The Economist Review of Indispensable

The Economist just published its review of my book, Indispensable and Other Myths: Why the CEO Experiment Failed and How to Fix It (University of California Press 2014). You can read the review here:|c.

I’m very grateful for the review, and I especially love the description of the book as “an all-guns-blazing attack on the way that Anglo-Saxon companies pay their bosses.” I’m afraid the critique wasn’t very good, though. It consists of only two paragraphs (the last two of the review), neither of which really engage the book’s central argument or the evidence that backs it up.

The first of these critical paragraphs seems a bit scattered. It asks if serious reform is possible, then jumps to saying that U.S. companies have had a difficult fifteen years, then cites examples of some successful U.S.companies before jumping again to an argument that pay “tightened up” after 2000. The paragraph concludes with an assertion that CEO pay is roughly on par with what hedge fund managers, leading writers, and some trial lawyers make.

I’m not sure what the connection is between these thoughts; they seem quite separate. Taking them in order, the author is certainly correct that shifting back to guaranteed pay will be very difficult. I make that point, at length, in Chapter 10. That is why I suggest an alternative form of performance pay, one that I believe will come without most of the pitfalls of the current structures. That too will be a difficult case to make to boards and shareholders, but I have to think that smart businesspeople will ultimately pay attention to what the data shows quite clearly: the current forms of performance pay are not producing better corporate performance.

It’s hard to know how to reply to the rest of the paragraph. Some companies have struggled recently while others have done well. True, but completely irrelevant to my point, which is that performance pay does not induce better performance. Pay “tightened up” after 2000. Also true, as I describe in great detail. When pay is tied to equity, it drops when the stock market drops. Since the market had a difficult decade after 2000, so did CEO pay. Now that the stock market has recovered, CEO pay has been rising again.

My primary concern is not with the amount of CEO pay, but the value companies are receiving. If higher CEO pay led to better corporate performance, I’d be all for it. It doesn’t, though, so companies are paying many multiples of historic norms for performance that isn’t any better. That’s the problem. Comparing CEO pay to the upper echelons of hedge fund managers, writers, or trial lawyers is completely irrelevant to what should be the central questions: are companies getting good value for their money, and are they structuring CEO pay in the most efficient way possible? I argue that the answer to both questions is “no.”

The second critical paragraph (the final one of the review), worries about the impact of guaranteed pay, citing the cautionary example of U.S. public schools. There are many industries that use salary as the primary form of compensation for their workers, including most public corporations for that matter. Some of these are successful, some are not, but I’m not aware of any evidence that guaranteed pay is at fault for the problems any of them are having. In fact, there have been experiments with performance pay in public schools, to test whether tying a teacher’s pay to the students’ performance will result in better performance. These experiments have generally been acknowledged as failures. Performance pay does not measurably improve students’ educations. You can see some studies here and here. There are some studies that point the other way, such as this one, but they seem to be in the minority (and that study could not rule out alternative explanations for the observed effects).

The last paragraph also raises the specter of losing CEOs to private companies or hedge funds if we shift to a different form of pay. This seems unlikely (and also contradicts the author’s earlier statement that CEOs might prefer guaranteed pay). Running a major manufacturing concern requires quite a different skill set than running a hedge fund, and the hedge fund market is, if anything, drying up as investors realize they are not receiving returns commensurate with the fees hedge funds charge. Private companies are a greater potential competitor for CEO talent. But the “talent war” the author alludes to does not exist. As a study by Elson and Ferrere points out, there is no real market for CEO talent. The vast majority of public company CEOs were not CEOs elsewhere before they received the top spot. It is relatively rare for a company to hire a sitting CEO away from another company.

The last line asserts it would be an “odd world” if private equity company owners could get “seriously rich” but CEOs of major corporations could not. But we lived in exactly this “odd world” from the 1940s through the 1970s. For over thirty years, the average pay at large public companies remained flat at around $1.4 million in today’s dollars. That’s substantial, but hardly “seriously rich.” And those CEOs were paid mostly in straight salaries. Yet companies ran quite well during that period, and they did not hemorrhage talent to private companies.

It’s worth emphasizing how thrilled I am that the Economist reviewed my book and gave the review so much space. I plan to wallpaper my office with it. But I do wish the reviewer had paid a bit more attention to the evidence I cite in the book and less to her/his intuitions about what might work.


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