President Obama’s pay czar Kenneth Feinberg has a daunting task. He has to intervene and override “market forces” to establish “fair pay” for the CEOs of major institutions that are reliant on government support for their survival. The difficulty in this process is a simple fact: football coaches are paid for their skill, but large company CEOs are not. Large company CEOs, with a few exceptions, are winners of a lottery that entitles them to huge payouts during their brief tenure. On behalf of the shareholders, the Boards of Directors of these firms have to do a better job of separating luck from skill.
In this piece from www.reuters.com today, Antony Currie and Rob Cox take on the topic of how much Goldman Sachs CEO Lloyd Blankfein should be paid: http://www.breakingviews.com/2009/12/02/goldman.aspx?sg=nytimes
An equally interesting article by David Reilly today notes that there were 1,144 people at JPMorgan paid more than $1 million and a mere 953 paid that much at Goldman Sachs: http://www.bloomberg.com/apps/news?pid=20601039&sid=at4ppiBSYMqE
It’s a sad but true fact that has been made clear by the 2007-2009 credit crisis: pay for CEOs at major financial institutions has more in common with winning a lottery than it does with college football, where coaches are paid for their skill. We start with football and the right honorable Mr. June Junes.
June Jones, former head coach of the American professional football team the Atlanta Falcons and the San Diego Chargers, was named head coach of the University of Hawaii football team after his predecessor led Hawaii to an 0-12 won-lost record in 1998.
Coach Jones moved quickly to change things in a big way. He was expected to, since his total compensation (about $800,000 split between his formal salary and donations from backers of the team) was almost 7 times greater than his spectacularly unsuccessful predecessor.
Here’s what Coach Jones did in short order:
- He brought in his agent Leigh Steinberg to help with a major image make-over for the team,
- He changed the team nick name from “rainbows” (an image beloved in both Hawaii and the gay community) to “warriors,”
- The uniforms went from green to black
- He redesigned the team’s logo to something more Polynesian and macho than a rainbow:
- He installed the “run and shoot” offense, which emphasizes the passing game
- He completely revamped the coaching staff
- He recruited some of the most talented players ever to play for the University of Hawaii
In his first season, the team achieved the greatest turn-around in NCAA football history, going 9-4 after the 0-12 record the year before. In Coach Jones’ final year at Hawaii, the 2007 team went 12-0 during the regular season behind quarterback Colt Brennan, now with the Washington Redskins. They ended up in the Sugar Bowl, which we don’t want to talk about. Was Coach Jones’ success a fluke?
Southern Methodist University, which had gone 1-11 in 2007, didn’t think so. They paid Coach Jones $2 million a year to take over the Mustangs. Two years later, the team is 7-5 and going to their first bowl game in 25 years. Coach Jones is making 18 times the salary his predecessor at Hawaii got paid because he’s 1 million times better. If it turned out he was just lucky at Hawaii, SMU would have fired him in a heartbeat.
Now what about Lloyd Blankfein at Goldman Sachs? The first thing that the compensation committee at Goldman Sachs has to do in setting pay for Mr. Blankfein is to decide how good he is, at least if they want pay and skill to be correlated. If we are talking about a long serving CEO who has built a company from nothing to something significant, it’s pretty easy to tell that the CEO is extraordinarily good. Bill Gates, Warren Buffett, Larry Fink at BlackRock, and Steve Jobs are obvious names that come to mind.
But what if you are one of the rotating CEOs at a big firm like Goldman Sachs? How can you tell whether a CEO is good or not? “Wait a minute, you have to be good to become the CEO of a big firm like Goldman Sachs” you might say. That’s how a lot of Board comp committees seem to think. Let’s look at some counterexamples, starting with Goldman’s former CEO Robert Rubin. His Goldman Sachs years were a success. His term as one of the lead directors at Citigroup resulted in the near failure of the firm. During his time as a member of the Harvard Corporation, the University hired and then got rid of President Larry Summers and lost $8 billion of its endowment. Give Rubin a 1-2 won-lost record. With hindsight, was he hugely well paid at Goldman because he personally was many multiples better than the next best choice (like June Jones) or was he just lucky to have 953 people working for him who were all getting paid more than $1 million each because THEY were really good?
It’s pretty clear that if the firm is big and well established, many CEOs are just filling a chair and won’t do anything really good or really bad. A few will fix a firm that was broken, like Lou Gerstner, who saved IBM. Others, who were extraordinarily bad with 20-20 hindsight, were grossly overpaid in the lead-up to disaster because the Board thought they were good but they weren’t. Kerry Killinger of Washington Mutual and Dick Fuld at Lehman are just two of the legions of CEOs who fit this description.
In the end, what’s readily apparent is that the skill set you need to BECOME the CEO is not the same skill set you need to BE a good CEO. Dick Fuld, for example, became CEO of Lehman because he was good at corporate in-fighting, the skill set needed to become CEO at Lehman. If you are Larry Fink, building BlackRock into a giant of a firm from nothing, you have a different set of skills than Lloyd Blankfein, who got tapped on the shoulder after Robert Rubin and John Corzine and Hank Paulson and a few others and told “it’s your turn.”
Among my Japanese friends, three have become CEOs of very large companies. One of them told me outright 15 years before he became CEO what his probabilities were, based on what year he entered the company (the length of the CEO’s tenure was pretty fixed and if you were born in the wrong year you had no chance), what school he graduated from, and who he was assigned to work for when he was 23 years old. Another correctly predicted that he would have good odds of being CEO because he’d been made head of the Bangkok branch of the bank. They knew how many lottery tickets there were in the CEO lottery, and they knew how many tickets they personally held.
In the end, it will ultimately be obvious to Board members which 5% of CEOs of big companies are really good (Lou Gerstner) and which 5% are really bad (Dick Fuld). The rest of the time, they haven’t a clue whether the CEO is good or bad, including during the first 19 years of Dick Fuld’s tenure as CEO at Lehman.
So why do CEOs get paid so much? Because they’re the CEO, not because they’re good. Everyone draws straws and the one with the straw that says “CEO” gets paid the most. Sometimes, but only sometimes, a really good person who gets passed over in the straw-drawing (like Lou Gerstner at American Express) gets a chance in the end to show how talented he really is. More often, that’s not what happens. Becoming the CEO is like winning the lottery, and CEO pay is a multi-year payout for being the last man standing, for drawing the right straw, not for being good because the board can’t tell if you’re good or not most of the time.
Mr. Blankfein, congratulations. You won the lottery. June Jones, damn, you’re good.
Donald R. van Deventer
Honolulu, December 4, 2009