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Dogbert On Executive Compensation…

July 3rd, 2009 · 10 Comments
Incentives · Just For Fun

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.)

Tags: Incentives · Just For Fun

10 responses so far ↓

  • 1 PeterM // Jul 3, 2009 at 11:25 am

    Well, here I was clamoring for a long economics piece to set me up for the 4th . . .

    I read Scott Adams’ book (I think monkeys and idiots are in the title) and it was very funny in spots, and had a few business/econ things that had me LOLing.

    From the perspective of a long government career, I’d note that frequently the person at the top of the pyramid often is not there because of skills. Sometimes they are (I recall that Jim Miller, an economist, deserved to be at the top of the heap at the Federal Trade Commission) but that seems to be the exception. It seems that politics and being a good backslapper are often just as important.

  • 2 Josh F // Jul 3, 2009 at 12:50 pm

    These Dogbert cartoons are funny (also agree with PeterM). But it is too bad that Dilbert cartoons have more understanding of basic reality than Vanderbilt professors. This paper is ungrounded ideology disguised as scientific conclusions (as is so common in economics). There is plenty of evidence of Board Capture out there. And the points that he claims board capture cannot explain are easily explained by adding a few obvious trends and facts about human behavior. No single simple theory explains all. I can think of a number of compensation trends his market explanation leaves unexplained.

  • 3 g4m3th30ry // Jul 5, 2009 at 1:34 am

    John –

    I’d like to understand how when the market sets a basic price for CEOs of certain size companies – certainly through a board and shareholders, but within the realm of monies other CEOs make – what exact evidence do you have that the market isn’t the controlling force?

    Just because an outcome seems out of proportion to what you might believe it should be, doesn’t mean it wasn’t mainly a market decision and doesn’t mean it was wrong.

    I think baseball players making 10 million a year seems a little ridiculous, but it is a basic market decision with other actors involved, including the union, the player, the player’s manager, the team, and the league itself.

    But you still don’t seriously think that they would continue to pay people 10 million a year if they couldn’t make more than they paid?

  • 4 g4m3th30ry // Jul 5, 2009 at 1:38 am

    Peter –

    One additional thought – politics are an important part of a CEOs job – dealing with investors, shareholders, the board, other stakeholders, etc, etc, etc – I true sometimes despise the politics in offices, but (all other things being equal) being able to play the political game in such a political climate is certainly worth more money than those who can’t work well with varying interests.

  • 5 g4m3th30ry // Jul 5, 2009 at 1:39 am

    Sorry – that should read “I too sometimes…”

  • 6 Josh F // Jul 5, 2009 at 11:06 am

    g4m3th30ry (if that’s your real name),
    The evidence of non-market-based CEO pay has been studied and comes in multiple forms: pay dynamics (such as how they only asymmetrically respond to performance), correlation between CEO pay and the board make-up (i.e. independent directors, and the web of interrelated relationships on boards), comparisons across countries, comparisons over time,….. Also there are some ways to use common sense here. First, just looking at the nature of governance at corporations and the voting structure, it is quite clear that there may be more incentives to be responsive to the CEO than to be responsive to shareholders (any type of activism in corporate governance is extremely difficulty and in effect requires an overwhelming majority of outrage shareholders to create change). Also, while it is true that a few CEO’s may have the ability to create a credible threat of leaving for an equally high paying job elsewhere, it is also quite clear that in many cases, (unlike baseball) there is no such threat.

  • 7 g4m3th30ry // Jul 6, 2009 at 4:45 pm

    John –

    It is true that my parents didn’t name me after a mathematical science that didn’t exist during the time I was born, so you can call me Michael if you’d like.

    As to your thoughts – I didn’t intend for my posts to argue that market conditions are the only thing that deals with executive, or CEO, salaries, just that it’s a major part of it.

    I think even with studies that show certain boards with certain ties might give more money to those CEOs with the same ties, doesn’t really tell us anything about whether the board and CEO themselves are making market based decisions.

    IIRC, years back, I think more than 5, Britain and some other European countries passed laws to allow all stock holders to be able to vote on executive compensation. In their minds, they thought the exorbitant salaries of CEOs and the like was a failure of the market that could be remedied by allowing more than just a board of directors to decide.

    They were wrong – even with normal, average joes, having a say, CEO salaries and compensation packages continued as they were.

    I mean if you own a company of say 1500 employees and in the market most CEOs of companies that size receive around 800K in salary plus bonus… what would the public think if your CEO only made 500K?

  • 8 BD // Jul 10, 2009 at 12:33 pm

    Quick comment on why CEOs wouldn’t collude to be lazy. If they got together and decided to all be lazy, then each one has incentive to work just a bit harder to reap a lot of profit from doing well. So you can’t expect them all to be lazy if the incentive is for them to work hard. This is an example of a prisoner’s dilemma actually helping to keep the CEOs from being lazy.

  • 9 Josh F // Jul 11, 2009 at 1:23 pm

    A few days ago I was at a lecture by Akerlof. He said (paraphrasing) that the key to incenting a CEO is for his identity to be aligned with the company and it’s success. He said if the CEO identifies with the company, there is no need for extravagant compensation or stock options. Conversely, if the CEO does not identify with company, no amount of options and compensation will create the right incentives.

    I agree with him (though I would add a few more behavioral dimensions to the issue).

  • 10 Coleen Clumpner // Dec 9, 2011 at 2:39 pm

    Walt upon Get married to, 1st Annual percentage rates ’09 A dozen:Twenty nine am 

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