Speaker 1: This is Masters in Business with Barry Ridholts on Boomberg Radio.
Speaker 1: This week on the podcast, I have Stephen Clifford. He
Speaker 1: is the author of the CEO pay Machine. If you
Speaker 1: have ever wondered why executives in public companies in America
Speaker 1: are paid more than just about anybody else and not
Speaker 1: a little more. Not twenty five times like it used
Speaker 1: to be in the before, or fifty times, which is
Speaker 1: more or less what it is in other countries, but
Speaker 1: five hundred times with the average worker gets Uh. This
Speaker 1: is going to be quite a fascinating conversation. Uh. This
Speaker 1: is not the usual screed from the far left of
Speaker 1: the political spectrum. Clifford is a former CEO. He's been
Speaker 1: a board member on numerous companies. This is somebody within
Speaker 1: the corporate corporate firmament who has just recognized how completely
Speaker 1: absurd executive compensation has become. Uh. He criticizes his fellow
Speaker 1: board members, He criticizes the so called independent outside advisors.
Speaker 1: He has lots of things to say about the consultants,
Speaker 1: calls them some pretty uh nasty names, says they're completely
Speaker 1: compromised and don't work for shareholders. And he discusses the
Speaker 1: impact of of just the gross excess pay not only
Speaker 1: on shareholders, which he says is unfair, but the impact
Speaker 1: on companies themselves. The more highly paid an executive is
Speaker 1: very often the worst the company has done, as well
Speaker 1: as the economy and society at large. Excessive executive compensation
Speaker 1: has ramifications. Listen, what's ten or twenty million dollars to
Speaker 1: a multibillion dollar company doesn't sound like a lot? Well,
Speaker 1: it turns out there are reverberations from that throughout the company,
Speaker 1: the economy, and society at large, and their substantial and significant.
Speaker 1: And not only that, but Clifford suggests that it has
Speaker 1: a very significant negative impact on future economic growth. So,
Speaker 1: with no further ado, here is my conversation with CEO
Speaker 1: and board member and now expert on executive compensation, Stephen Clifford.
Speaker 1: My special guest today is Stephen Clifford. He is the
Speaker 1: former CEO of King Broadcasting Company and National Mobile Television.
Speaker 1: He has served on the boards of directors of dozens
Speaker 1: of public and private corporations, and he was special depth
Speaker 1: the Controller of the City of New York during the
Speaker 1: city's fiscal crisis in the nineties seventies. He is the
Speaker 1: author of the ceo pay Machine, how it trashes America,
Speaker 1: and how to stop it. Stephen Clifford, Welcome to Bloomberg.
Speaker 1: Honored to be here. So you're a surprising person to
Speaker 1: write a book about executive compensation, to write a critical
Speaker 1: book about executive compensation. You were the CEO of multiple companies.
Speaker 1: You've sat on numerous boards, You've advised on executive compensation
Speaker 1: to the companies you worked with. How did this come about?
Speaker 1: It came about because I was working on boards. Uh,
Speaker 1: these are smaller companies, these aren't Fortune five hundred boards.
Speaker 1: But we were using the same system that the consultants
Speaker 1: UH put in it all companies. And as I was
Speaker 1: sitting there and serving on the comp Committee, I said
Speaker 1: to myself, Yeah, this system doesn't make any sense. This
Speaker 1: is a crazy system. And so too um. I said
Speaker 1: that to some members of the comp Committee and they said, oh, no, no,
Speaker 1: you don't understand. This is just how comp has done
Speaker 1: in this country. This is consultants have it all worked out,
Speaker 1: this is how it's done. Trust us. So I started,
Speaker 1: So I started doing some research on my own to
Speaker 1: bring my fellow comp Committee members around. And the more
Speaker 1: I got into it, the more I realized it wasn't
Speaker 1: just a stupid system that gave the CEO the wrong
Speaker 1: signals and uh lad the CEO to do wrong things,
Speaker 1: wrong incentives, perverse incentives. But it was also terrible for
Speaker 1: the for the country, it was bad for the economy.
Speaker 1: And so I started doing even more research. And everything
Speaker 1: I did told me this system is insane and it's
Speaker 1: hurting a lot of people. Let's let's put some flesh
Speaker 1: on of bones and and and this data comes from
Speaker 1: from your book. Since CEO pay in America has grown
Speaker 1: ninety times faster than the pay of the typical worker.
Speaker 1: Go back to eight the average large company chief executive
Speaker 1: was paid about twenty six times more than the salary
Speaker 1: of the average worker. Today it's somewhere between three hundred
Speaker 1: times and seven hundred times. How on earth did that
Speaker 1: come about? It came about because the pay consultants started
Speaker 1: in roughly the or so, and as they started to
Speaker 1: get clients, they realized that they had data on what
Speaker 1: other CEOs were paid. Now, until this time, CEO pay
Speaker 1: had been established really on the basis of internal equity.
Speaker 1: How the CEOs pay uh compared with everybody else in
Speaker 1: the cup Penny and that's why that ratio twenty five
Speaker 1: state stable from through the late late seventies. But they
Speaker 1: came in, they had this data and it was a
Speaker 1: great sales tool. So they said, now you got it
Speaker 1: all wrong. CEO pay should depend on what other CEOs make,
Speaker 1: and so U what we'll do is we'll establish a
Speaker 1: peer group and we'll tell you what other CEOs and
Speaker 1: these comparable companies making. Now let me interrupt you here
Speaker 1: and ask why should what other CEOs make be relevant
Speaker 1: to what we're gonna pay our CEO in our It
Speaker 1: should have no relevance whatsoever. So how is that sales
Speaker 1: job affected? Well, the sales job is effective because when
Speaker 1: you go through all the steps here, what it does
Speaker 1: is it greatly increases the CEOs pay. So of course
Speaker 1: they want to hire these consultants. CEOs want to hire
Speaker 1: the consultants. The boards kind of want to hire the
Speaker 1: consultants because the boards don't really they're happy when the
Speaker 1: CEO gets paid more. Uh why is that why the
Speaker 1: they're all golfing buddies or why do they really Well,
Speaker 1: let's start with every most boards. The majority of people
Speaker 1: on the board, our CEO s or x CEOs themselves Uh,
Speaker 1: so there's a little bit of tribalism. Is a little
Speaker 1: bit of tribalism. Uh. Secondly, they like to be able
Speaker 1: to hide behind the consultants and say, hey, we we
Speaker 1: we hired experts. You know, we had we had the
Speaker 1: best people in and they went through all the data
Speaker 1: and this is an objective measure. Now, the interesting thing
Speaker 1: about this is the way they get paid has nothing
Speaker 1: to do with the market. These are people that they
Speaker 1: love the free market of the market. For the labor
Speaker 1: market for chief executive exactly, there is no in fact,
Speaker 1: there isn't much of a labor market for chief executives.
Speaker 1: U When you look at chief executives. To be an
Speaker 1: effective chief executive, you have to know a tremendous amount
Speaker 1: about a single company. You have to know it's finances,
Speaker 1: it's marketing, it's competition, it's personnel, etcetera, etcetera, etcetera. Most
Speaker 1: of that knowledge is not worth much outside that company, right,
Speaker 1: so you see you companies rarely rarely go outside higher
Speaker 1: Another CEO of fortuneos were internal promotions. Really that's amazing.
Speaker 1: And so in other words, the skill set that an
Speaker 1: executive has probably isn't all that transferable to a different
Speaker 1: company unless it's in the exact same and that they
Speaker 1: are not Lebron James. Lebron James can take his skills
Speaker 1: to any NBA tail and improve it. Uh CEOs camp
Speaker 1: and you know there're only two of the fortune CEOs
Speaker 1: were previously CEOs of a public company. That's interesting. CEO
Speaker 1: is jumping between one large company and another happens about
Speaker 1: once a year, and when they do, they usually failed.
Speaker 1: The failure rate is quite high. You know, your reference
Speaker 1: to external equity reminds me very much of what took
Speaker 1: place during the real estate boom. Everybody the appraisers used parables.
Speaker 1: So what starts to happen in a rising market? It
Speaker 1: becomes the self fulfilling spiral and everything goes up because
Speaker 1: other houses are going up. Is the same thing taking place.
Speaker 1: That's exactly right, except it's a built inspiral. It's not
Speaker 1: just that it starts. What happens is you start with
Speaker 1: your peer group. Okay, I told you they assemble the companies. Well, surprise, surprise,
Speaker 1: companies choose peer groups that have highly paid CEOs. It's
Speaker 1: not an objective data say, it's not an objective data set.
Speaker 1: The book is filled with some fascinating data points. This
Speaker 1: one really stood out to me. Between two thousand and
Speaker 1: eleven and two thousand and fourteen, there were four CEOs
Speaker 1: who earned more than a hundred million dollars a year.
Speaker 1: These companies could have paid d CEOs less and gotten
Speaker 1: the exact same performance from them. How do we end
Speaker 1: up in a situation where people are making hundreds of
Speaker 1: millions of dollars on the backs of shareholds. Well, you
Speaker 1: have what I have termed the pay machine. And each
Speaker 1: year the companies crank up this machine. And as I
Speaker 1: as I mentioned, it starts with a peer group of
Speaker 1: of of highly selected other CEOs making a lot of money.
Speaker 1: Then the company quote benchmarks their CEO. So where does
Speaker 1: your CEO rank? Well, we're a good company, So everybody
Speaker 1: benchmarks their CEO at the seventy five percent diial of
Speaker 1: this group just random Well, no, we're better than those companies,
Speaker 1: so our CEO should be make what's the basis of
Speaker 1: assuming you're in the top quartile of what I assume
Speaker 1: is a fairly competitive market, simply corporate pride. There is
Speaker 1: no simply corporate pride. We're good, okay, there's there's never
Speaker 1: any performance They don't have to perform at seventy percentile
Speaker 1: at all. It's just corporate pride. One would think there
Speaker 1: would be some correlation between, Hey, if we're declaring ourselves
Speaker 1: in top quartile, then we should be top quartile and
Speaker 1: profit growth top quartile and revenue gains top portoial and
Speaker 1: market share gains. Yet those seems things never seem to
Speaker 1: come up. They don't come up at all. They don't
Speaker 1: come up at all. It's just corporate pride. So so
Speaker 1: this to me looks like a wealth transference scheme from shareholders,
Speaker 1: two managers and insiders. It I wouldn't I wouldn't use
Speaker 1: the word scheme because that's as if it were deliberately
Speaker 1: and conspiratorially designed. What happened is the consultants came in
Speaker 1: and step by step this machine was built and different
Speaker 1: different things we're ad and it's a very complicated system. Now,
Speaker 1: on the face of it, most of these apps in
Speaker 1: here by themselves seem to make sense when you put
Speaker 1: them all together. They guarantee with mathematical certainty that the
Speaker 1: CEOs pay will escalate and I regardless of performance, regardless
Speaker 1: of performance. So I to me, this is more something
Speaker 1: that evolved, but it evolved with two rules. One, the
Speaker 1: individual part of the machine had to have a certain
Speaker 1: surface logic, and to it had to increase the CEOs pay.
Speaker 1: And so each of those were selected for an evolution.
Speaker 1: So now you have a machine that guarantees that CEO
Speaker 1: pay will rise eight nine times faster than the average
Speaker 1: workers pay. That's amazing. I really like this quote from
Speaker 1: your book about stock price and profits quote, the price
Speaker 1: of your stock will tell you whether to maximize today's
Speaker 1: or tomorrow's profits. Explain that, well, that comes from Jensen,
Speaker 1: who you know, is that the father of the shareholder
Speaker 1: value school and the terrible idea which has been pretty
Speaker 1: thoroughly debunked over recent years. It has been debunked, but
Speaker 1: this is still the basis of CEO pay to really
Speaker 1: so so for those of you who may not be
Speaker 1: familiar with share how holder value, it's an idea that
Speaker 1: really got its biggest push from Milton Friedman and the
Speaker 1: Chicago School of Economics, which essentially says that instead of
Speaker 1: worrying about various constituencies clients, suppliers, employees, etcetera, um a
Speaker 1: corporation sole job is to maximize profit. Maximized shareholder value.
Speaker 1: Fair fair statement. Absolutely absolutely, and I think and that
Speaker 1: that school said, Okay, stock price is the only thing
Speaker 1: that counts, So every decision you make should be made
Speaker 1: by what will maximize the stock price. So you know
Speaker 1: you may have to trade today its profits for tomorrow's profits. Well,
Speaker 1: how much should you do that? Well, look to the
Speaker 1: stock of your look to the price of your stock.
Speaker 1: That will tell you how to do it. So so
Speaker 1: the idea is not necessarily thinking long term, but it's
Speaker 1: whatever you can do to raise profits, raise stock prices today. Well,
Speaker 1: the the theory behind that is that the market looks
Speaker 1: long term. So your your your stock price today. And
Speaker 1: in the Chicago school, everything is completely rational. Every actor
Speaker 1: is completely rational. So your stock price today is the
Speaker 1: discounted value of dividends plus the stock price ten years out,
Speaker 1: et cetera. And it's all perfect. And so the market
Speaker 1: looks long term. So that's why you can That's why
Speaker 1: you don't have to really look long term, because the
Speaker 1: market will do that. For that sounds so backwards. The
Speaker 1: way I had always learned what public companies should do
Speaker 1: is focus on long term health of the company and
Speaker 1: the stock price to take care of itself. That's right.
Speaker 1: This stood it on its head. This said that today's
Speaker 1: stock price tells you how good you are long term,
Speaker 1: and you could see why executives who are compensated with
Speaker 1: stock options. I love that concept. Well, the worst the
Speaker 1: worst thing about this is what how it focuses and
Speaker 1: misallocates company investment. Give us an example in between in
Speaker 1: the last ten years, S and P five have spent
Speaker 1: three point seven trillion dollars buying back their own stock.
Speaker 1: Now they buy back their own stock, fire it, retire,
Speaker 1: but they buy it back to keep the price high. Uh,
Speaker 1: they're not buying it back because it's undervalued. They're buying
Speaker 1: it it's already high. They're buying it back to keep
Speaker 1: the price high. Uh. What do they spend on R
Speaker 1: and D over that same period? Well, I can tell
Speaker 1: you they cut R and D by over that same period.
Speaker 1: They cut plant and equipment by over that same period.
Speaker 1: And I'm going to use something stealing from your book
Speaker 1: because I thought it was so stunning when I talk
Speaker 1: about three point seven trillion, trillion is a hard number
Speaker 1: to get your head around. Reading your book, you had
Speaker 1: an example that a trillion seconds is thirty two thousand
Speaker 1: years and that to me, that that tells you how
Speaker 1: much a trillion is and you've got three point seven
Speaker 1: trillion dollars that could be It could have been invested
Speaker 1: in product development, R and D, new technology, UH, job training,
Speaker 1: all these things for for long term health. And instead
Speaker 1: of doing that, they bought back their own stock. I mean,
Speaker 1: this is eating This is America's eating the seed or
Speaker 1: an American industry is eating its own seed corn. Let's
Speaker 1: talk a little bit about how this impacts uh inequality
Speaker 1: in the country, not just for employees, but across across
Speaker 1: the whole board of society. And I want to start
Speaker 1: with some again more data from the book you reference
Speaker 1: that this is a fairly uniquely American phenomena. In Japan today,
Speaker 1: the average ratio between CEO pay and worker pay is
Speaker 1: sixteen to one. It's a little higher. In Denmark, it's
Speaker 1: forty eight to one. It's about eighty five to one
Speaker 1: in the UK. How is it more than five hundred
Speaker 1: to one in the US. It's so incongruous with the
Speaker 1: less rest of the corporate world. Well, there are two explanations.
Speaker 1: One is that US CEOs are thirty times more valuable
Speaker 1: and productive than Japanese CEOs. That would be one. That's
Speaker 1: a little bit of a stretch. Another explanation is something's
Speaker 1: gone terribly wrong here. That seems more likely. Let's look
Speaker 1: at how this impacts, uh, the overall economy. You actually
Speaker 1: say that this isn't just a function of within the
Speaker 1: corporation there's pain equality. You suggest this effects work of morale.
Speaker 1: You suggest this effects research and development, This affects how
Speaker 1: we actually build a society. Expound on that. Well, it
Speaker 1: clearly hurts the companies. I mean we've talked, we have
Speaker 1: talked about how they've cut R and D and cut
Speaker 1: investment to keep their socker price high. UH A bigger guy,
Speaker 1: and they of course waste tens of million dollars on
Speaker 1: the CEO pay. But that's how the bush back is, Oh,
Speaker 1: that's company does billions of dollars. Who cares? I mean,
Speaker 1: so they so they waste that. That's a small part
Speaker 1: of the cost. A bigger part of the cost is
Speaker 1: the effect on company morale. I mean, when CEO is
Speaker 1: making five times what you make and he comes out
Speaker 1: and he says, there's no I in team, and we're
Speaker 1: all in this to other, it's pretty tough for you
Speaker 1: to swallow. And I mean this has been proven by
Speaker 1: study after study that the more the gap, the worse simmerale.
Speaker 1: How significant is the correlation between companies that spend billions
Speaker 1: on share buy backs and the reduction of things like
Speaker 1: R and D and plant investment, etcetera. Well, it's it's
Speaker 1: a one to one correlation. The more you spend, the
Speaker 1: more you spend on share buy backs, the less you
Speaker 1: have to put into R and D or put into
Speaker 1: RhE finite pie and and you've got you got so
Speaker 1: much money. And the more they're using fift of their
Speaker 1: net income is used to buy back chairs. The share
Speaker 1: buy backs are twice what they pay on dividends. The
Speaker 1: data point I thought you were going to go to
Speaker 1: from the book was that when you look at a
Speaker 1: company like Dell, I don't mean the E M C
Speaker 1: version of Dell today, but Dell, the direct built to
Speaker 1: order PC maker, over the course of that company's history,
Speaker 1: they spent more on stock buybacks than they ever made
Speaker 1: in profits the entire company's history, which, if you think
Speaker 1: about it should be impossible. It should be impossible, and
Speaker 1: somebody should have woken up and sure, did that stalk
Speaker 1: very well? It eventually had some real difficulties to it,
Speaker 1: and it wasn't necessarily apple. But let's let's bring this
Speaker 1: back um to income inequality. There's a data point I
Speaker 1: have to reference again. Since c. Ninety eight CEO pay
Speaker 1: Rose tan X, the median salary in America rose from
Speaker 1: forty eight thousand to fifty three thousand over the same
Speaker 1: time period. This is obviously inflation adjusted. That's a less
Speaker 1: than half a percent a year. What is this due
Speaker 1: to uh an economy? Well, it is very bad. This level,
Speaker 1: the level of inequality we income inequality we have in
Speaker 1: this country is very bad for economic growth. Why is that? Well,
Speaker 1: to start with, have any percent of our g d
Speaker 1: P is consumer spending? When the consumers don't get much money,
Speaker 1: it's hard to spend it. It's the thing I have
Speaker 1: to pay my workers exactly. And now the money when
Speaker 1: the money goes to the one tenth of one percent,
Speaker 1: as it has, let me stop here and say that
Speaker 1: about since nineteen of all the gains and growth of
Speaker 1: the economy have gone to the one tenth of one percent.
Speaker 1: Now that's a hundred and twenty four thousand households. So
Speaker 1: the reason the average American hasn't gotten a raise. All
Speaker 1: the money has gone to a very small percentage of people.
Speaker 1: They don't spend that. I mean, how many yachts can
Speaker 1: you buy? You know, after you have your fourth, you're
Speaker 1: not going to buy your pretty much done right, the
Speaker 1: power boat, a sailboat. Number one, you don't get the
Speaker 1: consumer spending Number two. Inequality imposes uh, a lot of
Speaker 1: hidden costs us healthcare as you're in come goes down
Speaker 1: to your ability to pay for your healthcare goes down. Uh.
Speaker 1: It imposed. It makes the country less healthy overall. Is
Speaker 1: that what you're implying it does? Incarceration rises, crime rises.
Speaker 1: We've seen crime falling over the same period when CEO,
Speaker 1: although we's even as crime is fallen, we've seen incarceration
Speaker 1: continue to rise. I could go to a study, but
Speaker 1: the company it's I think it's too complex to explain
Speaker 1: the study that says, well, crime would have fallen a
Speaker 1: lot more if there has been less in equal that
Speaker 1: makes sense. Let's talk a little bit about the impact
Speaker 1: of corporate board members and what they have done to
Speaker 1: pretty much rubber stamp this again. Another data point from
Speaker 1: the book that that I find is so fantastic. Board
Speaker 1: members at the company qual Calm quote from two thousand
Speaker 1: and nine through two thousand and fourteen authorized the repurchase
Speaker 1: of two hundred and thirty eight million shares at the
Speaker 1: cost of thirteen point six billion dollars, and at the
Speaker 1: same time, total shares outstanding increased two How on earth
Speaker 1: can that happen? Well, they were printing new shares to
Speaker 1: give to their executives, but two hundred and thirty six
Speaker 1: million shares was not enough to reduce the share count.
Speaker 1: The facts speak for themselves. That's astonishing. So another words,
Speaker 1: based on these prices, they gave away fourteen billion dollars
Speaker 1: and options to their That that is what the mathematics
Speaker 1: would say. So what is a board member who has
Speaker 1: a fiduciary obligation to a company? How do they process
Speaker 1: that information? What leads them to say yes, I think
Speaker 1: that's a good idea. What leads them to say that?
Speaker 1: As they say, first do they get stock of Well,
Speaker 1: they get stock depends on the company, but they tend
Speaker 1: to get stock. They get a fee overall and get
Speaker 1: a gig like that. That sounds like it's a great
Speaker 1: gig overall at good companies. That science of QualComp you'll
Speaker 1: be getting three or four thousand dollars a year in
Speaker 1: stock and cash for attending six meetings. Very nice side gig.
Speaker 1: And the way you justify it as you say, well,
Speaker 1: I'm not on the compensation committee, but these are my
Speaker 1: fellow members, and they've studied it and they have the
Speaker 1: good consultants, and so whatever the compensation committee proposes almost
Speaker 1: gets rubber stamped because you don't want to question your
Speaker 1: board members. And by the way, if you bring up
Speaker 1: a lot of questions about CEO pay and the other
Speaker 1: board members, uh, you're not gonna be asked on too
Speaker 1: many other boards. And as we've said, they're they're a
Speaker 1: nice gig. Uh. And then you can justify it by saying, well, look,
Speaker 1: it's what the real problem is. What all these other
Speaker 1: companies are doing. They're paying their CEO so much that
Speaker 1: we have to follow. We've got no option. We're forced
Speaker 1: to follow them. It's not our fault because if we don't,
Speaker 1: they're just gonna hold their breath till they turn blue
Speaker 1: and not come to work. Well, the the what they
Speaker 1: say is, oh, if we don't pay them, they'll go
Speaker 1: someplace else, which is nonsense. They won't go someplace else.
Speaker 1: They got no place to go that that that's astonishing.
Speaker 1: So I'm curious what sort of pushback have you gotten
Speaker 1: on the book from your fellow board members or or executives.
Speaker 1: I have gotten zero from uh from them, because why
Speaker 1: would they want to make noise about this? Uh? They
Speaker 1: have no effective They just do it. They just ignore it,
Speaker 1: go away. Here's a quote that I love. This is
Speaker 1: this is terrific. A good corporate board is like a
Speaker 1: club where you work on interesting problems with intelligent, congenial companions. Travel,
Speaker 1: good restaurants, amenities are all provided free of charge. Best
Speaker 1: of all, instead of paying club dues, the club pays you.
Speaker 1: So that sounds like a sweet gig. It is a
Speaker 1: sweet gig. When I was when I was coming close
Speaker 1: to retirement, I've decided that there was a very good
Speaker 1: gig and lined up a lot of board spots. And
Speaker 1: it's been I've I've enjoyed it. It's been wonderful. I've
Speaker 1: been well paid. Uh I, And yet you're biting the
Speaker 1: hand that feeds you. I believe that corporate boards have
Speaker 1: been incredibly irresponsible when it comes to CEO pay. I
Speaker 1: tried to be as I learned something about this. I
Speaker 1: tried to be more responsible. Some boards didn't like that.
Speaker 1: A couple of boards I was able to convince to
Speaker 1: move to a different system of pay. Other boards just
Speaker 1: ignored it. So here's an interesting quote. In theory, shareholders
Speaker 1: elect board members to represent them, but in actual practice,
Speaker 1: corporate boards are self prepared, actuated well. Corporate boards nominate
Speaker 1: who is going to be on the board uh absent
Speaker 1: a proxy fight or sometimes some egregious UH corporate behavior,
Speaker 1: the dominations go out and nobody opposes him. Nobody says, oh,
Speaker 1: I'm going to run for that board seat. And so
Speaker 1: every nominee, I would say the re election of boards
Speaker 1: is roughly the same as the re election of the
Speaker 1: North Korean polit bureau. That if you're nominated, you're gonna
Speaker 1: be Let's put some flesh on those bones. In two
Speaker 1: thousand and twelve, seventeen thousand and one corporate directors were
Speaker 1: nominated for board positions. Of that over seventeen thousand nominees,
Speaker 1: only sixty one. We're not approved, less than one half
Speaker 1: of one percent. As I say, we arrived, we arrival
Speaker 1: North Korea. That that that is just astonishing. So let's
Speaker 1: talk about independent directors on compensation committees. Wasn't that supposed
Speaker 1: to be, Hey, we're gonna use outside board members, we're
Speaker 1: gonna use independent experts, and therefore they don't feel um
Speaker 1: obligated to to grease the CEO. There's some objectivity. Why
Speaker 1: hasn't that worked out? Well, it hasn't worked out because really,
Speaker 1: what has changed. It's not that the it's not that
Speaker 1: they're people are not independent. Doesn't mean that the fundamental
Speaker 1: dynamic of the CEO being your friend. The CEO may
Speaker 1: have asked you on the board, but you're still independent.
Speaker 1: The fact that you have these in built in pay
Speaker 1: machine systems that guarantee that the CEO that's the status quo,
Speaker 1: that's the status quo. And so you're an independent director.
Speaker 1: You come on and this is what you do. This
Speaker 1: is how it pays hand gold in. The CEO gets
Speaker 1: a fift increase every year. Why would you, as an
Speaker 1: independent director start to make all sorts of ruckus about this?
Speaker 1: Nobody else is Let's talk about the Old Boys Club,
Speaker 1: the Old Boys Network. The average age of board members
Speaker 1: is sixty three, and women accounted for less than twenty
Speaker 1: percent of total directors. Minorities and the reappointment rate was
Speaker 1: why is it so problematic to get a more diverse board?
Speaker 1: And and the question that also comes up from this,
Speaker 1: why do we have so few women as not only
Speaker 1: board members but CEOs? Well, actually you have a more
Speaker 1: as board members than you have as CEOs. If you're
Speaker 1: looking at Fortune five hundred, less than five percent of
Speaker 1: CEOs are women. And uh, I think if you're looking
Speaker 1: for the number one characteristic of a CEO, you look
Speaker 1: like one tall, good hair, are all good hair, and
Speaker 1: good voice, good presence. Uh they're all They're all cast
Speaker 1: in Hollywood exactly. And so competency doesn't really seem to
Speaker 1: make that much. You know, if if you look at it,
Speaker 1: you'll find it looking like what is probably more important
Speaker 1: than competence. That's incredible, it is incredible. But but they
Speaker 1: are taller, they are in average, there are a few
Speaker 1: inches taller, three inches taller. They're in better shape, they
Speaker 1: work out their trim. Uh I gotta get busy, and
Speaker 1: uh am I too old for human growth hormone? Of this?
Speaker 1: I you know, I don't know. I haven't kept up
Speaker 1: my So let's talk about who the shareholders are these
Speaker 1: days and their impact. Mutual funds essentially owned the vast
Speaker 1: majority of equity stock. Why aren't mutual funds saying hey,
Speaker 1: you guys, are are you know given away the store?
Speaker 1: And we have a fiduciary obligation to our investors to
Speaker 1: make sure you don't. Well, of course, it's it's not
Speaker 1: just mutual funds, if you know, as you know today, Uh,
Speaker 1: index funds are you know, they're half the market now,
Speaker 1: it's still a smaller percentage than active funds, but it's
Speaker 1: growing rapidly. And Bill McNabb is, the CEO of Van Garden,
Speaker 1: said they were setting up um committees to essentially reach
Speaker 1: out and be proactive with corporate management on some of
Speaker 1: the more egregious practice. Well, I think I think Vanguard
Speaker 1: has always been one of the leading companies and one
Speaker 1: of the most responsible companies in that field. But you
Speaker 1: have huge investors, you know, the hedge funds almost always
Speaker 1: just vote straight management. Big big investors t I a craft,
Speaker 1: people like that. They almost always back management. Uh, it's
Speaker 1: very rare for these, for hedge funds or big institutional
Speaker 1: investors to vote against management. The rule had always been
Speaker 1: if you don't like what's going on, sell your stock.
Speaker 1: Don't try and make sense. Well, what about the opposite.
Speaker 1: Let's talk about activist investors who basically go to a
Speaker 1: company and say, you guys are doing it wrong. You
Speaker 1: manage team is terrible. You've got to make some changes.
Speaker 1: What is the impact of activist investors on compensation. I
Speaker 1: haven't seen it. I haven't seen compensation be the major
Speaker 1: issue of activist investors because, as we say, let's say
Speaker 1: you're wasting you know, you paid your CEO a hundred
Speaker 1: million dollars and you should have paid him ten million dollars. Well, frankly,
Speaker 1: ninety million dollars is not enough to raise up an
Speaker 1: activist investor campaign. I mean, you've not going to move
Speaker 1: the needle on a earnings pre share basis, right, So
Speaker 1: you've got to you've got to say that it's it's
Speaker 1: generally that the stock is terribly undervalued, and you can think, well,
Speaker 1: if I split off this division or split off this
Speaker 1: I can get a huge pop on the stock. That's
Speaker 1: when you go in and try and do it. We
Speaker 1: have been speaking with Stephen Clifford, author of the CEO
Speaker 1: pay Machine. If you enjoy this conversation, be sure and
Speaker 1: stick around for a podcast extras where we keep the
Speaker 1: tape rolling and continue discussing all things executive compensation. Be
Speaker 1: sure and check out my daily column on Bloomberg View
Speaker 1: dot com. You can follow me on Twitter at rid Halts.
Speaker 1: We love your comments, suggestions and feedback right to us
Speaker 1: at m IB podcast at Bloomberg dot net. I'm Barry
Speaker 1: rid Holts. You're listening to Masters in Business on Bloomberg Radio.
Speaker 1: Welcome to the podcast, Stephen. Thank you so much for
Speaker 1: doing this. I find this topic to be fascinating. I've
Speaker 1: I've read about and written about this over the years
Speaker 1: because it just seems to be so abusive and so
Speaker 1: unfair to shareholders, and yet there's so much built in inertia.
Speaker 1: The new compensation machine is very difficult to thwart it.
Speaker 1: It's become part of the firmament, and I assume it's
Speaker 1: going to continue for a while. In the book, you
Speaker 1: talk about a trinity Michael Jensen, Bill Clinton, and Milton
Speaker 1: Rock who who together or separately, helped create the climate
Speaker 1: that we have. So first, who is Michael Jensen? What
Speaker 1: did he do? Michael Jensen is a professor of He
Speaker 1: was long time at the Harvard Business School. UH. He
Speaker 1: was kind of the founder of the theory of founder
Speaker 1: and UH evangelist of the theory of shareholder value that
Speaker 1: the only thing that matters is the stock. He was
Speaker 1: a student of Milton Friedman when he went he went
Speaker 1: to Chicago during the Freedman esque. Uh, you know, the
Speaker 1: market is always right. And then Milton Rock, Milton Rock
Speaker 1: was the first pay, first big pay consultant. And unlike
Speaker 1: the rest of the pay consultants, who I say are
Speaker 1: are essentially corrupt hours Uh he not. Milton Rock wasn't
Speaker 1: that way. I mean, Milton Rock was was I think
Speaker 1: very serious. What Milton Rock never considered was how the
Speaker 1: system would work once everybody used to pay consultant, and
Speaker 1: so how the how this spiral would inevitably start once
Speaker 1: they were all using the same sense. He saw it
Speaker 1: long before it began. I mean he retired early. Yeah,
Speaker 1: he retired early eighties, and and I've got he he
Speaker 1: happened to be a pay consultant. He didn't consider, Gee,
Speaker 1: what if the whole world use these pay consultants, well,
Speaker 1: that we everybody would get a raise every year. We're
Speaker 1: all in the exactly. And then Bill Clinton. Bill Clinton campaigned,
Speaker 1: uh in he saw this as a political issue, and
Speaker 1: he said, I'm going to tax everything over a million dollars.
Speaker 1: He got elected in terms of actual dollar I'm sorry
Speaker 1: not tax Excuse me, i am not going to allow
Speaker 1: tax deductions for all over a million dollars. Well, he yeah, cash,
Speaker 1: stock anything. So he got in, he got in office,
Speaker 1: and then he was lobbied by the business groups that said, well,
Speaker 1: this is this is critical for American industry to pay
Speaker 1: for performance. And so they revised it and said, uh,
Speaker 1: if it relates to performance, then it's tax deductible. So
Speaker 1: and therefore stock options, the stock options by the by
Speaker 1: themselves were an unlimited amounts. We're uh any you know,
Speaker 1: so anything that related to what you can make anything
Speaker 1: and say it relates to performance. Ironically, this this is
Speaker 1: the thing that truly opened the floodgates to CEO pay
Speaker 1: going crazy. This was part of the bill Clint, the
Speaker 1: budget reconciliation bill that had the big new taxes coming in.
Speaker 1: It passed without a single Republican vote. Really, that's amazing.
Speaker 1: And then which is which is really surprising when you
Speaker 1: see what it ended up doing for the money class
Speaker 1: and the executives. There was a wonderful NPR Planet Money
Speaker 1: podcast on this exact topic, and it really fleshes it out.
Speaker 1: So let's talk a little bit about the inertia and
Speaker 1: how entrenched the CEO compensation machine has become. Are there
Speaker 1: any hopes that that we can get out from under
Speaker 1: the scheme or is this going to be with us
Speaker 1: for the foreseeable future? Boards? Uh and rectors will not
Speaker 1: reform this system. Uh by themselves. You have this new
Speaker 1: say on pay, which I don't believe will make much difference. Now,
Speaker 1: say on pay under Dodd frank Up, every at least
Speaker 1: every three years, a corporation must have it offer its
Speaker 1: shareholders the ability to have a non binding vote on
Speaker 1: whether they approve or disapprove of the pay system. What's
Speaker 1: happened is that two or three or four the most
Speaker 1: egregious pay systems and the most egregiously overpaid ceo s,
Speaker 1: there's a campaign on say on pay, and often it's
Speaker 1: effective and it will affect that uh, those three or
Speaker 1: four CEOs. The problem is they're all egregious, and so
Speaker 1: just focusing on anyone just doesn't get it done right, right,
Speaker 1: I mean, you've got you've got every one of these,
Speaker 1: Uh CEO is ridiculously overpaid and the whole system is
Speaker 1: causing so much harm to the to the country that
Speaker 1: UH hoping that say on pay is going to make
Speaker 1: any difference is uh, you know, it's like swatting swatting
Speaker 1: a few flies. So so we can't talk about executive
Speaker 1: compensation without bringing up Yahoo and Marissa Meyer. She she
Speaker 1: joined the company. It seems like less than ten years ago. UH,
Speaker 1: revenue has gone down, profits have gone down, market share
Speaker 1: has gone down. The thing of value at Yahoo is
Speaker 1: their steak in Ali Baba, which Merissa Meyer had nothing
Speaker 1: to do with. And she's been compensated to the tune
Speaker 1: of just about a quarter billion dollars. How on earth
Speaker 1: does something like that make any sense? Uh? This is
Speaker 1: most of CEO pay turns out to be paid for luck,
Speaker 1: not pay for performance. All. All of the studies have
Speaker 1: shown that, UH, CEO compensation and performance, no matter how
Speaker 1: you define it, is at best weekly weekly, correlated and
Speaker 1: a worse negatively carlate, which means the more you pay
Speaker 1: the CEO, the worse you perform. Now, Marissa Mayer was
Speaker 1: an example of this. She was there five years. By
Speaker 1: every measure her, the performance of the company was poor.
Speaker 1: Now maybe that's all her fault. I don't think it's
Speaker 1: all her fault because I think that the CEO is
Speaker 1: is not responsible for everything that happens. You know, the
Speaker 1: CEO has limited abilities to move a big ship. So
Speaker 1: Marissa didn't do a great job. Does she get singled
Speaker 1: out because she's a woman, and then making her the
Speaker 1: post a girl of over compensated? Well, I could give
Speaker 1: you executives who have been equally overcompensated. Who were men.
Speaker 1: Let's let's name a few. Well, i'll just take your name.
Speaker 1: You certainly name names in the book, Well, you know
Speaker 1: the book. What I did was I took the four
Speaker 1: highest page CEOs, the people named the highest paige CEO
Speaker 1: from two thousand and eleven to two thousand and fourteen.
Speaker 1: I didn't select them because I thought that they were
Speaker 1: examples of overpaide CEOs. I just took the highest I
Speaker 1: just took the highest page. So let's say you wanted
Speaker 1: to look at baseball players, and I took the baseball
Speaker 1: player had the highest batting affage for the last four years.
Speaker 1: Uh Now, when I got into that, it turned out
Speaker 1: that the first of all, if I took the base
Speaker 1: four baseball players with the highest batting AVU, you would
Speaker 1: have heard of them and there's only so many people
Speaker 1: can hit a hundred mile basketball or or a hanging
Speaker 1: curve ball. It sounds like lots of people can do
Speaker 1: with these various executives. It would appear to me that
Speaker 1: executive baseball players, let's say, seldom go from superstars two
Speaker 1: bums in a single season. This happens all the time
Speaker 1: with CEOs. I mean, we've seen we've seen CEOs crash
Speaker 1: and burn. You know, they're brilliant, they're they're the new
Speaker 1: poster child for for CEO, for top CEOs. Next year,
Speaker 1: they're out of a job. Most of Look, I was
Speaker 1: a CEO for fourteen years. When I was in the
Speaker 1: right place at the right time, I was a genius.
Speaker 1: When I was in the wrong place at the wrong time,
Speaker 1: I was a more Most of success is being in
Speaker 1: the right place at the right time, or something called fit,
Speaker 1: meaning that your skills, the particular skills you have, fit
Speaker 1: for what that company needs at that time. So let
Speaker 1: me take an icon of American business, Henry Ford. Henry
Speaker 1: Ford was a superb fit for the automobile industry when
Speaker 1: mass production and manufacturing efficiency were what was critical. When
Speaker 1: it became a question of customers styling Henry Foker is
Speaker 1: terrible fit any color as long as it's black, exactly.
Speaker 1: So you know when you're when you're fit, when you
Speaker 1: have the right fit for the right time in the company.
Speaker 1: You look pretty good when your skills are So I'm
Speaker 1: I'm a serendipity and luck really pay a big, big role.
Speaker 1: The race is not to the swift. So let's let's
Speaker 1: talk a little bit about consultants. I referenced them in
Speaker 1: my book. You spend a lot of time talking about consultants.
Speaker 1: And I have to begin with a quote, as I
Speaker 1: so often like to do, from Charlie Monger. I would
Speaker 1: rather throw a viper down my shirt fronts than hire
Speaker 1: a compensation consultant. So Charlie is not a big fan
Speaker 1: of them. Why do you think that is? Well, because
Speaker 1: compensation consultants are part of the ore. Are a parasitic profession. Uh,
Speaker 1: you'll have to put a little detail to that. Uh.
Speaker 1: Compensation consultants come in and say we're going to give
Speaker 1: you all sorts of studies in an objective way to
Speaker 1: pay your CEO. And uh, they're very anctious and and
Speaker 1: you'll pretend to be very serious and basically, what the
Speaker 1: what the CEO knows they're going to do is juice
Speaker 1: is pay. That's that's all. That's all these compensations. You
Speaker 1: don't even have to wink and nod. You just look
Speaker 1: at the record. And this is a big business. I
Speaker 1: was stunned to learn from your book management consulting industry.
Speaker 1: I would have guessed it was a couple of billion dollars.
Speaker 1: It's a two billion dollar industry. Oh yeah, now I'm not.
Speaker 1: I'm I don't paint all management cons aultants with the
Speaker 1: same brush. I find compensation consultants. Uh how big of that?
Speaker 1: Too much billion? To all pie are the compensations. I
Speaker 1: could not find a number on that. There's nothing, there's
Speaker 1: nothing public. Uh I would you know all of all
Speaker 1: of these companies have, all big companies have compensation consultants,
Speaker 1: and you know they're paid a million to ten million
Speaker 1: dollars at these places. Um, and really the only thing,
Speaker 1: the only thing they do is give you a big
Speaker 1: report and a lot of slides and a big power
Speaker 1: point and goose the CEO s pay. It's that simple.
Speaker 1: So here's an idea for any billionaire who wants to
Speaker 1: pursue it. You know, we've seen the way the thing
Speaker 1: tanks managed to push ideas out into the world, even
Speaker 1: though they may not be great ideas such as a
Speaker 1: shareholder value. Someone needs to for him in executive compensation
Speaker 1: think tank. They need to dog all of these consultant
Speaker 1: companies and essentially debunk every time they put out a
Speaker 1: slide deck to study something, and eventually, by doing that,
Speaker 1: someone will find a way to um put into the ether,
Speaker 1: put into the media and the conversation. Hey, these guys
Speaker 1: are wildly overpaid and for everything they say, you have
Speaker 1: to come up with the opposite, and I nominate you
Speaker 1: to do that. Well, and the book is a good start.
Speaker 1: I I don't I don't think that would work. Why not?
Speaker 1: Look does media pressure impacted comprit Directors would have to
Speaker 1: be brain dead not to know that their CEOs are
Speaker 1: wildly overpaid. I mean, how can you realistically go to
Speaker 1: you know, attend a meeting and say, oh, yeah, okay,
Speaker 1: so we're paying Joe this. So Joe has made forty
Speaker 1: million dollars this year. Well that's all right, because you
Speaker 1: know his peers are all paid. Let me give you
Speaker 1: an example. Suppose in nineteen eighty we had insurance consultants
Speaker 1: and they came to the boards and they said, hey,
Speaker 1: we got a great new way to do insurance. See,
Speaker 1: we're gonna have a peer group. We're gonna see what
Speaker 1: all your peers are paying for insurance. Okay, and then
Speaker 1: we're gonna have you pay at seventy at the seventy
Speaker 1: because you're well, no, no, this is a great idea
Speaker 1: that that you're a good company, you'll pay there. And
Speaker 1: by the way, because you need premium insurance your top court,
Speaker 1: top quart tile. And by the way, then um, we'll
Speaker 1: set for the for the insurance company. We're gonna set
Speaker 1: performance goals and if they hit those goals, will will
Speaker 1: double our our premiums cost. So so you accept that,
Speaker 1: you say, the company accepts that. It's now two thousand seventeen,
Speaker 1: you're on the board and you say, hey, I've been
Speaker 1: looking at our insurance. You know the cost, the real
Speaker 1: inflation inged cost has gone up a thousand percent, ten
Speaker 1: times uh and with how many our coverage is worse? Why?
Speaker 1: Why did? Why are we listening to these consultants? That's
Speaker 1: the position there in with CEOs, But they won't ask
Speaker 1: that question. So what has to be done to pressure
Speaker 1: board members, either through the media or what have you
Speaker 1: to my view, and this is this will be uh
Speaker 1: is that you need a blunt instrument, need a very
Speaker 1: blunt instrument to to wake these guys up. A law
Speaker 1: or I mean the Dodd Frank rule that requires the
Speaker 1: say on pay and the publication of this that hasn't
Speaker 1: seemed to thwart it. What what my because nothing else
Speaker 1: has worked. I'm saying you need a very blunt instrument.
Speaker 1: And what I'm saying is you need a luxury tax.
Speaker 1: I'm taking a page from Major League Baseball, a luxury
Speaker 1: you know, the Major League Baseball says, look, if your
Speaker 1: payroll gets over x, you gotta pay at tax. So
Speaker 1: I'm gonna say, if you pay your ceo everything over
Speaker 1: six million dollars to any executive, you gotta pay a
Speaker 1: tax to the federal government dollar for dollar. And by
Speaker 1: the way, I'm going to include everything. What you know,
Speaker 1: these number jets, the club got the biggest, the biggest thing.
Speaker 1: You know, when a CEO cashes in his stock options
Speaker 1: that's not reported as pay. Yeah. That so let's talk
Speaker 1: about fasby a little bit. There was an ongoing debate,
Speaker 1: primarily driven by Silicon Valley, which was do stock options
Speaker 1: counts as compensation, and one would think they should count
Speaker 1: as compensation, but they don't, well what they They finally
Speaker 1: forced them to say, yes, it's compensation. So this is
Speaker 1: the way. Then the accountants and the companies got around that.
Speaker 1: They said, well, when when we barry, we're gonna give
Speaker 1: you a million options at twenty. Stock is currently twenty now,
Speaker 1: so those million options will run it through a black
Speaker 1: Shoals model or something like that, and we'll say, okay,
Speaker 1: each option is worth is worth a dollar today. So
Speaker 1: we say you've got compensation of a million dollars. You
Speaker 1: got a million options. Now seven years later, the stock
Speaker 1: is at fifty. Not because you've done a good job,
Speaker 1: just because the market really well. Right, So you now
Speaker 1: cast in your million options for a gain of thirty
Speaker 1: dollars in option, you pocket thirty million dollars. That's not
Speaker 1: considered compensation. That is when when you read these ratio
Speaker 1: is three company have to go out when you exercise
Speaker 1: the option and replace that stock. It either has to
Speaker 1: replace that stock or print more stocks, or it's it's
Speaker 1: either dilutive or expensive. The shareholder loses. Uh. But according
Speaker 1: to the company, this uh, this money came from the
Speaker 1: tooth fairy. He just came in in the middle of
Speaker 1: the night put thirty million dollars under your pillow, and uh,
Speaker 1: very nice of them. And you know you left out
Speaker 1: the other half of that story, or the other possibility
Speaker 1: of that story, which is the stock doesn't go to fifty.
Speaker 1: The stock goes to ten, at which point the board
Speaker 1: reprices the stock options down to ten. There are no
Speaker 1: I don't even know if there's taxed, because you paid
Speaker 1: tax at twenty and clearly that calculation was wrong because
Speaker 1: it's not worth twenty, it's worth ten. And so you
Speaker 1: might even have a little fun with your tax amendment,
Speaker 1: do you amending your previous return. And then if subsequently
Speaker 1: that stock runs up, the companies in the same situation,
Speaker 1: it goes back to twenty and all of a sudden,
Speaker 1: you're mate, you're making money because because it's been repriced,
Speaker 1: because we had to give you the incentive. Now, this
Speaker 1: is this is one of the worst parts of it,
Speaker 1: the idea that these huge uh option packages at various
Speaker 1: other pay packages are necessary to motivate you. Now, CEOs
Speaker 1: are highly motivated to start with. You don't get you
Speaker 1: don't get to be a CEO if you know if
Speaker 1: you show up at eleven o'clock every morning. UM, A
Speaker 1: pay system is should only channel the motivation properly. Now,
Speaker 1: financial incentives at the CEO level, UH tend to have
Speaker 1: because they're so powerful, tend to narrow your focus completely.
Speaker 1: You're a ceo. You can make thirty million dollars this
Speaker 1: year if you increase earnings per share by x per cent.
Speaker 1: Let's say your whole bonus is based on You're gonna
Speaker 1: make that. You're gonna make that. You're going to make that.
Speaker 1: I mean, look, as you know, I could always make
Speaker 1: earning experience. I jump up and dance the mac arena
Speaker 1: with a you know, a few accounting changes. But but
Speaker 1: you're gonna make that. I don't care what you have
Speaker 1: to do. You're gonna make that. You are going to
Speaker 1: neglect everything else. You're gonna focus totally, totally on the
Speaker 1: Suppose I suppose I said, Barry, your performance measure next
Speaker 1: year is, UM, how many headlines your your radio story
Speaker 1: makes in the New York Post. Okay, you're gonna get
Speaker 1: thirty million dollars. If you make You're gonna be interview anybody.
Speaker 1: You'll make a headline. You don't care what right I mean,
Speaker 1: thirty million dollars is a powerful, powerful motivator there, right,
Speaker 1: you can ruin your show, but it's thirty million dollars
Speaker 1: and executives do the same thing. It's so powerful that that.
Speaker 1: And by the way, this has been shown in study
Speaker 1: after study and an experiment after experiment that for all,
Speaker 1: for all, um all, except repetitive, repetitive tasks or really
Speaker 1: distasteful tasks like you know, knocking on doors and selling magazines.
Speaker 1: Financial incentives tend to harm performance your your You perform best,
Speaker 1: and I'm sure you perform best when you are motivated
Speaker 1: by your conception of what a job well done is
Speaker 1: just pride and workmanship. I know that's old school, but
Speaker 1: I think it's important. It's it's, it's, it's it's not
Speaker 1: old school, in fact, is what how humans perform um
Speaker 1: And so you're saying stock options are motivating CEOs towards
Speaker 1: one thing, which is stock price. Yes, yeah, it's it's,
Speaker 1: it's and that's why. That's why. And you combine that
Speaker 1: with the theoretical justification of shareholder value, and this is
Speaker 1: one of the I think the is one of the
Speaker 1: worst things that's happened to American industry. So there are
Speaker 1: two issues that raises and and a shorter one and
Speaker 1: along the one. Let's start with the shorter one first.
Speaker 1: I've read numerous times people said, well, when you give
Speaker 1: stock options to executives, their interests or aligne with shareholders.
Speaker 1: But that doesn't make sense. They haven't taken any risk,
Speaker 1: they haven't put up any money, they're not thinking long term.
Speaker 1: To them, all they need to do is have um
Speaker 1: the stock price go up, whether they're responsible or not.
Speaker 1: How on earth does that align them with the interests?
Speaker 1: It is amazing. I look at these company proxies and
Speaker 1: you know, they have forty pages on executive compensation and
Speaker 1: the word alignment is used at least twenty or thirty
Speaker 1: times in each proxy. And you're absolutely right, there's no
Speaker 1: alignment at all. I mean heads heads I win, tails
Speaker 1: I break even with an option unless there's a repricement
Speaker 1: in which even tails went right, which even tails I win.
Speaker 1: So let's talk about the bigger issue, which is what
Speaker 1: I think the compensation that is attributed to stock options
Speaker 1: get so wrong. When you are giving a huge pile
Speaker 1: of stock options to an executive, you're essentially compensating them
Speaker 1: not for how well their company does relative to their peers,
Speaker 1: not for how well they do, but you're compensating them
Speaker 1: based on how well the stock market does. Absolutely, as
Speaker 1: as as you know, sevent of a company stock movement
Speaker 1: has to do with the general stock market or the
Speaker 1: industry and the sector. Right, the two of those are
Speaker 1: at least not more. The company itself is responsible for
Speaker 1: about a third if that much, if that much, and
Speaker 1: so hey, if you're in the right industry, in the
Speaker 1: right market, you're going to get big stock option gains,
Speaker 1: even if you perform much below your peer group. This
Speaker 1: is another thing that that stuns me. We say we're
Speaker 1: gonna they always say, okay, we're gonna pay according to
Speaker 1: a peer group. And then they say, but you're you're
Speaker 1: going to be paid at the seventy five percentile because
Speaker 1: we're a good company. They never ever test that you
Speaker 1: have to perform at the seventy five percent dial or
Speaker 1: you have to beat your peers at anything. That's shocking.
Speaker 1: There is never, there is never that test in everyone
Speaker 1: I've ever looked at once. Once you set your base
Speaker 1: at seventy peer group, you are not held for any performance.
Speaker 1: You're that you may have a uh your compensation may
Speaker 1: be linked to your stock price, it may be linked
Speaker 1: to earnings per share, but nothing about beating these peers,
Speaker 1: right the old line as I'm astonished but not surprised.
Speaker 1: So so here you raised the question that that uh
Speaker 1: I was thinking of, which is how did this company
Speaker 1: do relative to revenue? For is their peers relative to
Speaker 1: market share, relative to patents filed, relative to product introduction,
Speaker 1: relative to market penetration, relative to geographic expansion relative You
Speaker 1: could come up very easily with a dozen or hundred
Speaker 1: different metrics that you could use a loan or in
Speaker 1: combination with each other that would fairly say, hey, how
Speaker 1: has this company done relative to other companies in the space,
Speaker 1: relative to other companies of the same size, relative to
Speaker 1: any reasonable pier and those gains are the basis for
Speaker 1: our bonuses and compensation. You could although that would that
Speaker 1: would be that would be highly complicated. I I prefer
Speaker 1: much simpler system, which would be my simple. My My
Speaker 1: system is you get a salary pretty good salt, you know.
Speaker 1: Do you get a salary two three two million bucks
Speaker 1: and you get restricted stock? How can I live on
Speaker 1: two million dollars? Well, you know, maybe you know what
Speaker 1: the dudes are at the golf club. It's and I
Speaker 1: don't even play golf, but still it's very expensive. To
Speaker 1: let me tell you, I've I've lived very well. I've
Speaker 1: lived very well, and I belonged to a very nice
Speaker 1: golf club. Uh and I've never made two million dollars
Speaker 1: a year. That's a that's a book title scraping. So uh,
Speaker 1: I say restricted stock, and then there's one restricted stuff,
Speaker 1: not an option, but restricted stock. How long do they
Speaker 1: have to hold that stuff? To hold that stock until
Speaker 1: about five years after they've retired, after they've not even
Speaker 1: after they've left the company, after after they've left after
Speaker 1: I'm sorry, after they've left the company. So in other words,
Speaker 1: you're making them think long term plus five and there's
Speaker 1: only one performance requirement. M hmm, long term plus five.
Speaker 1: That stock has to perform better than the SMP five
Speaker 1: really lose half of it. So in other words, half
Speaker 1: the SMP five hundred is gonna underperform. One would think,
Speaker 1: I mean the distribution. So I'm just saying, look, you
Speaker 1: get you get a lot of stock in the company,
Speaker 1: so you're you're a shareholder that and your your interests
Speaker 1: truly are aligned. Your interest truly are aligned and you're
Speaker 1: a long term shareholder because you can't even get out
Speaker 1: the day you quit the company. Uh. And there there's
Speaker 1: a complicated way of how you can reduce this over
Speaker 1: time and um. And your test is that during that
Speaker 1: period you have to form better than the other guys
Speaker 1: are half your restricted share is goot forfeited And you
Speaker 1: mentioned blunt instruments. The way to make this work, one
Speaker 1: would imagine, would be to create a tax incentive if
Speaker 1: you use this plan, and a higher tax if you don't.
Speaker 1: That's right, right, that would I didn't I didn't have
Speaker 1: that in my book. But I think that's an excellent idea. Well,
Speaker 1: the the only way to get anybody to adopt something
Speaker 1: is to give them incentive or disincentives. And the current plan.
Speaker 1: Should you combine your you were three quarters away there
Speaker 1: your luxury tax with you don't pay the luxury tax.
Speaker 1: If you do it this way, you had both completely
Speaker 1: We we should have I should have had this interview
Speaker 1: before I read this. Well, can these are your ideas?
Speaker 1: I'm just add the luxury tax with this. I think
Speaker 1: it's an excellent idea. It's it's a way to make sense.
Speaker 1: The second edition will have it in there. You go,
Speaker 1: you can you can you can edit that UM before
Speaker 1: we go to our our standard questions, our favorite questions
Speaker 1: I had UM. I had one last question I had
Speaker 1: to ask you, which I thought was hilarious. A board
Speaker 1: member once asked you, how do you measure the first
Speaker 1: year's progress on a three year turnaround? So, in other words,
Speaker 1: people have bonuses and incent of every year on what
Speaker 1: was supposed to be a three year turnaround. How can
Speaker 1: you legitimately measure where you are? One of the problems
Speaker 1: is with the bonus system. You get an annual bonus
Speaker 1: as if everything important falls nice calendar within a calendar year.
Speaker 1: And the analogy that I used to show you how
Speaker 1: absurd an annual bonus system is. The analogy as he
Speaker 1: used in the book, is think of setting a bonus
Speaker 1: system for generals in wartime because we need to motivate them.
Speaker 1: We need not self motive. They're not self motivate, and
Speaker 1: we need to you know, they'll perform better if we
Speaker 1: give them a bonus. Well, that's the same that you have.
Speaker 1: I mean, it's so absurd, but although invade easy targets,
Speaker 1: they won't fight exactly exactly. It's pretty crazy. I mean,
Speaker 1: if if the Soviet Union, I'm Soviet univer that shows
Speaker 1: out my age. If if Russia wanted to truly debilitate
Speaker 1: the army, the military, and the United States, it would
Speaker 1: introduce an annual bonus system. That's amazing. So so let's
Speaker 1: talk a little bit about some of our standard questions.
Speaker 1: And these are the things I asked all of my guests. Um,
Speaker 1: tell us a little bit about your background that people
Speaker 1: don't know about you. Uh, well people don't. I doubt
Speaker 1: your listeners know anything about me, so they will after this, okay. Um.
Speaker 1: The first the job I had the most fun at
Speaker 1: was when I was Deputy Controller of the City of
Speaker 1: New York during the financial crisis. That was pretty interesting,
Speaker 1: was fascinating. I mean the cast of characters I was
Speaker 1: working with, uh and the issues I was working when
Speaker 1: I was a kid. I was thirty four years old,
Speaker 1: so that that was that was a lot of fun.
Speaker 1: My father in law used to own the New York
Speaker 1: City General Obligation bonds and when I think they had
Speaker 1: a coal function in two thousand something like that, and
Speaker 1: I remember he came came to me and said, all right,
Speaker 1: I have these bonds that are called in New York
Speaker 1: City geos. He was buying them for years in the seventies.
Speaker 1: They've been playing twelve four? What can you get me
Speaker 1: to replace him? And I said, I could get you
Speaker 1: some treasuries at four and a half five percent if
Speaker 1: you want muni bonds, they're just a tiny bit riskier,
Speaker 1: but it's tax free and they'll pay about four percent.
Speaker 1: And he's like, what the hell am I going to
Speaker 1: do with that? Were you there during the that was
Speaker 1: quite quite a period of time. My father in law,
Speaker 1: who is no longer with us, correctly surmised New York
Speaker 1: City UH is still gonna be around. So that was
Speaker 1: a yes to say the least. Tell tell us about
Speaker 1: some of your early mentors who affected um the way
Speaker 1: you approach being a CEO or a board member. You know.
Speaker 1: I would say that two early mentors I had were
Speaker 1: when I was in government UH in New York. One
Speaker 1: was a fellow named Bob will Ers, who is now
Speaker 1: longtime CEO of M ANDT Bank and the most As
Speaker 1: a matter of fact, his bank, which I think is
Speaker 1: about the twentieth biggest bank in the country, has the
Speaker 1: very fast growing recently has been the most successful bank
Speaker 1: stock among all banks that's grown at about twenty a
Speaker 1: year from forever. And then, uh, I just had lunch
Speaker 1: with him. And I just had lunch with another one
Speaker 1: of my former mentors, Jay Golden, who was the controller
Speaker 1: of the Brilliant Brilliant Guy New York City or New
Speaker 1: York State, New York City. I definitely recognized the name
Speaker 1: who affected your thoughts on executive pay. Again, you're not
Speaker 1: a typical CEO slash board member. What steered you? Who
Speaker 1: steered you in the direction you move? You know, I'd
Speaker 1: have nobody steered me. I just kept, as you know,
Speaker 1: I was doing this at a company level to try
Speaker 1: and to say, look doesn't make any sense. I mean,
Speaker 1: the incentives are all wrong in their perverse and they're
Speaker 1: going the wrong way. And then as I got into
Speaker 1: it and into it, I said, this is an outrage.
Speaker 1: And you know, I like to write, and so I
Speaker 1: started to write about it. But no, no, but no,
Speaker 1: I steered myself. That's that's interesting. Um. This is uh
Speaker 1: a listener question that that we've adopted every week, and
Speaker 1: it's it's actually one of the most popular questions we get.
Speaker 1: Tell us about some of your favorite books, fiction, nonfiction,
Speaker 1: compensation related or not. Okay, In the last three years,
Speaker 1: I would say my two favorite books were Daniel Kahneman's
Speaker 1: Thinking Fast and Thinking Slowly and I'll tell you a
Speaker 1: story about that. Uh and um, Why Nations Fail? That's
Speaker 1: a that was a big book that came out a
Speaker 1: year or two ago. Two M. I T. Professor hard
Speaker 1: one Harvard won M I T. I guess what was
Speaker 1: the author name of that? It's I know that. I'm
Speaker 1: gonna pull that up right now. Hold on a second.
Speaker 1: Let me tell you a fascinating story about Daniel Cokay,
Speaker 1: I read. I read his book, Thinking Fast and Thinking
Speaker 1: So I love the book. But I thought he had
Speaker 1: one Darren Asmo Glue, who was a recent UM guest
Speaker 1: on the show will be broadcast later uh this month. Well,
Speaker 1: he's a brilliant, absolutely brilliant thing. Well by the time
Speaker 1: this broadcast, it will have been last week or so. Okay,
Speaker 1: So Daniel Koneman, Nobel Prize winner, wrote this brilliant book.
Speaker 1: I thought he had one thing wrong. I thought he
Speaker 1: had made I thought he I had a better explanation
Speaker 1: for one of his examples than he did. So I
Speaker 1: don't need to go into it. I sit down and
Speaker 1: I this is at ten o'clock Seattle time. Ten am.
Speaker 1: It's one o'clock Princeton time. Where he is. I write
Speaker 1: him up an email. I said, dear Mr, I mean
Speaker 1: I enjoyed your doctor. I enjoyed your book. Uh, but
Speaker 1: I think you got one thing wrong. Ten minutes later,
Speaker 1: one ten Princeton time, I get back an email saying,
Speaker 1: thanks for the kind comments about your book. Uh, your explanation,
Speaker 1: uh would would seem to be pretty good. However, we
Speaker 1: checked before we did this, and here's why our explanation
Speaker 1: is right and yours is wrong. And I said, here's
Speaker 1: a No Bill Prize winner one ten answering an email
Speaker 1: from somebody he's never heard. I just found out astonishing.
Speaker 1: He's a fascinating guy. When I'll tell we don't have
Speaker 1: time for it, but I'll tell you a funny story
Speaker 1: about him, which I actually relate in that podcast. But
Speaker 1: he's really a fascinating guy. Um. So that's one book.
Speaker 1: Uh why why Nations Fail? It was to me, come
Speaker 1: pleat eye opener. Uh, fascinating. I never thought I love
Speaker 1: a book that all of a sudden makes you think
Speaker 1: the way I've been thinking all my life is wrong
Speaker 1: on this particular serspective changer. Yes, yes, I mean just
Speaker 1: what they call it paradigm. So what else? What else
Speaker 1: is give me one more book? Well, unless you have more, uh,
Speaker 1: I would have to you know, the most influential books
Speaker 1: that I've ever read. I would say that Richard Dawkins
Speaker 1: a selfish gene, probably influenced my thought more than any
Speaker 1: other book I've run across. That's that's fascinating. Um, So
Speaker 1: what do you see as the next shifts in the
Speaker 1: world of executive compensation? Is this going to continue on
Speaker 1: this trajectory with no ability to change it? Or are
Speaker 1: we going to start to see some changes? Uh? I
Speaker 1: don't think we'll see any changes until it becomes a
Speaker 1: political issue. I now, isn't isn't it a bit of
Speaker 1: a politicalitial already with with the incoming equality and or
Speaker 1: is that still a minor factor. I don't see it
Speaker 1: as a politic I don't think boards are scared. Boards
Speaker 1: are going to have to get scared and say to themselves,
Speaker 1: you know, if we don't reform ourselves, somebody else is
Speaker 1: going to. That's when it will start. They're not in
Speaker 1: that position now, nobody. You don't see anybody threatening legislation.
Speaker 1: It's got I think it's got to get to the
Speaker 1: point that where they say, you know, if we better
Speaker 1: do something. That Bernie Sanders won the election, they might
Speaker 1: have been a little more nervous, exactly exactly. And if
Speaker 1: you get you know, if in the next Democratic primary
Speaker 1: you get another Sanders type candidate who who's not quite
Speaker 1: to the you know, a little to the right of Bernie,
Speaker 1: but starts saying, if elected, I'm going to do something
Speaker 1: about this, then populous. Yeah, then I think boards might.
Speaker 1: But not until then that that's quite that's quite fascinating.
Speaker 1: So tell us about a time you fail, old and
Speaker 1: what you learned from the experience. We could be here
Speaker 1: a long time if I was just going to tell
Speaker 1: you about all the times I failed. And I looked
Speaker 1: at that question and I thought, I'm not sure I
Speaker 1: learned anything. Uh. Here, I failed because I was too bold,
Speaker 1: and then I failed because I was too timid at
Speaker 1: different times. So less I've failed when I when I
Speaker 1: didn't consult enough people, and I failed when I consulted
Speaker 1: a lot of people. So I've had as a CEO,
Speaker 1: you're going to fail a lot. So it's the luck
Speaker 1: and the fit issue more than anything, I think. I
Speaker 1: think the one thing I've learned be in the right
Speaker 1: place at the right time always helpful. UM, tell us
Speaker 1: what you do to keep mentally and or physically fit?
Speaker 1: What do you do to relax outside the I get
Speaker 1: tremendous amounts of exercise. Uh, And I find as I
Speaker 1: at your age, I'm seventy four and look well, thank you.
Speaker 1: I'm I'm thirty six, and I looked terrible as you
Speaker 1: as you age. Uh, physical exercise is the absolute key.
Speaker 1: It sends messages somehow to your body that hey, you
Speaker 1: gotta stay alive, you gotta stay alert. So I do
Speaker 1: a lot of exercising, uh, jim or anything in particular.
Speaker 1: Well I do I know? Well, I work out. I
Speaker 1: do about forty minutes on the elliptical every morning as
Speaker 1: I read the newspaper. Then I do about a forty
Speaker 1: minutes strength uh, stretching, strengthening, And then I played nine
Speaker 1: holes of golf most days. Really yeah, but I played. No,
Speaker 1: I'm not that I've actually I'm at at age seventy
Speaker 1: four and playing the best golf of my life. But
Speaker 1: what I do is the courses I live in in
Speaker 1: the city of Seattle, but I belonged to a course.
Speaker 1: It's about five minutes from my house. I play either
Speaker 1: by myself or in a twosome and we do it
Speaker 1: in an hour using a car. To you walking, I'm walking,
Speaker 1: And who's carrying your bag? I'm pulling it. Really that's
Speaker 1: pretty good. Um, alright, our last two questions, these are
Speaker 1: our favorite questions. I know we have to get you
Speaker 1: out of here in a few minutes. So what sort
Speaker 1: of advice would you give to a millennial or someone
Speaker 1: who's just starting their career as it relates to compensation. Uh, well,
Speaker 1: I'd have to repeat, avoid the wrong place at the
Speaker 1: wrong time, be in the right place at the right time,
Speaker 1: always good advice. And and our final question, what is
Speaker 1: it that you know about executive compensation and stock options
Speaker 1: and boards today that you wish you knew twenty or
Speaker 1: thirty years ago. You know, if I had known all
Speaker 1: of this twenty or thirty years ago and seeing it
Speaker 1: at the start, I might have been able to do
Speaker 1: something to uh, to arrest it at that time before
Speaker 1: it got amazingly out of control. I mean, it's so
Speaker 1: blatantly insane. I I say, it's this is it's kind
Speaker 1: of like doctors who used to bleed people. Why did they?
Speaker 1: Why did why did they didn't know better? Well, no,
Speaker 1: because everybody bled people. I mean, this is what doctors did.
Speaker 1: So this is the way a lot of people think about. Well,
Speaker 1: this is what this is how we do compensation, this
Speaker 1: is this is how a board is supposed to work.
Speaker 1: Thank you so much for being so generous with your time. Well,
Speaker 1: thank you for having me. This has been I've really
Speaker 1: enjoyed the talk. Here. We have been speaking with Stephen Clifford.
Speaker 1: He is the author of the CEO pay Machine. If
Speaker 1: you enjoyed this conversation, be shure and check out all
Speaker 1: of our other such talks. You can see the nearly
Speaker 1: hundred and fifty or so over the past three years
Speaker 1: at Apple, iTunes, Overcast, Bloomberg dot com and SoundCloud. I
Speaker 1: would be remiss if I did not thank my head
Speaker 1: of research, Michael bat Nick, and my recording engineer, Medina Parwana.
Speaker 1: Taylor Riggs is our producer slash Booker. We love your comments,
Speaker 1: feedback and suggestions right to us at m IB podcast
Speaker 1: at Bloomberg dot net. I'm Barry Hults. You're listening to
Speaker 1: Masters in Business on Bloomberg Radio,