CEO compensation – a symptom of institutional decay

So reading Emergence sprouted another thought regarding the increasingly bankrupt (literally and figuratively) model of the classic bureaucratic organizations. Again I point to Umair Haque’s post on the recent financial crisis:

The first step in building next-generation businesses is to recognize the real problem boardrooms face – that we’ve moved beyond strategy decay. Building next-gen businesses depends on recognizing that they are not about new business models or even new strategies.

The stunningly total meltdown we just witnessed in the investment banking sector – the end of Wall St as we know it – was something far darker and more remarkable. It wasn’t simple business model obsolescence – an old business model being superseded by a more efficient or productive one. The problem the investment banks had wasn’t at the level of business models – it had little to do with revenue streams, customer segmentation, or value propositions.

And neither was it what Gary Hamel has termed “strategy decay” – imitation and commoditization eroding the returns to a once-defensible strategic position, scarce resource, or painstakingly built core competence.

It was something bigger and more vital: institutional decay. Investment banks failed not just as businesses, but as financial institutions that were supposedly built to last. It was ultimately how they were organized and managed as economic institutions – poor incentives, near-total opacity, zero responsibility, absolute myopia – that was the problem. The rot was in their DNA, in their institutional makeup, not in their strategies or business models.

I think Umair is on to something and that CEO salaries may make for a great case in point.

For many years the left has decried growing CEO salaries as a sign of the market’s excesses – or worse, of a broader culture of greed. But excessive senior management salaries are, from an investors perspective, are a symptom of a staggeringly flawed institutional model. If your business depends that much on the one person at the top – if the current and future value of the entire organization rests in the hands of one person… then yikes! Shareholders beware.

The idea that a CEO is worth 1000, or even 100 times more than the “average” workers in an organization isn’t just a problem from a morale or ethical perspective (it may or may not be). If your average worker isn’t contributing that much value in relation to their ultimate superior than you have a massively top heavy – and hierarchical – organization. One where, I suspect, Umair would find there are poor incentives, near-total opacity, zero responsibility, absolute myopia. To be sure, ideas are probably not being floated about, and they are almost certainly not successfully emerging from the bottom up.

In short, it isn’t a happy place to be. And it turns out the markets may not think it is so good either.

3 thoughts on “CEO compensation – a symptom of institutional decay

  1. rabbit

    Massive CEO incomes are a sign that the owners aren't in charge anymore. The managers have taker over the business, and neutralized the shareholders.I do not understand how one can justify managers being on the board of directors. I REALLY don't understand it when the chairman is also the CEO (a practise, thankfully, which appears to be dying out). One of the primary responsibilities of the board is to ensure that proper management is in place, and they can not do that when they ARE management.

    Reply
  2. ALo

    It would be worthwhile to trace the reasons behind the growth in CEO's salaries, which is a more recent phenomenon (I don't have the stats on hand, but the many multiple differential with the average worker has accelerated dramatically in the last 20 years and more recently, I believe, since Sarbanes-Oxley).A hypothesis: a driver behind this increase has been the disclosure rules that make it imperative for public companies to publish the salaries of their senior executives. That, coupled with the work of compensation consultants, reinforced by heady economic times, tighter talent markets and the rise of the celebrity CEO, has likely been a huge driver of the increase. Once the information was readily available, companies/individuals could see how their pay scales compared to others in their industry. This put a huge pressure on Boards of average or lower-paying organizations to put in raises… after all, who wants to be below average? And why should that guy at that company over there get paid more than me? The cumulative effect of that has been a rapid increase in overall compensation levels for senior executives… and all the ugly side-effects it brings.Great example of unintended consequences. And also raises the question – are there some things for which a lack of transparency is preferable?

    Reply
  3. ALo

    It would be worthwhile to trace the reasons behind the growth in CEO's salaries, which is a more recent phenomenon (I don't have the stats on hand, but the many multiple differential with the average worker has accelerated dramatically in the last 20 years and more recently, I believe, since Sarbanes-Oxley).A hypothesis: a driver behind this increase has been the disclosure rules that make it imperative for public companies to publish the salaries of their senior executives. That, coupled with the work of compensation consultants, reinforced by heady economic times, tighter talent markets and the rise of the celebrity CEO, has likely been a huge driver of the increase. Once the information was readily available, companies/individuals could see how their pay scales compared to others in their industry. This put a huge pressure on Boards of average or lower-paying organizations to put in raises… after all, who wants to be below average? And why should that guy at that company over there get paid more than me? The cumulative effect of that has been a rapid increase in overall compensation levels for senior executives… and all the ugly side-effects it brings.Great example of unintended consequences. And also raises the question – are there some things for which a lack of transparency is preferable?

    Reply

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