Last Updated Aug 27, 2010 3:52 PM EDT
These days, most executive compensation sections go on for pages and pages with all kinds of ridiculously complex formulas and schemes even a crazed math genius couldn't figure out. The only thing they all have in common, aside from being sad and funny at the same time, is that they don't work. That means executives are obscenely compensated regardless of company performance.
This raises several rather important questions we'll try to answer:
- What really is the problem here? Is pay-for-performance a bad idea, a scam, or just a universally botched implementation?
- How did it get this way?
- And of course, the trillion dollar question, how do "we" fix the problem -- um, and who is "we" in that sentence?
Long ago investors got fed up with out-of-control executive compensation, so some genius came up with the idea of pay-for-performance. It made sense in theory and lots of companies, particularly in the high-tech industry, do it reasonably well.
Most of their executive compensation is in stock options. The stock goes up, execs make a bundle, the stock goes down, they make nothing. Of course, there are ways to manipulate that system -- stock repricing and option back-dating, for example -- but let's not overcomplicate things.
Unfortunately, corporate boards in other industries just said, okay, you want pay-for-performance, we'll give you pay-for-performance. For them, that's meant execs make obscene amounts of money if the company does poorly, and really, really obscene amounts of money if it does well.
Investors weren't happy with that, but the more nosey they got about the process, the more complex the compensation schemes became. And slowly, over time, executive compensation just kept rising and rising, like a big fat hot air balloon; the higher it goes, the more shareholder returns shrink.
How Did It Get This Way?
Well, corporate governance is really a myth, a euphemism for corporate self-governance. Boards are mostly made up of tired old former executives, hand-picked by the company's CEO and with minimal, if any, skin in the game.
What about investors? Unfortunately, the real investors -- you and me -- are too far removed from the problem. You see, institutional investors -- Barclays, State Street, Vanguard, Fidelity, and the like -- now own most of corporate America. Sure, it's actually our money, but the banks -- that's what they really are -- don't care; they get paid regardless of company performance. So they just spread your money around evenly, like peanut butter, so it looks like they're diversifying their portfolios and moderating risk.
It's essentially a runaway system with no checks and balances. See, I told you this wasn't complicated.
But how do we fix it? Now that's the rub. I've written about this before, and the fix seems to scare people. You see, it requires a moderate revamp of how corporations are structured and governed and how banks and markets are regulated. They do this reasonably well in the U.K., so it is doable.
But these days, if it isn't a quick fix, a silver bullet, a sound-bite, or a pill, it doesn't happen. You see, there's no corporate governance "diet" companies can go on to fix their bloated executive pay. But like I said, it is doable -- it just requires some fiscally conservative and intelligent leadership in Washington that has the people and the nation's best interests at heart. That's all. And I guess that's up to you and me.