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CEO Pay

The latest news is that the CEO of the new NBN (National Broadband Network) will receive a $2 million salary [1]. This has been defended as “the price required to secure the best person for the job“. The problem with this idea is that it’s not the first time that a multi-million dollar salary has been paid from tax money for a CEO of a communications company. Sol Trujillo did an absolutely awful job of running Telstra and was paid a package of $11 million (including bonuses) for doing so [2]. After finally quitting Telstra Sol then had a whinge about Australians supposedly being racist – he apparently didn’t realise that we would have loved him if Telstra’s monopoly services had operated well and if he had returned value for the stock-holders. Sol should have been sacked long ago, the government’s voting power (through owning half of Telstra) was enough to force him out.

Now the CEO of the NBN is going to be employed entirely at taxpayer expense (the NBN will initially be entirely government owned). So it seems reasonable to compare the pay of the NBN CEO to the pay of the Prime Minister of Australia [3] – which is currently $330,300. If we consider the perks of the job (free travel etc) to be worth an additional $200,000 (just a wild guess) then the Prime Minister gets paid 25% the proposed salary of the CEO of the NBN. Every day the PM makes decisions that are much more important than any that will be faced by the CEO of a communications company. So it appears that we can get someone suitably skilled for less than $2 million (I know some people believe that every PM has done a bad job – but I have not seen any evidence to suggest that the typical political leader is any less skilled than the typical CEO).

There has been a reasonable amount of research which can be applied when determining how to get people to do good work. One good analysis of some of the issues is Bruce Schneier’s blog post about Risk Intuition [4]. He points out that if there are penalties for employees who obey security procedures (in terms of unpaid overtime or bad reviews for not getting work done) and no penalties for breaking them then most employees will ignore the security procedures. It seems to me that CEOs have no real penalty for running a company into the ground (having a whinge after leaving the country with more than $40 million hardly counts as a penalty). So anyone who believes that paying more money gets more skilled people would have to believe that paying more for a CEO will tend to get a CEO who is more skilled at bilking the company (which appears to be the core skill).

It seems to me that most CEOs have little confidence in their own ability. Someone who believed that they could really do a good job as a CEO wouldn’t want a high salary, they would aim to have the company stock price improve in value at a rate that exceeds the average of the top 100 companies (or some similar index) and ask for a bonus in proportion to that!

For a government owned company (such as the NBN) a CEO who was confident in their ability would want a bonus paid after they had achieved their goals. The payment for the NBN CEO was incorrectly described as 0.3% of the project budget, according to my calculations $2M salary over 8 years is about 0.03% of the $43 billion budget. If a candidate for the CEO position believes that they can get the project completed on time and under budget while achieving all the goals then they should ask for 0.06% of the budget as their bonus payment if they succeed and a very low salary in the mean-time. If they believe that the project can’t be completed according to the plan then they should be saying so before the work starts. If however they are not confident in their ability then of course the smart thing to do would be to demand a high salary…

Now I think it’s worth considering someone who is known to be good at running a company. There are lots of bad things you can say about Bill Gates, but his skills at running a corporation tend not to be criticised. In 2004 Bill Gates (then the Chief Software Architect of Microsoft) and Steve Ballmer (MS CEO) each received $901,667 in salary and bonuses [5]. If we were to try and find a CEO who could be claimed to have a better record of running a corporation than Bill Gates then possible candidates include Michael Dell (of Dell computers) and Eric Schmidt, Sergey Brin, or Larry Page of Google. Given that it’s not going to be possible to hire such people it seems like a bad idea to offer someone with significantly less apparent skill than Bill Gates a significantly higher salary.

While on the topic of CEO pay, it would be good if the employment agreement would specify that no special golden-handshake would be awarded to the CEO when the NBN is privatised (we don’t want the CEO to be tempted to down-play the value of the company to encourage the buyer to give him a good payout). It would also be good if government ministers could be prohibited from being employed by the company that does the buyout – we don’t want another Bob Carr [6].

7 comments to CEO Pay

  • What you need to do is align the interests of the CEO and stockholders. As founders and large stockholders themselves, Bill Gates and Michael Dell have a built-in alignment. But for most CEOs, the system doesn’t align very well.

    You could come up with a system in which, as now, the company issues call options to the CEO, but in addition, the CEO must grant a put option with a long expiration date to the company. (The CEO would not be allowed to hedge the put option by short selling or buying put options until no longer employed.)

  • Austin

    It’s total garbage the “the price required to secure the best person for the job” argument.

    I’ll bet it’s a course in an MBA though. “How to secure the top price for your job”.

  • etbe

    http://www.schneier.com/blog/archives/2009/08/self-enforcing.html

    Don: Good point, the get and put options would give the CEO an incentive to do the job well – or refuse the position if there was no good chance of making the company perform.

    Bruce Schneier’s post about self-enforcing protocols is relevant to this discussion too. Some people have suggested making the CEO’s pay a multiple of the pay of the average employee – but this has been pointed out as being an incentive for outsourcing the low-paid jobs. It would however be useful to index the salaries of members of parliament to the median wage among all permanent residents over the age of 18 (you can’t just make the low-paid citizens emigrate).

    Your suggestion about put and call options is a good idea. Maybe prevent the ex-CEO from hedging for 6 months after quitting so that his successor can reveal any discrepancies in the company statements…

    Austin: I agree with you. But there are some things that people either “get” or “don’t get”. The people who don’t get it require the long explanations with all the data points.

  • I think it is all more complicated.

    For example I don’t think you could expect the best people to sit down and workout if they can meet targets for free.

    Similarly if the company is a mess, stemming losses might be a good performance, but couldn’t be trivially linked to share price.

    There is a lot of discussion of same in the UK currently. I’ve consistently voted against the renumeration packages offered to the board members of companies I get to vote in, because they are clearly milking the company for ridiculous sums of money for what is generally a performance typical of anyone who would have got the job.

    In many cases they were getting shares, but shares can be worth something even if they go down, so I think the option to buy is a good idea. But again may be tricky with things like take-overs.

    One company I had shares in, the FD is already motivated by an option to buy at the price the shares had when he joined. On the other hand he joined after the recent market collapse, so he’ll make a packet if the shares just recover as the market does.

  • etbe

    Simon: Someone who works in a factory or call center can expect to just show up and follow instructions.

    Someone who does professional work (such as computer programming) and wants career success plan a career path when taking a job. They have to consider what new skills they will learn, how those skills may be in demand by other companies, etc. Doing some homework before sending your CV is part of the process.

    It seems reasonable to expect that someone who expects to be paid a lot more can expect to do a lot more homework.

    A CEO who doesn’t want to do that can always return to beig an accountant (or whatever job he used to do).

  • Josh

    If they (we) paid “the price required to secure the best person for the job“.. then, by definition, we got the BEST person didn’t we?

    That being the case, this should all roll out smoothly and quickly with no bumps whatsoever and be a win-win for everyone.

    Surely the BEST person would ensure that this would happen, would they not?

  • Oh I agree someone looking for such a post should do their homework.

    But it may not be possible for an outsider to assess a company thoroughly.

    For example one company I owned shares in had operations in 4 countries, dealing with several different markets. I’m guessing it would easy to find someone who knew one of these well, but outside of that company it would be tough to find someone who knew all of them well.

    Although this may be the point, that even the best person in unlikely to be worth as much as some senior executives get paid. Indeed if the second best person for the job is paid a million less a year, it might be better to hire the second best person ;)