Racket

Like Matt, I can’t recommend this article highly enough. The defense of soaring executive pay in comparison with virtually stagnant wages otherwise involves claims that this is merely the rational outcome of the free market. The argument fails because there’s no “free market” operating here, but rather egregious self-dealing with very little market discipline involved:

For Ivan G. Seidenberg, chief executive of Verizon Communications, 2005 was a very good year. As head of the telecommunications giant, Mr. Seidenberg received $19.4 million in salary, bonus, restricted stock and other compensation, 48 percent more than in the previous year.

Others with a stake in Verizon did not fare so well. Shareholders watched their stock fall 26 percent, bondholders lost value as credit agencies downgraded the company’s debt and pensions for 50,000 managers were frozen at year-end. When Verizon closed the books last year, it reported an earnings decline of 5.5 percent.

And yet, according to the committee of Verizon’s board that determines his compensation, Mr. Seidenberg earned his pay last year as the company exceeded “challenging” performance benchmarks. Mr. Seidenberg’s package was competitive with that of other companies in Verizon’s industry, shareholders were told, and was devised with the help of an “outside consultant” who reports to the committee.

The independence of this “outside consultant” is open to question. Although neither Verizon officials nor its directors identify its compensation consultant, people briefed on the relationship say it is Hewitt Associates of Lincolnshire, Ill., a provider of employee benefits management and consulting services with $2.8 billion in revenue last year.

Hewitt does much more for Verizon than advise it on compensation matters. Verizon is one of Hewitt’s biggest customers in the far more profitable businesses of running the company’s employee benefit plans, providing actuarial services to its pension plans and advising it on human resources management. According to a former executive of the firm who declined to be identified out of concern about affecting his business, Hewitt has received more than half a billion dollars in revenue from Verizon and its predecessor companies since 1997.

In other words, the very firm that helps Verizon’s directors decide what to pay its executives has a long and lucrative relationship with the company, maintained at the behest of the executives whose pay it recommends.

[…]

Warren E. Buffett, the chief executive of Berkshire Hathaway and an accomplished investor, has noted the troubling contributions that compensation consultants have made to executive pay in recent years.

“Too often, executive compensation in the U.S. is ridiculously out of line with performance,” he wrote in his most recent annual report. “The upshot is that a mediocre-or-worse C.E.O.–aided by his handpicked V.P. of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet & Bingo–all too often receives gobs of money from an ill-designed compensation arrangement.”

One can also put this in comparative context: “According to a separate survey that was reported in the same day’s Wall Street Journal, the average American CEO earns 475 times what his average employee earns — not counting executive perks that aren’t required to be reported as salary, yet, so the actual number is probably higher. The average Japanese CEO earns 11 times what his average employee makes.”

Or, from yet another angle, one can note the extent to which corporations use a variety of tactics to make CEO pay less transparent. (There’s also a good discussion at the linked posts of the lack of information on the part of individual shareholders, which further insulates the executive circle-jerk.) This gets us back to the eternal wisdom D^2 learned from business school: “Good ideas do not need lots of lies told about them in order to gain public acceptance.” If CEO compensation that vastly outpaces inflation even for those heading less-than-stellar companies were in a company’s rational interest, one would think companies would want this made as widely known to investors and analysts as possible. The fact that they don’t is instructive.

In theory, there should be market discipline imposed as some companies start to be more rational and hence gain an edge. The problem is that 1)the inefficiency of above-market salaries for executives won’t necessarily have a massive impact on the bottom line, and of course the more companies that go along the less damage to any company that does it, and 2)there’s an obvious principal-agent problem; above-market CEO salaries might not entirely be in the long-term interest of the company, but in the long run everyone in charge of determining salaries is dead. (And will pass away on top of a huge pile of cash.) But, at any rate, defenses of American executive compensation that invoke the “free market” are simply a non-sequitur.