Saturday, February 9, 2013

Executive Compensation and Innovation


It is shareholder annual meeting time of the year. I received a packet from a company I am invested in asking me to vote on a number of issues. This is a company with significant engineering resources so it hits close to home. In fact, knowing more than one engineer that works there is part of the reason I invested. One of the major issues, and actual the first thing to vote on, was executive compensation. Of the about 60 page packet, more than 20 pages were devoted to executive pay. Most of the pages are devoted to talking up the executives, how awesome the company and stock has done since they have been there, and how underpaid they are compared to comparable companies. Then finally 15 pages through the section the last three years of compensation is listed. About $19 million last year, about $18 million the year before and $13 million in 2010. 

Yes, I think CEOs should be compensated more than everyone else in the company. Yes, I think they should have equity in the company so that their interests are aligned with the shareholders. No, I do not think that a non-founding CEO should be paid four times as much as the people directly under him or 300+ times as much as his secretary. 

In 2010, I made less than $5000 for the four and a half months that I worked during the entire year. In March or anytime after I would have taken a full time engineering job (or “internship”) for half of what I make now. The company could have hired 200 new engineers, or 200 of almost any type of people in 2010. Yet it did not hire me. That company and I each wasted 2000+ hours of quality engineering time and the CEO of this company took home more than I might make in a lifetime. Personally, I feel that the difference between $1.9 million and $19 million in terms of actual quality of life or motivation to be nearly negligible. In other words, 900% more money might mean only 7% more effort, from one guy. I don’t see the value created. 

Coming at this from another angle, while I was in Singapore I met the human resources compensation director for an international US company with operations in 17 countries. I took a four hour bus tour of the city and young white guys kind of stick out to each other in Asia so we talked a little. We talked about how in India there are three levels of hierarchy or seniority for every one level of engineering in the United States. It seems like people in India get promotions all the time, but still do the same job. Then I asked about executive compensation. His succinct answer was simple, and completely mind boggling how truly unscientific it was. They look at what comparable companies pay their executives. 

I suddenly felt duped. Instead of a concrete way to measure value, like how I can justify my salary through cost savings and warranty reductions of my projects, executives are paid based on what other executives are paid. Then raises, extrapolating from shareholder documents received above, are determined by corporate profits and growth and with a little bit related to executive experience. This particular CEO who was paid $19 million in 2012 is being proposed a 9% pay raise. I can not justify these expenses, I will vote no. I do not see how one person can be worth more than 1000 times minimum wage, especially after I have worked for minimum wage a number of times. This company should invest in innovation, people, the future, or at least a bigger dividend rather than lining the pockets of such a small group of people. 

What kind of executive compensation innovations do I propose? A salary cap, not based on any government number, but as a ratio to the other employees in the company. Such as perhaps no one could be paid more than 100 times the lowest paid employee. Even at minimum wage that is $725 an hour, which is not terrible. Plus, if the CEO wants $800 an hour, then everyone in the company would probably get a raise. It brings everyone up at the same rate. Another idea, is to give the CEO the raise of the median worker every year. If that is only two or three percent so be it. I say that because the CEO's income is directly tied to the company and the people he manages. Some might say the CEO is the best employee at the company, give him the highest raise, but I say the CEO is the median CEO of the company who's fortune rises and falls with the success of the whole organization. Let his or her compensation reflect that. 

A disclosure of thoughts on billionaires, I do feel that founders ought to be rewarded highly for their innovation be it in business models or products or 100 hour weeks or whatever it is they do to found an organization. Mark Zuckerburg for example started something unique, I say pay the man for such innovation. Same for Bill Gates and other superstar creators. But a CEO that is simply moving into an established role through business school and the 40 year corporate pyramid climb is not the creator or innovator. He didn’t create a new pyramid, he simply got to the top of one of them. I feel there is a difference between founder equity and management equity. One is much harder to gain. 

2 comments:

  1. Isaiah,

    Ben and Jerry's had a similar limited salary ratio at one point. Early on, nobody at B&J's made more than 5x (and later 7x) anyone else. When Ben left the role of CEO, they couldn't find anyone to work for as little as he was making, so the ratio blew up to something like 400-to-1. The reason that executives are paid comparably between companies is so that they don't leave to somewhere they will be paid more. You'll find that in some industries (such as aerospace engineering) engineers mostly receive raises to keep them at a comparable level with engineers at other companies.

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    1. Yeah, it's the same in automotive and construction engineering as well. It's just interesting that the ratio is 400 to 1!

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