Thursday, December 3, 2009

Why are executive stock options taxed by Ottawa at half the rate of employment income? To incent bad practices?

Bonus culture called destructive, beyond repair

Henry Mintzberg of McGill University calls the executive pay system a form of legalized corruption that cannot be reformed.

I've long thought excessive CEO pay is the cancer eating away at sound corporate management. Excessive pay for top management distorts decision making. It encourages reckless and short-term behaviour that damages the enterprise and undermines the wider economy.

Mostly this cursed phenomenon takes the form of CEOs betting the company for a quick windfall, hence the crisis in global finance that brought us to the brink of a second Great Depression.

A more insidious and routine consequence of excessive pay is the incentive it provides the CEO to cut payrolls and marketing, R&D and new-product development expenses to fatten the bottom line in the short term, triggering a bonus tied to that year's profit. The result is an enterprise gutted of its competitive strengths, easy pickings for hungry upstart rivals.

In a remarkable piece in Monday's The Wall Street Journal, Henry Mintzberg calls excessive pay what it is – not an outrage, but a crippling, clinically diagnosable disease afflicting our corporate body politic.

There's always the taint of resentment when the public expresses fury over what it perceives as unfairly gotten gains by corporate "fatcats." That's not Mintzberg, who rightly identifies the curse of excessive pay as a dagger pointed at the heart of an enterprise and the broader community.

By the 1990s, we saw the first appearance of the "hired hand" billionaire – people like Robert Goizueta at Coca-Cola Co., Jack Welch at General Electric Co., Michael Eisner at Walt Disney Co. and Sandy Weill at Citigroup Inc. These were CEOs who had become billionaires from stock options and other forms of inflated compensation for merely caretaking the legacy of founders who died generations ago.

Worse, in each of those cases, the celebrity CEO left his enterprise in worse shape than he found it, destroying shareholder value while reaping a personal fortune from deeply discounted options to buy company stock at prices not available to other investors.

Mintzberg allows that in this moment of public anger about the role of excessive pay in driving the financial sector, in particular, over a cliff, "there is no shortage of recommendations for fixing the way bonuses are paid." But Mintzberg, long associated with McGill University and among the most thoughtful management gurus since the late Peter Drucker, has "my own recommendation: Scrap the whole thing. Don't pay any bonuses. Nothing."

"When you look at the way the compensation game is played – and the assumptions that are made by those who want to reform it – you can come to no other conclusion. They system simply can't be fixed. Executive bonuses – especially in the form of stock and option grants – represent the most prominent form of legal corruption that has been undermining our large corporations and bringing down the global economy. Get rid of them and we will all be better off for it."

Mintzberg is about as radical a thinker as, well, Warren Buffet, who pays himself $175,000 (U.S.) to run America's largest conglomerate and has said outsized pay for most CEOs is "a reward for the passage of time." Common sense tells you that if the chief executive of the United States can get by on $400,000 a year to preside over a $14 trillion economy, a fertilizer company CEO should not be hauling in $18 million a year, in the case of Potash Corp. of Saskatchewan.

The rage comes over the destruction or undermining of great firms, whether it's Massey-Ferguson Ltd. or Nortel Networks Corp. or Citigroup, now 60 per cent owned by Uncle Sam due to the reckless practices to which Citi has been inclined for decades. The CEO of ICU patient Citi, Vikram Pandit, was paid $32.2 million for his labours last year.

Plato thought a community's highest wage should not exceed five times its lowest. By 1991, CEOs were making about 140 times the average worker's pay. In this decade, the ratio was up to 400 times.

As the head of the New York Fed asked a few years ago, "Could it be that today's CEOs are 240 times smarter than they were in the 1980s?"

Populist rage isn't terribly useful. A common-sense rethink of pay practises is, among the boards who set CEO pay. Bonuses, Mintzberg argues, create behaviour that is dangerous to the enterprise. Even in the most benign cases, they isolate leadership from the people who do the actual work.

In paying CEO bonuses, says Mintzberg, "at the worst, you get a self-centred narcissist. At the best, you get someone who is willing to be singled out from everyone else by virtue of the compensation plan. Is this any way to build community within an enterprise, even to foster the very sense of enterprise that is so fundamental to economic strength?"


Dr Mike said...

In other words , they should have done away with the corporate structure & kept the trusts.

Works for me.

Dr Mike

Anonymous said...

Brent,I COULDN'T agree more!!!!!This travesty (along with the ludicrous sums paid to "I-Bankers") is killing the system.

The ONE question that has been asked and not satisfactorily answered is: Where are the shareholders???

The 'solution' may only lie in a protracted bear market which will finally have the shareholders beying for the blood of these overpaid, underperforming CEOs.


crf said...

One way of dealing with the problem is much higher tax rates on income above a certain threshold.

The highest rate is 29% for income above 126000. What a joke.
More brackets should kick in at income above 200000, and the maximum rate should be much higher.