Fixing Executive Compensation: Social Engineering, or Ethics?

A little over two years ago I wrote a post called The Next Big Trust Scandal—suggesting it would be Executive Compensation.

I may have gotten that one right. Think of the fuss lately about corporate junkets (most recently, Northern Trust) , CEOs on private jets, etc. And of course, Obama’s proposal to cap executive compensation.

Which brings us to yesterday’s Wall Street Journal Op-Ed page, where two respected academics (Judith Samuelson, Lynn Stout) write “Are Executives Paid Too Much?”

They get a few things quite right—and one big thing quite wrong.

They suggest an epidemic of short-termism is responsible not only for compensation excesses, but for value destruction in the economy as a whole. In this they are surely right—or, to be accurate, I completely agree with them.

They also offer a simple, practical and powerful suggestion:

“Top executives who receive equity-based compensation should be prohibited from using derivatives and other hedging techniques to offload the risk that goes along with equity compensation, and instead be required to continue holding a significant portion of their equity for a period beyond their tenure.”

Well done.  But now for that Other Thing. The heart of their problem statement is:

“Our economy didn’t get into this mess because executives were paid too much. Rather, they were paid too much for doing the wrong things…. The system was perfectly designed to produce the results we have now. To get different results, we need a different system.”

No. The problem extends well beyond “the system,” and it won’t get fixed at the same level it was caused.

We cannot let business off the hook by claiming the rat maze was incorrectly designed, the cheese was of the wrong variety, or was hidden in the wrong corners. The solution does not lie (solely, or even mainly) in tweaking financial incentives, even in shifting timeframes.

The solution to egregious excesses—and to a lot more—simply must include a healthy dose of personal accountability for doing the right thing. A conscience. An inkling that society has expectations, and the power to demand that they be met. For lack of a better term, ethics.

Samuelson/Stout’s three solutions—metrics, communications and compensation structures—don’t include a simple social demand to behave decently.

What has to happen, I think, is not behavioral engineering, but shock therapy.

I am not being naïve here. In fact, I think they may be. The verbs in their recommendations are “we need new ways to measure,” “must change the ways they reward,” “need to ensure.”

The academics and the exec comp consultants are not going to force change. In fact, by treating the issue as a strictly technical one, solvable by just tweaking metrics and rules, they are actively complicit in the continued non-ethical framing of the problem.

Force is what’s needed. CEOs and Boards don’t do things because an academic says they should. Radical politicians have it right when they say, “power comes only to those who take it.”

My suggestion is for a lot of people to get really ticked off. The authors may deride Obama’s solution, but a president proposing policy exerts a lot of pressure. Columnists, bloggers, authors, short-sellers, reformers—get angry. Shareholder activists, get active. Demand accountability and decency.

As Alfie Kohn says, “monetary incentives work. They incent people to get more monetary incentives.” If we believe the only reason corporate people behave the way they do is to maximize their own personal bank accounts, then we will get nothing but more rats, moving in slightly different directions, more and more firmly grounded in nothing beyond their rat-ness.

Ironically, author Lynn Stout may understand this well, having recently written a paper called Taking Conscience Seriously. It looks good. One hopes she will allow her thoughts on conscience to more deeply infect her writings on altering corporate compensation.