10 May 2007
Executive Pay and Competition
Today (10th May 2007) the Financial Times published a letter of mine about Executive Pay.
The letter can be accessed (by subscribers) on the Ft.com website at: http://www.ft.com/cms/s/0977b7b2-fe93-11db-bdc7-000b5df10621.html .
The letter was writen in response to an article by Clive Crook (FT 3rd May 2007) which can be accessed (by subscribers) at http://www.ft.com/cms/s/1850f93a-f928-11db-a940-000b5df10621.html .
This is the text of my letter:
Sir, Clive Crook makes an interesting analysis of the proposition that America's rewards-for-merit contract is breaking down ("America frets about executive pay", May 3).
He refers to Prof Lucian Bebchuk's evidence that patterns of top pay reflect an abuse of management power. Mr Crook appears to accept these arguments in specific cases, but seems reluctant to accept that there is a system-wide problem, because market forces should be expected to deliver appropriate outcomes on executive pay.
If there was a well-functioning competitive market in executive talent then we would expect executive pay to reflect changes in supply and demand in that market; more big companies needing leaders would push pay upwards, more suitable candidates would push pay downwards. Instead, as Mr Crook observes, the growth of CEO pay appears linked to the growth of the companies they manage, and has very little to do with supply and demand. Mr Crook believes that this anomaly can be explained because the CEOs of big companies are not readily interchangeable.
Clearly they are not readily interchangeable, but this fact increases the market power of the incumbents. It should make us more rather than less concerned about the abuse-of-power hypothesis.
Clearly, many people compete to become CEO of large organisations, and it is very difficult to secure such jobs. However, all the competitors benefit if executive pay moves generally upwards, and collectively they have the power to ensure that it does.
This kind of competition has nothing to do with the economically efficient competition that squeezes out surplus costs for the public good. There is indeed a very serious system-wide problem.
Patrick Gerard
As the above letter suggests, there are serious problems with the way that competition works in the market for executive talent. This matter should be investigated by competition authorities. I myself have raised the matter with the Office of Fair Trading in the UK (follow the link "Competiton Law" in the left hand column) and the US (see blog entry for 3rd August 2006).
The letter can be accessed (by subscribers) on the Ft.com website at: http://www.ft.com/cms/s/0977b7b2-fe93-11db-bdc7-000b5df10621.html .
The letter was writen in response to an article by Clive Crook (FT 3rd May 2007) which can be accessed (by subscribers) at http://www.ft.com/cms/s/1850f93a-f928-11db-a940-000b5df10621.html .
This is the text of my letter:
Sir, Clive Crook makes an interesting analysis of the proposition that America's rewards-for-merit contract is breaking down ("America frets about executive pay", May 3).
He refers to Prof Lucian Bebchuk's evidence that patterns of top pay reflect an abuse of management power. Mr Crook appears to accept these arguments in specific cases, but seems reluctant to accept that there is a system-wide problem, because market forces should be expected to deliver appropriate outcomes on executive pay.
If there was a well-functioning competitive market in executive talent then we would expect executive pay to reflect changes in supply and demand in that market; more big companies needing leaders would push pay upwards, more suitable candidates would push pay downwards. Instead, as Mr Crook observes, the growth of CEO pay appears linked to the growth of the companies they manage, and has very little to do with supply and demand. Mr Crook believes that this anomaly can be explained because the CEOs of big companies are not readily interchangeable.
Clearly they are not readily interchangeable, but this fact increases the market power of the incumbents. It should make us more rather than less concerned about the abuse-of-power hypothesis.
Clearly, many people compete to become CEO of large organisations, and it is very difficult to secure such jobs. However, all the competitors benefit if executive pay moves generally upwards, and collectively they have the power to ensure that it does.
This kind of competition has nothing to do with the economically efficient competition that squeezes out surplus costs for the public good. There is indeed a very serious system-wide problem.
Patrick Gerard
As the above letter suggests, there are serious problems with the way that competition works in the market for executive talent. This matter should be investigated by competition authorities. I myself have raised the matter with the Office of Fair Trading in the UK (follow the link "Competiton Law" in the left hand column) and the US (see blog entry for 3rd August 2006).
Labels: Bebchuk, CEO, Clive Crook, Competition Law, power
03 January 2007
Home Depot & Bob Nardelli
I sent the following letter to the FT on 3rd January 2007. It was not published.
Dear Sir,
I find it ironic that the departure of Bob Nardelli from Home Depot is being described as a victory for shareholder activists, who thought he was overpaid. Your report (Home Depot chief Nardelli steps down – ft.com, 3/1/07) suggests that Mr Nardelli will receive a severance package worth $210m, in addition to the more than $120m that he has received in compensation since joining the company. The problem of overpayment is therefore even greater now that Mr Nardelli is not running the company!
Home Depot’s share price rose 3% on this announcement, suggesting that shareholders value the potential improvements in performance far more than the $210m.
The traditional argument for high executive pay is that shareholders have to pay high to attract the best performers. However, in this case, shareholders are paying even more to get rid of a perceived poor performer, than they were paying to attract a perceived good performer. This is surely conclusive proof of Professor Bebchuk’s contention that high executive pay in the US is far better explained by the power of CEOs than by considerations of markets or performance. (Pay Without Performance by Lucian Bebchuk and Jesse Fried, Harvard University Press, 2004).
Yours faithfully,
Revd. Patrick H Gerard
Dear Sir,
I find it ironic that the departure of Bob Nardelli from Home Depot is being described as a victory for shareholder activists, who thought he was overpaid. Your report (Home Depot chief Nardelli steps down – ft.com, 3/1/07) suggests that Mr Nardelli will receive a severance package worth $210m, in addition to the more than $120m that he has received in compensation since joining the company. The problem of overpayment is therefore even greater now that Mr Nardelli is not running the company!
Home Depot’s share price rose 3% on this announcement, suggesting that shareholders value the potential improvements in performance far more than the $210m.
The traditional argument for high executive pay is that shareholders have to pay high to attract the best performers. However, in this case, shareholders are paying even more to get rid of a perceived poor performer, than they were paying to attract a perceived good performer. This is surely conclusive proof of Professor Bebchuk’s contention that high executive pay in the US is far better explained by the power of CEOs than by considerations of markets or performance. (Pay Without Performance by Lucian Bebchuk and Jesse Fried, Harvard University Press, 2004).
Yours faithfully,
Revd. Patrick H Gerard
Labels: Bebchuk, failure, Nardelli, power
