You Can Cap The Pay, But The Greed Will Go On

By Rakesh Khurana and Andy Zelleke
Sunday, February 8, 2009

President Obama is now three weeks into his new job -- annual salary $400,000 -- and already he and his team are working overtime to make sure that no one at the helm of a bailed-out firm will pocket much more than he does. It's time, the president said last week, for "restraint," not millions in bonuses.

The indignation over executive excess has mounted as the wretched indulgences stack up. Bank of America ($45 billion in bailout money) sponsored a five-day "NFL experience" at the Super Bowl; Wells Fargo ($25 billion in bailout funds) was planning 12 nights in Las Vegas for select employees.

With business executives seemingly oblivious to the nation's crisis, it's easy to see the appeal of capping exorbitant pay and wild spending. But corporate America's problem is more fundamental than that.

Since roughly the mid-1980s, the American public corporation has been run primarily for the purpose of creating vast wealth for its senior executives. True, executives have also sought to produce a return for shareholders and to deliver useful products or services to customers. And, of course, their businesses do provide jobs. But these concerns, for the most part, have been ancillary to the primary objective of enriching those at the very top.

Take the now-infamous example of the recently ousted Merrill Lynch chief John Thain, who not only splurged on his office decor but also had the audacity to propose a $10 million bonus for himself. In recognition of what? A year's work in which the company continued to make bad business decisions, lost about 80 percent of its value, sold itself to Bank of America to stave off possible collapse and appears to have seriously damaged its buyer's franchise? After a less-than-heroic performance, Thain's grasping for $10 million -- presumably because he thought it could be had -- represents what has come to be expected from America's business leaders.

It wasn't always this way. In 1960, the ratio of CEO pay at large companies to that of the president of the United States was about 2 to 1. In 2007, it was more than 20 to 1. In 1980, executives at large companies made about 40 times what the average worker made. Last year, CEOs made about 360 times more than the average worker. During the golden age of U.S. economic power, business schools taught future executives to see themselves as trustees of their companies and stewards of our economic resources.

But today, to the people who run them and the investors who own their stock (mostly very temporarily), public companies have become largely personal ATMs, machines from which to extract as much personal wealth as quickly as possible, within the boundaries of the law (usually). The distinction between creating something of enduring value and merely extracting as much value as possible has dissolved.

Senior executives don't simply want to be paid well. Especially in the past 15 years or so, they have aspired to personal fortunes that were previously attainable -- or even imaginable -- only by the entrepreneur who risks everything in launching the (rare) new venture that proves wildly successful. Ironically, immediately before joining Merrill, Thain had served as the rather modestly compensated CEO of the New York Stock Exchange, brought in to restore sanity following the Dick Grasso era. Grasso had secured almost $200 million in compensation from the NYSE -- a dubious windfall from an organization entrusted with a public regulatory mission.

But the grasping hand of the American executive is not confined to Wall Street. Just look at Robert Nardelli's conduct as head of Home Depot. Nardelli managed to leave his six-year tenure at the top with about $250 million in his pocket -- perfectly legally -- despite the company's lackluster performance in the stock market and against its competitors. How did these leaders, legally accountable to shareholders, get away with such excessively lined pockets? For one, few investors in these companies have cared much about the underlying company or the business it conducts. They don't stick around long enough for that.

On the NYSE today, the average share is held for less than a year, as compared to about five years in 1960 and two years in 1990. What matters isn't what the companies are actually doing but the expectation that the shares can be unloaded to a "greater fool" at a higher price. In the prevailing business culture, little has been meaningfully valued by either executives or shareholders beyond the short-term accumulation of wealth. Notable exceptions abound, of course -- think Warren Buffett. But in general, there is little evidence of concern for the long-term health of a corporate institution or the welfare of employees. Nor has there been much concern for the impact of the firm's activities on the national economy.

"This is America," the president said last week. "We don't disparage wealth." True enough. But the contemporary business culture has distorted the spirit of traditional American capitalism -- ill at ease with unearned wealth -- by rewarding mediocrity and even failure.

As a society, we have bought into a system in which we ask little of corporate leaders beyond the aggressive pursuit of short-term self-interest. For two decades, this model has formed the core paradigm taught to our business-school students. "Shareholder value" was of utmost importance. Notions of obligation to the society in which the corporation is embedded have been set aside, even mocked. CEOs loved this model, as it provided cover for their pursuit of kingly riches. And the rest of us have accepted it because it appeared, through the workings of the "invisible hand," to be consistent with a globally competitive economy.

This system -- and the predictably reckless choices made by some of its most powerful players -- has brought our economy to the brink of collapse. To scold business may feel good and may even help move legislation along. But we need much more than a good scolding and limits on sky-high paydays. We need to rethink how American business ought to be run, including changes to fiduciary duties, legal liability, takeover rules and business education, among many other areas.

We may decide, to borrow a bit from Churchill, that our current system is the worst way to conduct business, except for any other way we could try. But we still need to try. And for those on Wall Street smarting from the compensation caps announced last week, figuring out how best to move forward is the ideal course of action. As the president said: "We certainly believe that success should be rewarded."

Rakesh Khurana is a professor at Harvard Business School. Andy Zelleke is co-director of the Center for Public Leadership at Harvard's John F. Kennedy School of Government.

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