So I had this grand master plan for a great post this morning, but then I realized that it was the start of a holiday weekend and people probably aren’t clamoring for 1500 words with some snarky lesson about economics. As such, I present to you instead two comics with snarky lessons about economics, courtesy of Dilbert:
I was about to conclude that Scott Adams knows more about economics than he lets on when I thought better of it and looked up his Wikipedia page. Turns out he actually studied economics in college and has an MBA from UC Berkeley. Personally, I take that as a good sign that there is career hope for me yet. 🙂
Anyway…in fairness, the stock-based compensation isn’t really as great as Dogbert would like to think- yeah, he can ride a wave of good times, but he also gets punished when his company does relatively well in a crappy overall market. Ideally, performance-based compansation would reward Dogbert for his company doing well relative to the general market outcome, since (unless his company is a bank or makes American automobiles, apparently) Dogbert doesn’t have the ability to control the performance of the overall market.
Economists have understood this for a while, and they refer to the concept as “relative performance evaluation.” Basically, this translates to “we figure out who your relevant competitors are and reward you if you do better than they do.” This seems appropriate because it filters out the market effects while leaving a form of performance-based incentive in place. However, some people worry that this could result in a bunch of executives sitting around and colluding to be lazy- after all, it’s the compensation equivalent of grading on a curve, as in “hey, if we all agree to not study, then none of us will fail.” In practice, this is unlikely to happen since there’s always that one nerdy kid (or executive) who goes off and secretly studies, blowing the curve for everyone. (And then gets beat up on the soccer field after 5th period. But I digress.)
In their paper “Relative Performance Evaluation for Chief Executive Officers”, Robert Gibbons and Kevin Murphy give an overview of the pros and cons of the system and then make a few observations. I will summarize those observations here since the authors managed to make even the abstract of the paper too verbose and technical to actually want to read:
- Observation of CEO compensation contracts gives evidence that relative performance evaluation is in fact significantly based on relative performance evaluation.
- Even though a form of relative performance evaluation is in place, it appears as though the benchmark is related to overall market performance than specifically to industry or competitor performance.
But wait, there’s more! (Too soon for that? I couldn’t decide.) The very day after Scott Adams published the above strip, he comes with another gem on executive compensation:
I am curious as to how many of Adams’ readers actually get the joke that he is trying to make. Adams is trying to make a point about the concept of “board capture”, which is a situation where Chief Executives take advantage of weak Boards of Directors and dispersed and/or disinterested shareholders in order to get exorbitant pay packages for themselves approved. (In case you weren’t aware, shareholders and Boards of Directors are responsible for setting the compensation for Chief Executives.)
Randall Thomas (of the Vanderbilt School of Law) has a paper that discusses why American CEOs are paid more than their foreign counterparts. Unfortunately for Scott Adams’ parody, Thomas is critical of the explanation that American CEOs have more control over their boards and shareholders and instead offers market-based explanations for the disparity.
There, you learned something. Now go enjoy your 4th of July weekend. 🙂 (I might post more if I get bored, but no guarantees.)