I believe that Pay without Performance by Professors Bebchuk and Fried is an important theory and a book that has some merit. ' But like many economic and human phenomena, I think that there are numerous factors that influence the CEO pay market; managerial power is only one such factor, and in my opinion, is not the most important factor.
I fundamentally believe, and this belief is supported by a large number of important economists,2 that the manner in which executives are paid in the United States is a major source of competitive advantage, and we fool with it at our peril. As I have asked a number of institutional investors over the course of the last ten years, "Would you prefer to have the executive pay model, corporate governance, and total returns of Japan, or would you rather have those same factors in the United States?" In other words, would you rather have a package of the low pay, "perfect governance," and the terrible stock market returns in Japan, or would you rather have ours? I ask the TIAA-CREF people in the audience who manage all of your pension funds, "Would you rather have U.S. stocks in your fund or Japanese stocks in there over the last fifteen years?" The answer is obvious. The way U.S. executives are paid has played a tremendous role in creating trillions of dollars in economic value.
I will show you that the way we pay our executives, with tremendous pay for performance, trumps the managerial pay model. I will ask and answer four basic questions: (1) What about the managerial power theory do I agree with? (2) What do I disagree with? (3) Is a high level of CEO "pay for performance" compatible with the managerial power theory? and (4) Does CEO pay for performance exist?
II. WHAT ABOUT THE MANAGERIAL POWER THEORY Do I AGREE WITH?
I first heard about Bebchuk and Fried's managerial power theory in 2002 when The Economist published an article3 about a paper they published that year that put forward some of the main ideas developed in their book.4 This is a very important paper. I agree that the balance of power must and is shifting away from management towards the board. I attend several compensation committees a week (as a subcommittee of the board), and have for the last ten years, which is 1000 to 1500 meetings, and the playing field is clearly shifting from management to the boards. I would argue that, in an agency theory world, the board, which is focused on the company only two days or so a quarter, must give the benefit of the doubt to the management, who is there every day. The board simply does not have full information. But, does that mean that there cannot be things in place that could in fact do a better job of monitoring, signaling, and motivating?
The second thing I agree with is that Supplemental Executive Retirement Plans (SERPs) and deferred compensation clearly need better disclosure.5 Until two years ago, virtually none of our competitive studies for the compensation committee would have a SERP in it in terms of comparing this executive SERP to their competitors' SERPs. Now, that is de rigueur, and it is standard that we put into a SERF calculation. I guess we can thank Mr. Grasso for that phenomenon.
I agree with Bebchuk and Fried that there should be more stock ownership and that shares should be held for longer periods of time.6 We have done research on stock ownership for fifteen years.7 It was not all that popular during the stock option heyday in the mid-1990s, but companies that have high levels of stock ownership, where the CEOs own significant amounts of stock, dramatically outperform those where they do not own a lot of stock. Finally, I agree that executives should be required to preannounce the sale of their stock.8
III. WHAT ABOUT THE MANAGERIAL POWER THEORY DO I DISAGREE WITH?
I disagree with Bebchuk and Fried's major point that the fundamental corporate governance and pay model is broken. …