Excessive Executive Pay: What’s the Solution?

Published on Working Knowledge (of Harvard Business School), by Roger Thompson, September 21, 2009.

In the search for culprits in the global financial meltdown, bloated executive pay and the excessive risk-taking behavior it fueled stand out as prime suspects. Of the two, pay dominates the headlines and provokes the most public and political outrage …

… While boards have improved in recent years, the speed at which they were improving lagged behind the speed at which solutions should have been implemented. I’m much more of the view that we need to rethink our corporate governance structure in fundamental ways for the 21st century.

There are three things we have to think about during the conference. First, when did executive pay become unmoored from internal labor market considerations? Executive pay in the postwar period was often based on what the people below you were paid. One consequence of the trend in going outside the company to hire a new CEO was that pay became set across a horizontal spectrum, decoupling it from the internal labor market as well as the specific culture of the firm. Maybe that went out of balance.

Second, we need to reconsider the idea that the CEO is somebody who simply leads an economic entity. We have to think about what it means in the 21st century for businesspeople to see themselves as part of the stewardship and leadership of our society. That’s built into the mission of HBS. It’s not something you do as an afterthought. And it’s not something you do after you retire. It’s part of the job description.

Third, it’s not clear that the current system has produced the type of society that we want. We’ve had dramatic increases in inequality. We’ve had an economic meltdown caused, some people argue, at least in part by faulty pay systems. The fact that we had an economic crisis that brought capitalism to its knees raises fundamental questions about the viability of the system.

Part of a definition of a good society is one in which those who are charged with running its most important institutions are fairly compensated, but in a way that doesn’t reduce the legitimacy and the respect of the institutions they are charged with running. One of the consequences of executive compensation has been a dramatic loss of trust in business. As somebody who loves the free enterprise system, I believe excessive compensation has contributed to lowering the legitimacy of the free market system because it ends up making the system look more like a game than an institution producing goods and services that advance the general social welfare. (full text).

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