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Don founded Kamakura Corporation in April 1990 and currently serves as its chairman and chief executive officer where he focuses on enterprise wide risk management and modern credit risk technology. His primary financial consulting and research interests involve the practical application of leading edge financial theory to solve critical financial risk management problems. Don was elected to the 50 member RISK Magazine Hall of Fame in 2002 for his work at Kamakura. Read More

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Kamakura Blog

Dec 28

Written by: Donald van Deventer
12/28/2009 9:06 PM 

In our blog on December 4, we argued that it’s obvious that the basis for compensation varies by the job: football coaches are paid for their skill, but large company CEOs are not.  Large company CEOs, we argued, are winners of a lottery that entitles them to huge payouts during their brief tenure.  In that piece, we compared the high correlation between skill and compensation among American collegiate football coaches and financial services CEOs, focusing on Coach June Jones of the Southern Methodist University Mustangs and Lloyd Blankfein, CEO of Goldman Sachs. Santa Claus came earlier this year, delivering updates on both men on December 23 and 24. We also add an update for the firing of Texas Tech's Mike Leach on 12/30.

We start with Lloyd Blankfein.  In our blog, we argued that a CEO is essentially indistinguishable in skill in a big company from the second or third or fourth most capable people in the company; in spite of that, they make many multiples of the total compensation of people number 2, 3, and 4.  Is there a reason for this?  In the case of Bill Gates or Steve Jobs, of course there is.  In the case of Warren Buffett, there is as well, even though his compensation was reported today at about $200,000 a year. In the case of a typical CEO, like Lloyd Blankfein of Goldman Sachs, the job merely calls for the CEO not to run the well-oiled train called Goldman off the tracks. The rapid rotation of CEOs at Goldman is further confirmation that the CEO’s incremental value to the firm is not much different from his successor or the rotation would not have happened so quickly.  Our argument was bolstered on December 23 when the venerable Financial Times named Lloyd Blankfein its “Person of the Year” in this story:

In its article praising Mr. Blankfein, the Financial Times was clear in summarizing his value creation at Goldman:

“So far, however, he shows little sign of altering Goldman’s essential strategy (or wanting to pay its employees less).”

That’s right—the marginal value of a CEO at a very large firm is minimal because the CEO rarely alters the strategy of the firm in a significant way.  Why are CEOs like Lloyd paid so much compared to the number 2, 3 and 4 managers at the same firm?  By being the last man standing in corporate politics, you have essentially won a lottery that entitles you to compensation grossly out of proportion with your marginal contribution to the firm’s value and grossly out of proportion to the marginal contribution of the second, third and fourth most capable people at the firm.  Congratulations again, Lloyd.  You won the lottery.

On December 24, we were also given an early Christmas present in the form of the Hawaii Bowl football game, where our favorite American football coach June Jones had a starring role:

What happened?  Well, the right honorable June Jones further gilded his reputation as one of the best football coaches in the United States, adding to the accolades that we listed in our December 4 blog.  First, he led the SMU Mustangs to their first bowl game and first winning record in 25 years.  More important, in spite of the fact that SMU was favored to lose to Nevada by 11-12 points, they instead beat the odds by overwhelming Nevada 45 to 10.  Now, not only has Coach Jones engineered the biggest turnaround in the history of NCAA major college football (1999’s Hawaii team improved to 9-4 from 0-12 in 1998), he also engineered the biggest turnaround in major college football in 2009.  SMU was 1-11 in 2007 and 2008, and 8-5 this year.

June Jones, you are worth every cent of your $2 million per year compensation because you are damn good.  Lloyd Blankfein, congratulations again for winning the lottery among your cohort at Goldman Sachs.  I hope you framed the lottery ticket.

When will the shareholders start compensating CEOs based on their marginal contribution to shareholder value?  Not soon enough.

UPDATE: On December 30, 2009, Texas Tech University fired its hugely successful football coach Mike Leach for abusing a player with a concussion.  Good on ya, Texas Tech.  Football's "pay for performance" can and does work in both directions.  It took 2 days for Texas Tech to (a) hear the news and (b) fire the coach.  Back to CEOs, why did it take the Boards of Citigroup and Merrill Lynch so long to get rid of Charles Prince and Stanley O'Neal? And how come Lehman's Board never fired Dick Fuld?

Donald R. van Deventer
Kamakura Corporation
December 28, 2009