Executive Pay

We spent a fair amount of time in b-school talking about aligning manager interests with shareholder interests. It seems like the simplest way to do that is to have the managers be owners.

I wonder how many executives would choose to stay in their jobs if their salaries were dropped to $100,000 and the Board of Directors told them if they want to make money, then they should invest their own funds in the business and they will make money when shareholders make money.

Now, I realize executive pay is a free market and a good manager is worth a good salary and much of CEO pay is really the cost cover the legal risk of being an executive, but still, I think it’s an interesting thought experiment.

It’s a thought experiment modeled after Warren Buffet, who takes a salary of $100,000 for running Berkshire Hathaway, but has become a billionaire by owning a fair size chunk of that company.

If this became the norm in executive pay, I would guess that we would see a different group of people occupying the executive suites. Speaking of executive suites, I’d bet those suites would not be as well-appointed if the managers were owners.

Now, some folks might argue that executives often do have significant portions of their pay and bonuses tied to the stock performance. On the surface, that seems like a logical way to align the interests. But, experience has proven otherwise and the explanations are simple.

For example, managers with stock options, stock grants and stocks bought with non-recourse loans from the company help align executive interests with shareholders on the upside, but not the down side. Managers personally lose nothing, except potential profits, for taking big risks to try to move the stock price up.

Not only that, but executives often have severance agreements that reward them relatively handsomely for getting fired. So, the only downside to taking big risks is the executive’s ego.

So, what happens under such pay schemes? Executives take big risks.