine enough light of publicity on this, even these shameless companies maybe get shamed into changing their policies. But that’s not a case of markets working. That’s a case of markets failing and then investigators catching the scoundrels and forcing reform.
PAUL SOLMAN: That’s true of those who’ve arguably broken the law, think Kuttner and others; and more controversially, they think it’s also true of those CEOs who made great gobs of money in the name of a supposedly free market.