I’ve been complaining about the topic of this book for at least fifteen years. Actually, my basic complaint has been broader—that almost all CEOs are, when not actually idiots, indistinguishable in their abilities and performance from any moderately competent manager. If this is true (and it is), one necessary consequence is that high pay for CEOs is stupid. For example, when I entered business school, in 2000, I was dragooned into going to a talk by Jack Welch, then CEO of GE and regarded as a colossus. I discovered, to my chagrin, that he was a total moron. A little further research after going home quickly confirmed this impression, as contrarian as it was. And in my earlier life as a corporate lawyer I knew personally many other such, if less famous, lionized nonentities. Steven Clifford agrees, and the question he asks, and answers, is essentially “Why do big corporations pay so damn much to morons?”
I think The CEO Pay Machine has probably a bit too much outraged repetition of interchangeable anecdotes, and a bit too little technical exposition, but I am not a layman (in addition to my law experience, I have served on a public company board and taught business law at a major business school), so maybe Clifford’s balance makes sense. It is not easy to explain modern corporate governance simply, and it has to be simplified to make it tolerable to the layman reader. His background, as a CEO and board member himself, certainly seems to fit him to write this book, and he generally succeeds.
Clifford starts with explaining that background, as well as how, in his capacity as a member of the compensation committee of a large (private) corporation, he persuaded the board to change the multi-stranded pay offered the CEO to instead consist only of salary and restricted stock that vested over time. The rest of the book is devoted to showing why multi-strand, so-called “incentive” or “performance,” pay is stupid and pernicious, and that the correct alternative is switching to only salary and restricted stock. The author frames his discussion by noting what is well known, that American CEO pay has increased in recent decades far faster than pay for any other level of job. Often this is measured as the ratio of CEO-to-average-worker pay, which is somewhere between 300 and 700 times in America today, depending on how it’s measured, up from 26 times in 1978. The corporate governance reasons for this increase in pay are what Clifford dubs the “CEO Pay Machine.”
Before he explains the mechanics of the Pay Machine, though, he detours to make a series of claims about the negative societal effects of excessive CEO pay. The book’s subtitle is “How It Trashes America and How To Stop It”; it’s a stretch to say that CEO pay “trashes” America as a whole, and trying to show that it does sometimes makes Clifford’s reach exceed his grasp. For example, I doubt if excessive CEO pay hurts employee morale and productivity as much as he says, or reduces product quality because workers are resentful. Most workers can’t or don’t think past their next paycheck, and as Joan Williams says in White Working Class, usually the lowest-paid workers are much less resentful of the rich, who are perceived to have earned their money, than of the parasitical “professional managerial elite,” of which CEOs are not members. Clifford then spends a whole chapter solely on inequality, focusing on the “Mega Rich,” those whose income is in the top 0.1% (a level I am personally desperately striving to reach). Some of what he says is undoubtedly true—inequality has increased, social mobility is low, and the outsized gains accruing to those in unproductive fields such as finance harms society as a whole, both by misallocating talent and by reducing trust. But some of what he says is less true—it is not at all clear that inequality increases crime, or undermines democracy, or that supply-side economics is responsible for income stagnation. He also claims that “capitalism [by which he means the free market] is difficult to defend on the basis of morality or equity,” which the billions of people lifted in recent decades out of poverty by the free market would probably disagree with.
Clifford’s core point, though, is that most of the Mega Rich are business executives. Of course, if he focused on assets rather than income, which is much more important for inequality given that there is massive turnover from year-to-year in the top income getters and much less turnover among the top asset holders, business executives would be a vastly smaller percentage of the Mega Rich. But he’s not wrong that business executives take home a lot of the income pie. Which would be fine, for most of us, if they baked the income pie. But they don’t. It’s more like they steal it, still warm, from the window sill—and that’s the point of the rest of the book.
After this extended introduction, Clifford describes the Pay Machine. In brief, because of a combination of events, primarily the rise of third-party compensation consultants offering supposedly objective analysis and tax changes under the Clinton administration, boards began paying CEOs based on (roughly) the 75th percentile of pay to CEOs of “peer companies,” and expanding pay to multiple strands of cash, stock, stock options, bonuses, and so forth. (Another cause was clever theory from clever business school professors, who in my experience exemplify the aphorism, “Those who do, do; those who can’t, teach.”) When combined with additional disclosure mandated by the SEC, the risk-averse, consensus-driven culture of most boards (and their frequent domination by the CEO), along with that that the shareholders’ money is being used by the directors, this created an escalator effect that skyrocketed CEO pay. This effect was then further enhanced by favorable accounting and governance treatment given to stock options—and nobody had any incentive to stop it.
If this were all, the obvious conclusion is that such a grossly defective and expensive system in a free market should self-correct. Of course, American public companies, covered by an extensive web of regulation often desired by them, and often designed by them, hardly exist in a free market. But even without that web, the Pay Machine doesn’t correct itself, because of the thicket of myths, or “collective delusions,” that grew up around it, each of which was totally false but served to justify this bizarre system, found only in America. Clifford identifies these as the importance delusion (the CEO actually has a significant impact on company performance); the market delusion (there is a competitive market for CEOs that justifies paying them so they won’t leave); the motivation delusion (CEOs need extra pay to motivate them); the performance delusion (it’s possible to measure performance accurately); and the alignment delusion (incentives other than actual stock can align stockholders’ interests with CEO interests).
When I started my business career after business school, working briefly for a successful entrepreneur who owned several companies, he instructed me that the one key, critical characteristic of a successful businessman was “the ability to get things done.” That sounds too simple, but he was right, as I have found out for myself. Strange as it seems, most people just can’t get everything done that needs to be done. Thus, CEOs are not important—anybody who can get things done can be a great CEO, if he has a little luck, and any decent company has multiple people who meet that description. Sure, there are a few unique CEOs, Steve Jobs being the preeminent example—he “transmitted inspiring visions and authentic values to [his] employees.” (Now, of course, Tim Cook has turned social justice warrior, so we can confidently predict the gradual demise of Apple, and Jobs’s wife is blowing all the money he made for her on gun control and other left-wing policies that Jobs refused to fund, so Jobs is doubtless grinding his teeth in his grave.) But such CEOs are very rare, and always confined to founder CEOs whose wealth is usually consists of significant stock holdings in their own companies, not cash payments or stock options. Run-of-the-mill CEOs are nothing at all like Steve Jobs; they are much closer to the janitor in their importance.
I think the “market delusion” is also very important and rarely pointed out. It is simply not true that CEOs are often in demand by other companies, especially outside their own narrow industry. Unlike sports stars, paying CEOs with an eye to what is offered to their own CEOs by supposed “peers” who in reality have zero interest in hiring your CEO is dumb. Plus, as Clifford points out, most CEOs who are externally hired, in any industry, are either mediocre or total flops. Internal hiring is much more likely to be successful, as well as cheaper and easier. And the “alignment delusion” is also too often ignored—stock options, for example, are not at all the same thing as stock ownership, and create enormously distorted incentives.
All this is quite good. A problem, though, is that this comprises maybe half the book. The other half is taken up with endless, minute descriptions of the pay packages of the four highest paid CEOs in the years 2011-2014, including listing every single board member of the relevant boards. Yes, this is supposed to illustrate how the Pay Machine works, and it does, but really, it’s excessive and boring. Also, sometimes Clifford oversimplifies. He repeatedly says that “hedge fund managers and private equity billionaires pay lower tax rates than everybody else.” This is not true—they pay the same tax rates, but returns from their investments, so-called “carried interest,” are taxed as capital gains. The argument is that since that is most of their actual income, it should be taxed as ordinary income. I agree with this, as it happens (as did Donald Trump, until he was captured by the vampire squid, Goldman Sachs), but in fact they don’t pay lower rates, and this is not a “loophole.”
But the biggest failure of the book is a failure to grasp the critical role played by lawyers in this system. It is incomprehensible to most people how bottom-feeding plaintiff’s lawyers circle any public company like sharks, looking to jump on any event that can be cast as a problem, as an excuse to file a cookie-cutter lawsuit and extort money from the shareholders to benefit themselves, under the guise of benefiting the shareholders. This is the one of the main reasons compensation committees use outside consultants. They see perfectly clearly that the system is rigged to benefit CEOs, and they understand that “everybody does it” is a stupid response. But it is the only response that prevents the lawyers from seeing a possible weakness and zooming in for the kill. Paying a CEO less than other companies, if the company then does poorly, is guaranteed to get a lawsuit that may be very hard to get rid of. Any sticking out from the crowd attracts the sharks; better to stay within the herd. While Clifford mentions lawyers and lawsuits once or twice, and he must be aware of this problem, he almost totally ignores it—even though it is a big part of the explanation why excessive CEO pay only happens in America, with our uniquely lawyer-friendly system.
Clifford ends up where he began, recommending that all big company CEOs only be paid with a salary (1/3 of compensation) and restricted stock grants vesting over time (the other 2/3, with a clawback of the latter if corporate performance is lower than an objective benchmark, such as the S&P 500. No stock could be sold while a CEO worked for his company (up to 50% of the value could be used as collateral for loans, though Clifford does not address what happens if the value drops and a margin call is made, or discuss the need to restrict more sophisticated hedging structures that eliminate risk). Pay in general should be established mostly based on “internal equity”—that is, to be not excessive relative to the pay of others working for the company. Any pay, in any form (including perks) over $6 million would incur a dollar-for-dollar increase in corporate tax.
These are all great ideas. I wholly endorse them. Unfortunately, as with so many good ideas, the political will to implement them is lacking, and the ability of the malefactors of great wealth to manipulate the political system to their benefit appears nearly infinite, which is why the Trump administration is packed with Goldman Sachs functionaries, their allies, and their sycophants. Clifford seems to think someone like Bernie Sanders would be different, which is, um, unlikely. But when, and if, the political stars align, a book like this could be very valuable to policymakers creating a new dispensation.