CEO remuneration still a sticky issue - Jack and Suzy Welch - July 6, 2008

http://www.thetimes.co.za/Careers/Article.aspx?id=795934

No overall system of setting pay is better than the free market

Top managers in the United States and Europe have been
harshly criticised lately for their growing salaries and bonuses. Is
the problem due to bad communication, or greed? — Stefan Eiselin,
Switzerland

You can be sure both bad communication and greed have
something to do with the heated controversy over executive
compensation.

Some companies surely are not clear or candid enough in
explaining why their top people earn what they do, and some top people
probably want to earn more than they’re worth. That said, we would
actually suggest another reason for all the recent sound and fury over
CEO pay. Clashing ideologies.

That’s right: We think the debate over executive
compensation is exactly as it appears — a philosophical divide. There
are those who believe that many CEOs just make too much money compared
with average workers and their relative value to the organisation, and
that someone — be it the shareholders themselves or government
regulators — must close that gap. Outsized CEO compensation, this group
generally believes, is bad for society and morally wrong. Then, there
are people who generally don’t say what they believe, because it’s so
politically incorrect. But allow us to step in, because we share their
view. Yes, most CEOs make a ton of money, and sometimes they make too
much. But in the market economy, salaries are set by supply and demand.
The companies that field the best teams win and, because of global
competition, the best teams tend to be expensive.

Now, is this free market system of pay perfect?
Absolutely not, which is why it sometimes happens that under-performing
CEOs receive huge sums of money when they are fired. These situations
can be hard to avoid. Some CEOs — former Hewlett-Packard chairman and
CEO Carly Fiorina, for example — get large severance deals because
their boards, without an internal successor, guaranteed them to sign
on. Others, like former Citigroup chairman and CEO Charles Prince and
Merrill Lynch’s former chairman and CEO Stanley O’Neal, left their
troubled companies with more money than some people would have liked,
because of stock grants and compensation earned during more successful
years.

Such endings look and feel wrong, but invites criticism.
But from where we stand, no overall system of setting pay is better
than the free market. Indeed, one of the best things about it is that
it rewards companies that perform well, and those tend to be the talent
magnets that pay everyone well, from the CEO to the front lines.
Moreover, there’s just no better alternative. Forget government
involvement. Politicians will want to outdo one another with promises
of putting CEOs in the poorhouse. The CEOs will appear at Capitol Hill
hearings every year to explain their business models, describe their
competitive situations and defend their pay packages as they relate to
both. Now, there’s a productive use of everyone’s time!

As for shareholders setting pay, the problem comes less
in the ideology of it than the logistics. How can thousands of people
formulate a company’s pay levels? The insurance company Aflac recently
agreed to let its shareholders vote annually on the compensation of its
top five managers. The vote is nonbinding, but perhaps it will meet the
needs of its supporters for some sense of input. And a sense of input
is actually about all that shareholders should have. Because it is
ultimately their elected representatives, the board, that must set
executive compensation, as its members are the closest to the company’s
challenges and the top team’s performance, not to mention the cost and
viability of replacing the CEO or other executives. They know, in other
words, the free market’s human resource landscape. Sure, cronyism is
always a worry when boards determine the top team’s pay. Luckily,
there’s a check-and-balance in the company’s financial performance and
stock price. A board can overpay a CEO, but not forever.

The debate over executive pay, by contrast, may last that
long. One side wants the community, or some subset of it, to set CEO
pay and the other believes the market forces of supply and demand
should play that role. Perhaps, as you suggest, greed and bad
communication are involved in the mix, but as ideological debates go,
this is one for the ages.