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90 Cents of Every 'Pay-For-Performance' Dollar for CEOs Are Paid for Luck
- hammock 10y agoCEOs are primarily paid to bear risk, so this makes perfect sense to me.
- ethanbond 10y agoAh that's why all the CEOs of failing institutions are scraping up spare nickels to pay for the bus!
- cmurf 10y agoWhat risk are they bearing in comparison to the company itself, or separately even its shareholders? Or heck, even its bond holders? About the last person whose shouldering risk is an officer of the company, that's the whole point of officers vs boards vs shareholders.
- retube 10y agoOfficers are increasingly taking on more and more legal liabilities. There's definitely a growing need for danger money in some industries. Would you be a bank CEO if it meant jail if one of your 100,000 employees was caught laundering cash or passing on insider information?
- ErikAugust 10y agoDoes this actually happen? I cannot think of a single, real-life example.
- cmurf 10y agoCan you provide an example of a bank CEO going to jail for an employee doing anything illegal, when the bank CEO did not know or participate in it the crime whatsoever? Or alternatively, what crime were they charged with?
- jaynos 10y ago>Would you be a bank CEO if it meant jail if one of your 100,000 employees was caught laundering cash or passing on insider information? IF that was actually a risk, I might consider it, but thanks to the Holder Memo, we have "Too big to jail". "Kareem Serageldin was an executive at Credit Suisse who was described by friends as an “investment-banking monk.”[1] As of April 30, 2014, Serageldin was also the “only Wall Street executive prosecuted as a result of the financial crisis” that triggered the Great Recession.[2] On Friday, November 22, 2013, Serageldin—the former Managing Director/Global Head of Structured Credit in the Investment Banking Division of Credit Suisse Group—was sentenced to 30 months in prison in connection with a scheme to hide more than $100 million in losses in a mortgage-backed securities trading book at Credit Suisse.[3] Serageldin also agreed to give back $25.6 million in compensation to Credit Suisse, and was later ordered to pay more than $1 million to settle an SEC lawsuit." [1] [1] https://en.wikipedia.org/wiki/Kareem_Serageldin https://en.wikipedia.org/wiki/Kareem_Serageldin
- dv_dt 10y agoI think that's making a mountain out of a molehill. How many CEOs have even been charged for anything close to that, how many CEOs have been charged at all even when they have been involved. Current case: Wells Fargo CEO.
- nerdponx 10y agoYou mean like what happened at Wells Fargo?
- cmdrfred 10y agoYou may be certifiably insane. When has that ever happened?
- wstrange 10y agoExcept they typically have no downside risk at all.
- njharman 10y agoMore like they're (pre)paid to be the scapegoat. If something really bad happens, C levels take the blame, their golden parachute and go get job somewhere else. The company and major investors get to keep on truckin!
- newscracker 10y agoIn my observation (in larger tech companies), CEO compensation is like how some options trading courses market themselves - "markets go up, you make money, markets go down, you make money; it doesn't matter which way the markets go, you always making money." I have not seen a CEO ever take a huge financial loss or a huge cut regardless of whether the company did well or not. The CEOs somehow make a lot of money for themselves. Even when instituting pay/compensation cuts for the rest of the workforce, they make sure their part is on the paltry base salary component that's been negotiated in a way that bonuses and stocks always exceed this by several tens of times (if not larger). Guess what? They always get large bonuses and generous stock grants. The only tangible risk CEOs take, many a times with not much to worry about, is the risk of being fired but still exiting with a one time super nice golden parachute instead of continuing to extract a lot more money from the company.
- mpdehaan2 10y agoExcellent points in this article - another factor is they are often paid outrageous base salaries (plus options) for the success of a company, when the success of that company can often be in spite of the CEO, coming from within, and embodied equally by all of the collective employees. Executive comp is a major racket, enforced by the standard that this is "what the market average is". Which is set by executives overpaying themselves. Ask yourself if your CEO is really working 100x as hard as you, or 100x smarter than you. The answer is usually a definite no. I'd really like to see more fair pay in this area and a culture that treats contributions of all employees more equally.
- blahi 10y agoCompensation has nothing to do with whether somebody works harder or is smarter than everybody else. Perhaps you would like to step in Satya Nadella's shoes for a couple of weeks?
- Ensorceled 10y agoNo. But I get the feeling almost anybody could have filled Balmer's ...
- blahi 10y agoDo you have any knowledge about what Balmer's initiatives at Microsoft were? What his goals and objectives were?
- Ensorceled 10y agoNo. But I know their stock was pretty much flat for 14 years.
- blahi 10y agoThe growth during those 14 years was factored in the stock... This exact thing was actually discussed on Martin Shkreli's stream a couple of weeks ago. Maybe you shouldn't have such strong opinions about things you perhaps don't understand? And not even attempting to understand according to your own admission.
- deleted 10y ago[deleted]
- jbb555 10y agoBonuses are not to be considered to be pay for performance. They are to be considered as a part of pay that can be withdrawn if either the company does badly and can't afford it, or if the employee does visibly badly. They are a good thing for the company because they can decide not to pay it, except in as much as they allow the company to pay more because they can withdraw it if necessary
- sidlls 10y agoBonuses for executives or bonuses for regular employees? Every bonus item in any employment package I've had has always been tied to the company's performance and my individual performance. I have never once worked anywhere with an automatic, performance-independent bonus, from tiny shops working as government contractors to large and well-known corporations. This is anecdotal, obviously, but I'm talking about myself and literally hundreds of thousands of other employees across all the organizations I've worked for. I am not denying such bonus structures exist in some places, but I'm skeptical that it's common or not considered an extreme aberration.
- TeMPOraL 10y agoI don't know if it's common, but I'm currently employed in such a company. Basically, at the interview I asked for $X / month after benefits[0] and taxes, and what I'm being paid is ($X - benefits - taxes) / month base, + performance bonus equal to the amount that went to the government in my name. I get the bonus by default, but they can suspend it if I perform visibly badly. [0] - don't know the right English vocabulary for that; in Poland, if your employer pays you X directly, then he actually costs you Y, where Y > X, and the difference is what he pays as a contribution to your social security and health insurance. EDIT I was misremembering things, so I doublechecked my payslip and fixed the comment to reflect "real reality".
- sidlls 10y agoSo your bonus is linked to your performance.
- whack 10y agoPlease update the headline to reflect the fact that this study is focused purely on CEOs, and stock-price-based-performance. The vast majority of people who are paid-for-performance are not CEOs, and are not graded based on stock-price movements.
- milesskorpen 10y agoThey found a way of structuring bonuses that works nearly twice as well — too bad it was a bit buried in the summary: "Indexing the option, and setting the strike price much higher than the granting-day price almost doubles the option’s motivational power"
- johnhess 10y agoI love this very honest appraisal of how pay-for-performance incentives ought to work, and I wish more companies would step back and ask themselves if their "traditional" incentive structures have the motivational factor they're "traditionally" assumed to have. While startup performance is less correlated to market performance than an established firm, the concept of setting the bar as outperforming the industry/market is brilliant, and I wonder if there's a good analog in the startup space, particularly for employees. Bonuses and stock options are all well and good, but they incentivize the firm's survival and success. A single employee may be unable to change that, even if they perform exceptionally. Those incentives are great for "share the wealth" and "all for one, one for all" camaraderie, but they don't incentivize individual performance.
- draw_down 10y agoSounds like a good racket.
- AndrewKemendo 10y agoI don't think it's possible to reliably link pay to performance for anything other than measurable immediate production - like manual labor. Forget reliably doing it for executives. The reason is, because long term price impacts of individual performance are not knowable, so they cannot be priced effectively. The executive compensation system right now is built on social proof and positioning, not on auditable causal decision chains. Too many dependencies to make causal connections.
- aisofteng 10y agoReplace the definition of T with "the number of unicorns helping" and nothing changes. The author's T does not represent anything tangible or measurable. These conclusions are meaningless in any practical sense.
- woopwoop 10y agoI remember an interesting theory about golden parachutes in Steven Landsburg's "The Armchair Economist". In a typical publicly traded company, the CEO is actually much more heavily invested in the company than the shareholders. His salary, and probably the major part of his assets, are dependent on the performance of the company. On the other hand, the average share holder is well diversified. Therefore, a CEO will be incentivized to pursue a highly conservative strategy, while the shareholders may wish that he takes more risk. To offset this, the shareholders may make it known that a generous severance package, as well as generous benefits if the company does exceptionally well, are on the table, to simultaneously soften the blow if he takes a bad risk, and sweeten the deal if he takes a good risk. In other words, the point of executive compensation may not be to produce better results on average, but rather to increase the variance of the results.
- rhino369 10y agoAnd the original golden parachutes were created to incentivize a good acquisition. A CEO whose company gets acquired is often firing himself. So the whole idea was to give them a huge score if it happened. Otherwise CEOs might fight takeovers just to keep their jobs. And, if a lot of the CEO performance results is just luck, then bad luck can ruin them. If a company is on the brink of failure, nobody is going to take the job without a parachute. It could be their last job if they take the blame.
- st3v3r 10y agoSo why not make the golden parachute "if we get acquired, you get this" instead of "if you get fired, you get this".
- simon_ 10y agoAnalyses on this topic are always so bad. Some counterpoints: (1) CEOs are intentionally aligned with shareholders, for good reason. Shareholders often make money due to luck, so eliminating luck from CEO compensation without breaking alignment is a very hard problem. (2) Going in, a CEO (or a shareholder) needs to lock down a big future payday in the upside case, in order to compensate them for the risk of the downside case. Yes, the upside case usually involves some luck, but the "optionality" to get paid in a lucky outcome is a valuable part of the deal. (3) CEOs are also paid to be trustworthy agents for shareholders/boards. Like... if I am a billionaire looking for you to oversee a big part of my capital, I may pay a lot just because I know you are a good/smart/reasonable person who will be autonomous but raise the right issues to me if needed, reliably. I might know all that just because we have been buddies for years, and even though there are lots of objectively more talented people out there who would do the job for less, paying you more would not be irrational for me.
- c3534l 10y ago(1) The study specifically talks about the motivational effect of performance pay and finds that the component of luck means that performance pay must be more difficult to achieve in order to motivate the executive officers to align their interests with the company. (2) You could reduce the financial risk of executive officers by paying them a fixed salary. In fact, different companies offer very different compensation plans. This was a review of those plans to see what did and did not work. Generous performance pay does not work. (3) This is an issue of whether executive officers should be paid well in general, not the value of performance pay. And at any rate seems to be a justification for nepotism in an area of business that is already dysfunctionally nepotistic.
- hbt 10y agoOn a related note, is there any successful pay for performance scheme for engineers? Pay-per-performance is well established in sales and marketing. Even when the sales/marketing strategy requires a large team to implement, the spoils go to the top. It seems the only time engineers get properly compensated for the value they create is when it is so obvious and the owners can't get away with stiffing them. Startups are well known for stiffing engineers because the teams are small, there are no repercussions and the founders don't have much of reputation to begin with. It's harder in bigger companies since it sends the wrong message to others in the company and destroys your reputation. Maybe there is no such thing as fair compensation. Just get leverage and negotiate or obtain a position of power (authority) within the company.
- ransom1538 10y agoFrom my years of startup experience: luck determines basically everything. What company you end up picking, what team you get placed on, how your interviews goes (remember merge sort)?, what problems you need to work on, who your boss is... even if your company survives. Your entire company can lose funding because of an argument on a golf course or Apple TOS change (sigh). At larger companies what team you are on is well.. everything. How were you picked for that team? Because the boss of the other department was on holiday that day. I smile when I hear people actually think they can control their own luck. That is how religion started. Whatever makes you happy. "I am going to pick my OWN boss, I am going to join the start up I want to join with MY purpose." No, you will pick the boss from a super small subset that has a position open and you are going to find a company that needs you 'currently'. Who gets promoted? Generally, lucky loud people. Who makes sales quota? People given the best accounts (luck). Who goes IPO? People that bumped into an untapped market. Do what you want. People's evaluation of you is just based on luck.
- zip1234 10y agoSo are you a fatalist?
- rm_-rf_slash 10y agoEverything is based on luck. 99.9% of humans in history were born into what the average American today would consider extreme, abject poverty. I did not choose to be born into a family of upper-middle class American academics. I did not choose to be born on time with excellent health any more than my uncle's fetus chose to be exposed to lead paint, get born 3 months early, and become severely developmentally disabled for the rest of his life. Even if spmeone came from literal rags and made literal riches, they still benefited from a civil society, rule of law, access to education, and so on. I am fully convinced that the only healthy and ethical approach to live is to be grateful for everything you have, and empathetic for others whose needs are unmet.
- lutusp 10y ago> Everything is based on luck. ITYM chance, not luck. Luck describes a supernatural force. Chance describes simple randomness.
- pitchups 10y agoA while back I came to the following conclusion : "We often attribute our success to our skills and talent and failure to luck - while quite often it is the other way around." :)
- gnicholas 10y agoThe article seems to assume that CEOs are believe that they have very little impact on a company's success, and that they calculate how much effort to exert accordingly. My understanding is that CEOs tend toward hubris and that this assumption is false in most cases. If so, then it might be more efficient to up the strike price, but the current situation isn't as inefficient as it seems (thanks to hubris). Relatedly, if CEOs were granted deeply-underwater options, wouldn't they demand much more in base pay, to compensate? I'm not saying they "deserve" higher base pay—just that if a board wanted to institute this change, they'd get push back from the individual. Otherwise it would look like a disguised pay cut (imagine if your boss came to you and said that to incentivize employees to work harder, all options were going to be issued underwater).
- lutusp 10y ago> ... Paid for Luck I wish academics would have the sense to avoid the word "luck" when "chance" is the principle at work. These people should know better.
- calinet6 10y agoTrue at all levels; statistics are rarely taken into account in _any_ performance review or measurement process. It is always assumed that the individual is responsible for his or her own performance. However, the opposite is largely true: the system and environment the person is in accounts for a disproportionate level of the end result. It's an uncomfortable truth because it mucks with our sense of free will and control, but it is a well known phenomenon (attribution bias) with countless examples. This CEO incentive pay version is simply the most extreme.
- smallnamespace 10y agoIt's well worth it to remember than equity is just a call option on the value of the firm. Therefore, it's often in the equity-holder's interest to do two things: 1. increase the volatility of the underlier (by making riskier investments, etc.) 2. Re-strike the option to be closer to at-the-money, by loading up with more debt or paying out cash as dividends Both actions increase the odds that the firm goes bankrupt, but also increases the expected payout to equity holders. When you increase equity compensation to executives, you basically encourage them to do riskier things.
- neximo64 10y agoOr you know, 'luck' is just what couldn't be mathematically described in the model, attributing it to randomness.
- musgrove 10y agoNot sure how one would control for "luck" in a (legitimate) academic study. The definition of it is broad, to say the least.
- JamesBarney 10y agoIs this 90% a upper or lower bound? I mean did they try to measure luck and found that it accounted for 90% of returns?(lower bound because their measure of luck was probably imperfect) Or did they measure talent and were able to account for 10% of the returns(upper bound).
- pierrebai 10y ago"I've met very few good plumbers, it takes a special person of talent to be a great plumber." "I've met very few good truck drivers, it takes a special person of talent to be a great truck drivers." ... There is a whole premise in many post about this story that it's somehow a very rare thing to be able to run a company well and that the person filling the role of the CEO is the main driving factor of success. (Instead of economic factors, outside forces, performance of other employees... oh! I know! The other employees performs solely because the great CEO makes them do so.) I think there's a lot of egotism being expressed in this thread... (Especially by VCs who basically say they're impervious to misjudging someone's abilities and its true influence on success.)
- gravypod 10y agoI think this video, by Louis Rossmann, is very important to this discussion. https://www.youtube.com/watch?v=-q6hpsGjcIo https://www.youtube.com/watch?v=-q6hpsGjcIo I don't think you can ever accurately account for what is "luck" and that it is actually harmful to our own abilities to call something luck and write off whatever was actually done by the CEO. I think this is a good watch and I look forward to hearing what others think about the video.
- tmpdude01 10y agoThis is a profound misunderstanding of corporate governance, and the fact that so many people here somehow agree with the assertion that CEOs are paid for luck is astounding.
- wstrange 10y agoIt would help if you could add some more substance to that assertion. CxOs clearly require some competence- I don't think that is in dispute. It is the 200x + salary differential that is in question and the subject of the article. Can you cite some other studies that contradict this?
- dvtv75 10y agoWhat study are you citing that disproves this particular piece of research?
- deleted 10y ago[deleted]
- lefstathiou 10y agoI think there is a simple and rationale explanation for this... I believe founders that step away from the role of CEO seek to put in place someone who prioritizes the business as (close to) as much as they do (ie before family, friends, life etc). The problem is how do you find someone to love (yes love or at least pretend to) the business without them owning a meaningful piece of it (the equity that is)? When granting sixeable equity is not an option (most founders I know who built successful companies are highly protective of it) the solution is you buy it. Mark Zuckerberg owns 30% of Facebook. The professional CEO that one day replaces him will own 0.0000001% of it. That's not very motivating for entrepreneurial CEO types who are ideal for these roles. Mark isn't going to go to sleep easy at night unless he knows the person running the show eats sleeps and breathes Facebook the way he has for the last 30 years. That person is buying his dream, he's buying their loyalty and commitment (and great judgment, etc etc).
- Tharre 10y agoAs much as I'd like to believe that CEOs are basically payed for chance, this research is deeply flawed. As in, it's literally trying to measure the (practically) immeasurable. More specifically, it's this assumption: > We model the impact of a manager on her firm’s performance by assuming that a manager who exerts effort and manifests her talent increase the firm’s expected return by the magnitude of her talent. that is simply not true. The performance of every CEO is amplified by the amount of people he's affecting. And that is made even worse by the fact that companies are competing against each other, meaning that usually it's not their total performance that matters, but the difference to the next best company. You end up with so much noise in your data that yes, the result looks random. But is it? We don't know. The only accurate measure of performance (that we know of) is performance itself.
- chatmasta 10y agoDoes overpaying the top executives of a company, regardless of performance, increase motivation of all the other employees of the company? After all, the underlines want to become the CEO one day. The higher the reward for the CEO, the more tantalizing the carrot dangled in front of his underlings.
- mcguire 10y agoPeople keep talking about "shareholders" in the comments here. Where, exactly, do shareholders come into the picture? C*O compensation is set by the board of directors. The board is determined by the executives' recommendations. The only shareholder who matters is Carl Icahn; the only power most shareholders have is to sell shares. And I'd be willing to bet something that their willingness to do that is only related to short term performance.
- jwatte 10y agoNow consider that whether you end up born in an industrialized country into circumstances that will let you become a CEO in the first place requires a lot of luck...
- jernfrost 10y agoMichael B. Dorff wrote a book about this called "Indispensable and Other Myths": http://blog.translusion.com/posts/CEO%20Salaries/ http://blog.translusion.com/posts/CEO%20Salaries/ His conclusions were that CEOs don't really matter all that much. Exceptional ones like Elon Musk or Steve Jobs are quite rare.