How can Supply have all the Power and Demand have None?

A New York Times article on director scrutiny for executive pay joined the twitter this
morning. The lack of examination of executive pay’s precipitous rise over the past two
decades, as well as accountability for company’s boards of directors in these matters
was pushed into the spotlight.

The Times notes that “the exchange’s” (NY Stock that is) “board took at lot of heat for
that” (executive pay to Dick Grasso) “controversy,” according to Sarah Anderson, a
Washington based expert on executive pay. The House committee on “Oversight and
Government Reform” (could any title be farther away from the wheels of commerce?)
looked at pay practices before the explosion of insolvency drew their attention away
towards a new shiny penny.

We still lack clear opinions and leadership in this matter, especially in media and in
government. Executives are not entitled to private jets, nor are they entitled to pay for
Bat Mitzvah’s where Aerosmith performs, with pay earned for running “public”
companies. Generals in the United State’s Army earn a touch over $200,000 per year
for service and seem to stay happily in their jobs. If you ask student’s at Harvard
Business School (which is the mac Daddy of business schools, no?) if they would be
happy to earn $1 million per year, it is likely that a resounding percentage (think
purity level of Ivory Soap 99.44% maybe?) would say damn yes!
What happens along the way from youthful exuberance to this surreality?. The
headlines keep claiming that the top people will go “elsewhere” if they are not paid
$10 or 20 or 50 million dollars per year. The question I have is “Where?”
There are 500 public companies that are listed in the Fortune 500. Hundreds of
thousands (perhaps millions really) of executives have credentials worthy of note, and
could easily serve in their area of expertise for many companies (including the one
they currently work for). When a CEO, CFO or other top company official dies,
replacements are always found, even for founders whose will, personas and visibility
would render them legend (Sam Walton is a wonderful example).

So how is it that the supply (the top level employees) have all this power and ability to
hold the line while demand (companies that are powerful, influence politics on
multiple continents, have strong allies in government, and have billions of dollars)
have none?

The whole concept of Supply and Demand was coined in the 1700’s by James
Denham Stewart, and is perhaps the most well known idea behind the study of
economics. Governments have regulated against “collusion” (the practice of acting in
concert to unfairly impact one side of the market to favor the other” so the equity of
the market seems likely, yet somehow the CEOs must be paid tens of millions (or
hundreds of millions if you don’t mind) of dollars for manning the controls.

The CEO of GE (currently Jeff Immelt, on who’s watch as much as 90% of the market
value of the company disappeared) is a credentialed executive. He should earn a
salary and a cash bonus if the company does well again. He should be penalized for
his performance during his tenure, and the board of directors should be mindful that
if the company’s stock rises from its low of $6.00 to $25.00, Mr. Immelt should not be
thanked for quadrupling shareholder value, nor should his options be re-priced with
such a low baseline price that would allow him to earn in the face of shareholder’s
losing (1) the longest running dividend on Wall Street and (2) billions of dollars on his
shift.

It makes no academic sense. The supply (the number of jobs running Fortune 500
companies) is fixed, and demand (number of guys and gals with credentials (MBAs,
Ph.Ds and so on) is rising (especially as the health and age of able workforce rises).
This would on a simple level create a strong argument that the prices for those
workers should drop, especially on an adjusted real dollar basis. Ask any farmer who
has a bountiful, frost free winter in the orange groves how it works, and they’ll explain
why prices fall when supply increases. Somehow in the face of the immutable reality
of many educated executives, the pay of workers, providing the unit price labor in the
company’s offering shrinks, while in real and adjusted dollar terms, CEO pay soars.
If you asked why Russia minted so many billionaires in the last 20 years it would be
simple; the former communist party guys took the state’s assets for themselves (as
opposed to just siphoning off a percentage back in the Politburo days). CEO’s did the
same. They asked board members to grant massive amounts of options, which are
riskless (to them) rights to buy stock at a given price, and then did the things to drive
the stock prices up quickly within the option periods, which were not necessarily to
the company’s benefit in the long run.

If you run a car company, as an example, you might act like this: The stock is trading at
$10 per share and making $1 per share. You take over and get $2 million dollars per
year, retirement benefits, stellar perquisites like a plane and five star travel, and 3
million five-year options to buy stock at $10. The company needs new plants and
equipment and workers all joined up because the company had a pension plan
(company paid) and health insurance and other benefits. You don’t invest in new
plants, but seek a partnership with an off balance sheet subsidiary you formed to
handle issues surrounding plant investment and made a deal to allow the investors in
that entity (bondholders) to have higher interest and payment six years from now in
exchange for lower payments today. You brought in investment bankers who
examined the pension fund (does the term “trust” funds mean anything to anybody
anymore?), and decided it was “overfunded.” You purchased an annuity from an
insurance company to provide “minimum benefits” to pension retirees and used the
excess money to buyback stock to “enhance shareholder value by increasing income
per share.” The Company earns $2 per share next year and the price increases to $25
(the investment bank recommends it based on growth), so the options are worth $45
million dollars. Five years later the higher fees kick in and the insurance company
annuity you bought doesn’t work and the company is losing money and the stock
drops to $.20 per share. No penalty, no accountability and completely legal, believe it
or not.

These are defensible actions that will result in increased bottom line, increase in your
warrant value but may not enhance shareholder value in the long term (see how
Toyota, Nissan and Honda’s balance sheets look and the levels of their executive
compensation.) Certainly most companies that bought back stock could use the cash
to run their businesses in the broken capital markets environment we have today.
So how can we pay these guys? Well there are some ideas: (1) a cash bonus. Lawyers
get a cash bonus at every firm in the United States and none of them seem to leave,
(2) Lend them money, (an amount that they can pay commensurate with their salary
and wealth) at the lowest rate a company can borrow at and let them “buy” shares, or
(3) a pat on the back and a hearty “thanks” from the board and the shareholders. If
that doesn’t work, studies show disgruntled employees don’t do good jobs anyway.
Stop lying; and take a stand experts. There are so many men and women that could
take the roles in sales, operations, marketing, finance and management at the large
companies that if they stood on top of each other we might be able to touch the
outer rings of Saturn. The great universities turn out more each year and there is no
lack of “supply.” Public companies are for the “shareholders,” not for the executives.
Stop the excesses, the greed and the madness and go back to 1950s America, where
a CEO lived in a nice 6 BR home in a great area, belonged to a country club and
drove a nice car.

If that model doesn’t bring the greatest Americans resumes to solve the difficult
problems facing us, its great. Those great Americans will start businesses, and
because we’ve established their greatness (as we agree we have), jobs will be
created, and the economy will benefit. I will never argue that these CEOs turned
entrepreneurs will be entitled to the money from building their own enterprises,
which their brilliance and risk they will take will afford them; assuming that they
actually take that risk of course. If they don’t, they will earn a couple of million dollars
running the powerful companies they run and the rest of the formally excessive
compensation they earned will be left to hire people, expand and rebuild their
businesses. They need lots of rebuilding. It’s win-win.

Be mindful, be careful and good luck!A New York Times article on director scrutiny for executive pay joined the twitter this morning. The lack of examination of executive pay’s precipitous rise over the past two decades, as well as accountability for company’s boards of directors in these matters
was pushed into the spotlight.

The Times notes that “the exchange’s” (NY Stock that is) “board took at lot of heat for
that” (executive pay to Dick Grasso) “controversy,” according to Sarah Anderson, a
Washington based expert on executive pay. The House committee on “Oversight and
Government Reform” (could any title be farther away from the wheels of commerce?)
looked at pay practices before the explosion of insolvency drew their attention away
towards a new shiny penny.

We still lack clear opinions and leadership in this matter, especially in media and in
government. Executives are not entitled to private jets, nor are they entitled to pay for
Bat Mitzvah’s where Aerosmith performs, with pay earned for running “public”
companies. Generals in the United State’s Army earn a touch over $200,000 per year
for service and seem to stay happily in their jobs. If you ask student’s at Harvard
Business School (which is the mac Daddy of business schools, no?) if they would be
happy to earn $1 million per year, it is likely that a resounding percentage (think
purity level of Ivory Soap 99.44% maybe?) would say damn yes!
What happens along the way from youthful exuberance to this surreality?. The
headlines keep claiming that the top people will go “elsewhere” if they are not paid
$10 or 20 or 50 million dollars per year. The question I have is “Where?”
There are 500 public companies that are listed in the Fortune 500. Hundreds of
thousands (perhaps millions really) of executives have credentials worthy of note, and
could easily serve in their area of expertise for many companies (including the one
they currently work for). When a CEO, CFO or other top company official dies,
replacements are always found, even for founders whose will, personas and visibility
would render them legend (Sam Walton is a wonderful example).
So how is it that the supply (the top level employees) have all this power and ability to
hold the line while demand (companies that are powerful, influence politics on
multiple continents, have strong allies in government, and have billions of dollars)
have none?

The whole concept of Supply and Demand was coined in the 1700’s by James
Denham Stewart, and is perhaps the most well known idea behind the study of
economics. Governments have regulated against “collusion” (the practice of acting in
concert to unfairly impact one side of the market to favor the other” so the equity of
the market seems likely, yet somehow the CEOs must be paid tens of millions (or
hundreds of millions if you don’t mind) of dollars for manning the controls.
The CEO of GE (currently Jeff Immelt, on who’s watch as much as 90% of the market
value of the company disappeared) is a credentialed executive. He should earn a
salary and a cash bonus if the company does well again. He should be penalized for
his performance during his tenure, and the board of directors should be mindful that
if the company’s stock rises from its low of $6.00 to $25.00, Mr. Immelt should not be
thanked for quadrupling shareholder value, nor should his options be re-priced with
such a low baseline price that would allow him to earn in the face of shareholder’s
losing (1) the longest running dividend on Wall Street and (2) billions of dollars on his
shift.

It makes no academic sense. The supply (the number of jobs running Fortune 500
companies) is fixed, and demand (number of guys and gals with credentials (MBAs,
Ph.Ds and so on) is rising (especially as the health and age of able workforce rises).
This would on a simple level create a strong argument that the prices for those
workers should drop, especially on an adjusted real dollar basis. Ask any farmer who
has a bountiful, frost free winter in the orange groves how it works, and they’ll explain
why prices fall when supply increases. Somehow in the face of the immutable reality
of many educated executives, the pay of workers, providing the unit price labor in the
company’s offering shrinks, while in real and adjusted dollar terms, CEO pay soars.
If you asked why Russia minted so many billionaires in the last 20 years it would be
simple; the former communist party guys took the state’s assets for themselves (as
opposed to just siphoning off a percentage back in the Politburo days). CEO’s did the
same. They asked board members to grant massive amounts of options, which are
riskless (to them) rights to buy stock at a given price, and then did the things to drive
the stock prices up quickly within the option periods, which were not necessarily to
the company’s benefit in the long run.

If you run a car company, as an example, you might act like this: The stock is trading at
$10 per share and making $1 per share. You take over and get $2 million dollars per
year, retirement benefits, stellar perquisites like a plane and five star travel, and 3
million five-year options to buy stock at $10. The company needs new plants and
equipment and workers all joined up because the company had a pension plan
(company paid) and health insurance and other benefits. You don’t invest in new
plants, but seek a partnership with an off balance sheet subsidiary you formed to
handle issues surrounding plant investment and made a deal to allow the investors in
that entity (bondholders) to have higher interest and payment six years from now in
exchange for lower payments today. You brought in investment bankers who
examined the pension fund (does the term “trust” funds mean anything to anybody
anymore?), and decided it was “overfunded.” You purchased an annuity from an
insurance company to provide “minimum benefits” to pension retirees and used the
excess money to buyback stock to “enhance shareholder value by increasing income
per share.” The Company earns $2 per share next year and the price increases to $25
(the investment bank recommends it based on growth), so the options are worth $45
million dollars. Five years later the higher fees kick in and the insurance company
annuity you bought doesn’t work and the company is losing money and the stock
drops to $.20 per share. No penalty, no accountability and completely legal, believe it
or not.

These are defensible actions that will result in increased bottom line, increase in your
warrant value but may not enhance shareholder value in the long term (see how
Toyota, Nissan and Honda’s balance sheets look and the levels of their executive
compensation.) Certainly most companies that bought back stock could use the cash
to run their businesses in the broken capital markets environment we have today.
So how can we pay these guys? Well there are some ideas: (1) a cash bonus. Lawyers
get a cash bonus at every firm in the United States and none of them seem to leave,
(2) Lend them money, (an amount that they can pay commensurate with their salary
and wealth) at the lowest rate a company can borrow at and let them “buy” shares, or
(3) a pat on the back and a hearty “thanks” from the board and the shareholders. If
that doesn’t work, studies show disgruntled employees don’t do good jobs anyway.
Stop lying; and take a stand experts. There are so many men and women that could
take the roles in sales, operations, marketing, finance and management at the large
companies that if they stood on top of each other we might be able to touch the
outer rings of Saturn. The great universities turn out more each year and there is no
lack of “supply.” Public companies are for the “shareholders,” not for the executives.
Stop the excesses, the greed and the madness and go back to 1950s America, where
a CEO lived in a nice 6 BR home in a great area, belonged to a country club and
drove a nice car.

If that model doesn’t bring the greatest Americans resumes to solve the difficult
problems facing us, its great. Those great Americans will start businesses, and
because we’ve established their greatness (as we agree we have), jobs will be
created, and the economy will benefit. I will never argue that these CEOs turned
entrepreneurs will be entitled to the money from building their own enterprises,
which their brilliance and risk they will take will afford them; assuming that they
actually take that risk of course. If they don’t, they will earn a couple of million dollars
running the powerful companies they run and the rest of the formally excessive
compensation they earned will be left to hire people, expand and rebuild their
businesses. They need lots of rebuilding. It’s win-win.

Be mindful, be careful and good luck!