Executives and their Income
Filed under: CEOs, compensation, contract, employees, finance, governance, pay |
Comments (11) I’ve blogged a number of times about what is commonly and loosely called “executive compensation.” The term is woefully imprecise. In point of fact, most “compensation” is not, in fact, compensation. The carrot dangled in front of a horse is not compensation; it is motivation. Compensation is what you give someone after the fact as reward for a job well done, or at least for a job that met contractual requirements. If I hire the neighbour’s kid to mow the lawn, and he does so, then I should compensate him. Most of the money garnered by senior executives at publicly-traded companies these days is not, in fact compensation. It’s money they get from selling shares in the company, shares granted to them as part of an effort to align their interests with the interests of shareholders.
The looseness of use of that word in the realm of finance is not at all unique. Witness the “bonuses” paid to AIG employees two years ago, which were not in fact performance bonuses at all but rather retention payments designed to keep key employees on what seemed at the time to be a sinking ship.
See more recently this piece by Peter Whoriskey for the Washington Post: With executive pay, rich pull away from rest of America. Here’s just a taste:
The top 0.1 percent of earners make about $1.7 million or more, including capital gains. Of those, 41 percent were executives, managers and supervisors at non-financial companies, according to the analysis, with nearly half of them deriving most of their income from their ownership in privately-held firms….
Notice that (contrary to the article’s title) the key factor in the growth of executive income here is not in fact “pay.” The key factor is investment income. And it’s not even “pay” in the loose sense of ‘money given by an employer,’ since there’s no indication here what portion of that investment income comes from shares in a CEO’s own company, say, versus a diversified portfolio. But it’s hard to hold Whoriskey to blame for the linguistic imprecision here; confusing pay and compensation and income is altogether standard.
The other point to be made here is about justice. According to Whoriskey, “…executive compensation at the nation’s largest firms has roughly quadrupled in real terms since the 1970s, even as pay for 90 percent of America has stalled…” Setting aside imprecision of language, that suggests a significant disparity — not disparity of outcomes (which are a given, here) but disparity of rate of improvement.
Now according to Leslie McCall, a sociologist quoted in Whoriskey’s story, people become concerned about such inequality “…when it seems that extreme incomes for some are restricting opportunities for everyone else.” And that may be true about people’s reactions. But of course, it’s very hard for people to tell when it is actually the case that extreme incomes for some are restricting opportunities for others. As economists often point out, income is not a fixed pile, waiting to be handed out. The way you distribute income actually changes the size of the ‘pie’ due to the way money incentivizes. Incentivizing executives with stock and stock options may on the whole be a failed experiment, but that doesn’t change the fact that it is impossible to know whether the average worker would be better or worse off had those incentives never been offered.
Splitting CEO & Chair
Filed under: accountability, boards, CEOs, governance, shareholders |
Leave a Comment Research in Motion (a.k.a. “RIM”, maker of the Blackberry) has been under pressure to split the role of CEO and Chair. RIM has been facing serious scrutiny of late, and questions have arisen in particular about whether the company needs new leadership. Splitting the role of CEO and Chair would be an awfully good start.
See this Globe & Mail story, by Janet McFarland: Shareholder calls for splitting CEO, chair roles at RIM.
A small investor in Research In Motion Ltd. …is anticipating big support for a shareholder resolution calling on the BlackBerry maker to split the jobs of CEO and chairman.
Mutual fund company Northwest & Ethical Investments LP has argued RIM co-CEOs Jim Balsillie and Mike Lazaridis should not also be co-chairs of the company’s board, arguing a “high performance” board needs independent oversight of management.
The story quotes Bob Walker, vice-president of Ethical Funds at Northwest & Ethical, as saying that keeping the two roles “has become standard practice, not just best practice.” More to the point, perhaps, is that it has become widely-recognized not just as standard, but as best. The board’s job is to oversee the CEO, and it’s hard to do that effectively if the CEO runs the board. (This was precisely the point of Friday’s blog entry on conflict of interest among mayors and chairs.)
You may well hear people point out that there’s no evidence that splitting the roles of CEO and Chair is beneficial, in the sense of increasing long-term shareholder value (or in terms of any other outcomes, for that matter). Fair enough. But to say that there’s no evidence is not to say that there’s no reason. Shareholders have a right to good governance, and that right doesn’t depend on concerete outcomes, any more than a client’s right to zealous legal representation does.
There’s another reason to favour splitting the chair & CEO. Even if such a split isn’t directly correlated with increasing shareholder value, it may well be correlated with other things that matter. My colleague Matt Fullbrook, of the Clarkson Centre for Board Effectiveness, puts it this way:
Since the early 2000s, splitting the Chair/CEO roles has become the norm in Canada, and with good reason: more than any other individual governance best practice, Chair/CEO split with an independent chair is highly correlated with adoption of other good governance practices and disclosure. That there is still push-back on splitting the roles is baffling.
Conflict of Interest for Mayors (and Other Committee Chairs)
Filed under: accountability, boards, CEOs, conflict of interest, ethics, governance, government, politics |
Leave a Comment This is a blog entry ostensibly about municipal politics, but with real lessons for the world of business.
I was on CBC radio yesterday (along with corporate governance expert Prof. Richard Lelblanc) to talk about conflict of interest case involving Halifax’s city council (technical the Council for Halifax Regional Municipality).
To make a long story short: the Mayor was involved in some financial irregularities that may (I honestly don’t know) just be a matter of either poor judgment or poor understanding of proper procedures. Whatever. The interesting part came when some members of Council wanted to reprimand the Mayor for his role in those decisions. The Mayor insisted on chairing the discussion, and indeed even voted on the matter when it came up for a vote. (Here’s an article about the fiasco, by Michael Lightstone for the Chronicle Herald: Halifax council won’t suspend mayor.)
Needless to say, in participating in the vote over his own fate, the Mayor was in a rather significant conflict of interest. He had an official duty to exercise, one that required the exercise of judgment. And he clearly also had a very significant personal interest in the matter, one that any reasonable outsider would be justified in suspecting of influencing the Mayor’s judgment.
Now it always bears repeating: conflict of interest is not an accusation. It is a situation one finds oneself in. There’s nothing unethical about being in a conflict of interest. (If a lawyer finds out that one of her clients wants to sue another of her clients, she is in a conflict of interest, through absolutely no fault of her own.) What matters is how you deal with the conflict.
The best thing for the Mayor to do would have been to:
- recognize the conflict,
- put it on the table, and
- recuse himself (i.e., hand over the gavel, decline to vote, and preferably leave the room so that the rest of Council could have a full and frank discussion).
What’s really at stake in conflict of interest has very little to do with the integrity of individuals. Rather, it has to do with the integrity of a decision-making process, and of an institution. So the worry is not that the Mayor would necessarily have been biased in how he chaired Council that evening. Maybe he bent over backwards to be fair in his chairing duties. Who knows? And that’s the point. We don’t know, but for important institutions we need a high level of certainty that key decision-makers are exercising their judgment in the interests of those they serve, rather than themselves.
And there, of course, is the lesson for the world of business, and in particular for corporate governance. A Mayor, effectively, is the CEO of a City. In addition, he or she also is “chair of the board of directors,” where the board here is City Council. In the world of municipal politics, it is relatively rare for Council (normally chaired by the Mayor) to sit in judgment of the Mayor as chief executive. But in the corporate world, such judgment is a big part of the job of a board of directors. And that is precisely why it is widely considered “best practice” for the CEO not to also serve as Chair. One of the Board’s key roles is to advise and oversee the CEO. Doing so requires that the Board be able to deliberate in a way that is reasonably independent from the CEO’s own influence. Any organization that has the CEO act as chair of the very body that must regularly deliberate over his or her own performance is not just “finding” itself faced by a conflict of interest, but is actively constructing one.
Ethics & Economics, Part 2: The Market
Filed under: competition, consumers, economics, markets, trade, values |
Comments (5) This is the second in an occasional series on the relationship between ethics and economics.
Today’s topic is the market. ‘The market’ isn’t anything magical. It’s just the term we use for the abstract entity that is the aggregate of all actual markets for particular goods — the sum total of the market for cars plus the market for poetry plus the market for pedicures and so on. Seen another way, the market is just a whole bunch of people (and organizations) buying and selling stuff from and to each other.
The market is ethically significant. And in general, that significance is positive: markets are generally morally good. There is an ethical justification for markets, such that, with some exceptions for particular goods, where markets do not exist we wish they did.
Reasonably-free markets have three basic moral virtues. One is freedom. In a free market, each of us is free to buy whatever we want, within the limits of our ability to pay. That’s not the only kind of freedom anyone could hope for. The sense in which everyone is “free” to buy whatever model of car they want is not very compelling for those who cannot afford a car at all. But scarcity is a basic fact about the world, and the freedom to make one’s own choices within the confines of such scarcity is hardly trivial.
The second virtue of free markets is efficiency. For very many goods, reasonably-free markets are not just one way to provide those goods: a reasonably-free market is the most efficient way to provide those goods. I’ll have more to say about efficiency in a later instalment in this series. But very briefly, we can begin to understand efficiency as a moral value if we consider its opposite, namely inefficiency. Inefficiency means wastefulness, or getting fewer outputs from more inputs. Almost no one is in favour of inefficiency. And in a world where many people see their basic needs go unmet, inefficiency is a great evil.
The third great virtue of the market is its ability, famously described by Adam Smith, to turn self-interested behaviour on the part of one person into (reasonably) good outcomes for others. Smith’s point wasn’t that people are selfish, nor that they should be. His point was that everything you own, everything around you, exists because someone made it. And chances are that — hand-made gifts aside — they made it for you not because they love you, but because they needed to make a living. The market turns my needs into a way of satisfying yours, and vice versa. And it generally happens without someone putting a gun to our heads to make it happen.
But markets also have moral failings. One is the very lack of coordination that I referred to as “freedom” above. That lack of coordination means that markets are notoriously bad at providing for the production of genuinely useful public goods, like highways and lighthouses and police forces and so on. For such goods, it’s much more effective to have some central authority, preferably with coercive powers, collect taxes in order to build them.
Markets are also much better at providing what people want than it is at providing what they genuinely need. So markets produce junk food and video games and porn in abundance, but relatively little delicious health-food and educational games and poetry. Of course, in casting the former as “bad” products and the latter as “good” ones, I’m merely appealing to popular stereotypes. In reality, there’s very little rationale for thinking video games are better than poetry. That’s just an elitist bias. But still, it probably is fair to say that there are products that are out-and-out socially bad: it’s no great bragging point for the market that it has brought us so many brands of cigarettes, for example. So if — and this is a very big if — we were much more certain, and much more unanimous, than we are about what things are genuinely good in life, then it might make a lot more sense just to have governments direct the making and provision of those things.
One of the key starting points for any sane consideration of issues in business ethics is the realization that the market serves a moral purpose. It’s an imperfect mechanism, to be sure, but its value for promoting human freedom and wellbeing is such that what we ought to think in terms of balancing various market virtues and vices against each other, rather than thinking in terms of the market as an alternative to important human values.
Should a Catholic Charity Take Money from Hooters?
Filed under: brands, charity, marketing, philanthropy, protest, scandal |
Comments (5) This is twice in two weeks that I’ve blogged about Hooters. I swear it’s a coincidence.
From MSNBC: Catholic charity says ‘no’ to Hooters fundraiser
St. Patrick Center, a Catholic charity that provides assistance to homeless people, has canceled a Thursday fundraising “Dine and Donate” event with a downtown Hooters restaurant after drawing complaints that such a collaboration wasn’t in keeping with the Christian faith….
This is not exactly an isolated incident. Charities of all kinds have to decide, on a pretty much constant basis, who they’ll accept money from and who they want to associate with. In some cases, the struggle is an internal one; in other cases, it’s the result of external criticism. (Just look at the criticism UNICEF faced for making a deal with Cadbury.)
It’s worth pointing out that a charity faces two different issues, here. One is simply the source of money. A charity might consider money from certain sources as ill-gotten gains. In such cases, the money from certain sources is going to be unwelcome, even if donated very discretely. In other cases, the issue is publicity. Some charities might be willing to take money from anyone, in principle, but worry about the impact of having their name associated with — well, with Hooters for example. These two issues (dirty money and a dirty reputation) are separable, at least in principle. But secrets are pretty hard to keep secret, especially in an era in which transparency is valued and in which corporate donors are relatively eager to publicize their good deeds to spit-shine their image. So really, the key concern is liable to be reputation.
And in terms of reputation, the anything-goes strategy seemingly suggested by some idealists is likely to be fatal to just about any charity. Those who think it’s “obvious” that St. Patrick Center, for example, should be happy and eager to take Hooters’ money should ask themselves: if Hooters is OK, how about the local strip club? How about a hardcore porn magazine? I’m not at all saying those various enterprises are all alike, in all morally-relevant ways. I’m just pointing out that most people will see some place where they would like a line drawn. And ethics bleeds into prudence here. Most charities have reputation and goodwill as their only real capital. A company that makes cars can recover from scandal by, well, making good cars. You don’t have to love the company to love the cars. But an organization whose only real asset is its reputation — well, sully the reputation and you’re pretty much sunk.
But then, neither can your typical cash-strapped charity afford to be too prissy about sources of cash. Look too closely at any donor and you’re very likely to find skeletons in the closet.
—
Thanks to Tara Ceranic for showing me this story.
Should Rioters be Fired?
Filed under: crime, employees, law, privacy, risk, scandal, trust |
Comments (5) The post-Stanley Cup riots in Vancouver last week have generated a minor landslide of commentary. Much of it has focused on just who the malefactors were. In an age of social media, this has amounted to more than mere speculation: the identities of quite a few of the trouble-makers have come to light. Those who participated in the riots have thus brought very public shame upon themselves and their city. But what about the shame brought upon their employers?
Over at the “Double Hearsay” law blog, the question is asked from a legal point of view: Can employers fire Vancouver rioters? The short version of the legal analysis there is this. Any employer can fire an employee “without cause” as long as they give proper notice. In order to fire without giving a couple weeks’ notice, an employer has to have “cause:”
Generally speaking, an employee can be fired for his private conduct if that conduct is “wholly incompatible” with the proper discharge of his employment duties, or if it would tend to prejudice the employer….
The latter possibility is the relevant one here. If an employee participates in a riot and is widely known a) to have participated in shameful behaviour and b) to be your employee, then the employee has effectively done something “prejudicial” (i.e., likely to negatively effect your business).
OK, so that’s the legal side. Labour law draws a reasonably clear line around what you as an employer can do, and what the court will support your having done. But that still leaves open the question, should you even attempt to fire an employee who you know to have participated in a riot, say like the recent one in Vancouver or last year’s at the G20 in Toronto?
Here are a few quick considerations:
1) The legal issue of an employee behaving in a way that is “prejudicial” to the employer is also of course a very reasonable ethical consideration. A riot like the one in Vancouver is accompanied by significant public outrage, and guilt by association is a very real problem. In many industries, a business lives or dies by its reputation. As Warren Buffett has said, “Lose money for the firm, and I will be understanding. Lose a shred of reputation for the firm, and I will be ruthless.”
2) By participating — even somewhat passively, let’s say — in a riot, an employee reveals quite a lot about his own character and judgment. Do you really want someone with that little judgment working for you? Your company, no matter how laid back its corporate culture, has some sort of authority structure. It’s fair to ask just how suitable an employee is to work within any authority structure when they’ve publicly egged on another human being in burning cop cars or assaulting firefighters.
3) Even from an ethical point of view, the legal notion of “due process” is relevant. So if you’re considering firing someone for taking part in a riot, you can’t in all fairness do so based on mere hearsay, or without giving him a chance to defend himself. The right process is at least as important as the right outcome.
4) Finally, it is worth considering whether there are alternatives to firing. Maybe being laid off for a few weeks is sufficient. Or perhaps the employee can demonstrate his contrition by doing volunteer work. But it should be remembered that the solution has to fit the reason for firing in the first place. If your worry is that participation in a riot demonstrates a fundamental lack of judgment, then volunteer work isn’t going to erase that worry.
As a lawyer friend of mine put it, “rioting seems to strike at the core of social order.” And social order is at the core of business. It’s not unreasonable to think that participation in a riot is a disqualification for employment — but such a conclusion still has to be implemented prudently and fairly.
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Thanks to Dan Michaluk for tweeting this story and bringing it to my attention.
Business Ethics Lessons from G20 Cop’s Arrest
Filed under: crime, government, protest, trust, Uncategorized |
Leave a Comment What lessons can we take from a story about police brutality and apply to the world of business?
As many readers will know, the meeting of the G20 here in Toronto last summer was not, on the whole, a happy experience. Protestors, both peaceful and otherwise, were plentiful, and there were serious questions about the way the Government, and in particular the Toronto Police Service, conducted themselves. No one came out looking very good. Protestors torched cop cars and broke shop windows. Some of the tactics used to quell the riot resulted in accusations of police brutality.
Nearly a year later, after a fraught investigation by Toronto Police’s Special Investigations Unit, one police officer has been charged with assault. See this story by Jennifer Yang, for the Toronto Star: Toronto police officer charged in G20 assault:
After nearly one year, two closed investigations, and a public squabbling match between Toronto police and the agency tasked with investigating them, criminal charges have finally been laid in the case of Dorian Barton.
On Friday, the Special Investigations Unit charged Toronto police Const. Glenn Weddell with assault causing bodily harm in connection with Barton’s arrest during the G20 summit last June. The charge came on the same day the Toronto Star publicly revealed Weddell was the previous unnamed officer photographed during Barton’s violent arrest….
Strictly speaking, this isn’t a story about business ethics, but still it provides plenty of fodder for discussion of issues that are centrally important to business ethics. Issues such as:
- Who watches the watchers? Any regulatory system — whether a system of policing criminality or a system of vetting new pharmaceuticals — requires safeguards to make sure that those who wield regulatory power wield it wisely. That’s why police forces have systems for hearing complaints from citizens and for investigating wrongdoing by their own officers. And it’s also why regulatory decisions are typically subject to parliamentary oversight and judicial review.
- With great power comes great responsibility. Self-regulation is crucial for those given the power to enforce rules. Such self-regulation can take many forms. First and foremost, it needs to include individual self-regulation and the adoption of principles of integrity and good conduct. But individual ethics needs to be bolstered by an informal system of peers reminding each other of their obligations. When one regulatory bureaucrat or police officer edges too close to crossing a line, it is essential that colleagues be ready to point out that “That’s not how we do things around here.”
- What are the limits of team loyalty? It is no exaggeration to say that modern civilization is built on something akin to teamwork. And the number one challenge in literally every organization involves getting a number of people with different personalities, talents, and points of view, to work together effectively. Fostering loyalty is a key part of that. But loyalty must have limits. Lawyers are supposed to act as zealous advocates, but are not allowed to suborn perjury. Police and soldiers and firefighters often depend on teamwork for their very lives, but they jeopardize their social value if they put fraternal loyalty above the public good. And corporate employees are expected to help build shareholder value, but not to break the law in doing so.
One of the worst mental habits that can be adopted by people who proclaim an interest in business ethics is that of thinking that the ethical issues found in business are categorically different from those found in other walks of life. Commercial contexts do raise a number of special issues, but we can learn a lot about those issues by thinking about the ethical issues that arise in seemingly quite different domains.
Workers vs Machines
Filed under: economics, employees, productivity, protest, technology, workplace safety |
Comments (2) A recent item in the NY Times dealt with the fact that many companies these days seem relatively reluctant to invest in new employees, but comparatively willing to invest in new machinery. The evidence for that is mostly anecdotal, but interesting none the less.
Here’s the story, by Catherine Rampell: Companies Spend on Equipment, Not Workers
Companies that are looking for a good deal aren’t seeing one in new workers.
Workers are getting more expensive while equipment is getting cheaper, and the combination is encouraging companies to spend on machines rather than people….
The story gives the distinct impression that the issue here is not just an issue of machines or people; it’s about machines versus people, and machines are clearly winning the hearts and minds of employers these days. On the face of it, that sounds bad. Workers — people — matter, from a moral point of view, and machines don’t. So, other things being equal, it is better to spend money on doing something good for people (e.g., providing someone with a job) than it is to spend money on mere machines.
But two perhaps-not-obvious points need to be made, here.
The first point is that even when employers choose to purchase machines instead of hiring employees, that needn’t be a bad thing socially, nor bad for labour as a group. Machinery tends to boost productivity, and boosting productivity boosts wealth, so from a social point of view (including from the point of view of blue-collar workers) it is good when companies invest in machinery. Even if machines displace workers in a given industry, that needn’t spell trouble for workers as a class. In the early 19th Century, Luddites destroyed mechanized looms in a vain attempt to forestall the effect of the industrial revolution on employment patterns in the textile industry. And yet, in the long run, the industrial revolution did nothing to worsen the lot of labourers. Indeed, it ushered in an era of prosperity that made the lot of labourers as a whole vastly better. To be sure, changes in technology result in unemployment in the particular sectors in which new technologies are introduced. But that tends to be a temporary problem. The standard Econ 101 example is transportation. The advent of the automobile surely resulted in some unemployment among those who had formerly worked in the horse-and-buggy industry. But, in the long run, those workers eventually found jobs in the auto industry, and were no worse off. And so on.
The second point is that, even if we focus on the employees of a particular organization, labour and machines are not always (and maybe not even often) in competition. Machines and tools can make employees’ lives better, and in those cases, certainly, spending money on machines and tools is a good thing. The most obvious case is when the equipment purchased is, say, safety equipment, or when the machines purchased are ones with additional safety features or features that make work less back-breaking.
But purchase of equipment can also be good in another way. Machines and tools of various kinds can make labour more productive, and more productive labour is more valuable. Not everyone realizes that the productivity of labour — the amount of goods that can be turned out per hour of a worker’s time — varies vastly across the globe. An hour of an American worker’s labour, for example, produces far more output than an hour of a Chinese worker’s labour. And the reason has little to nothing to do differences in work ethic or intelligence or talent. The difference lies in national differences in access to tools, and to differences in organizational and managerial strategies. So investing in better equipment can be a way of investing in the productivity of your workers.
Of course, past some threshold, when labour is more productive, employers may decide they need less of it. The most famous example of this is in farming, where one man with a big tractor now often does the work that a dozen men might have done in years gone by. But the devil is in the details. We should at least recognize that investment in machinery is not automatically contrary to the interests of labour.
Roger Martin on Executive Compensation
Filed under: CEOs, compensation, corporations, governance, leadership, pay, shareholders |
Leave a Comment Yesterday I attended the Annual Meeting of the Canadian Coalition for Good Governance, along with a handful of colleagues from the Clarkson Centre for Business Ethics.
The meeting’s keynote speech was given by Roger Martin, Dean of the Rotman School of Management. (Disclosure: I am a Visiting Scholar at Rotman.)
Martin’s speech was basically a summary of the key ideas from his new book, Fixing the Game: Bubbles, Crashes, and What Capitalism Can Learn from the NFL. (I mentioned Martin’s book a few weeks ago, in a blog posting called Business, Football, and Incentives.)
Here is a rough summary of what he had to say, paraphrased and condensed:
Prior to the mid-70’s, stock-based compensation for CEOs was rare. But starting especially in the 80’s, it became very common indeed. Martin traces the sea change to a famous paper by Michael Jensen and William Mecklin, called “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure” (PDF here). The basic idea at the time was that paying senior executives, and especially CEO’s, in company stock or stock options would align their interests with those of shareholders. Shareholders naturally want the value of stock to rise, and paying CEOs mostly in stock gave them a very concrete reason to want stock to rise, too.
It was a fine theory, says Martin, but it didn’t work out well. If you compare the era of stock-based compensation to an equivalent period before, you see that returns went down about 15% and stock volatility went up about 15%. Those definitely aren’t the kinds of results that shareholders were looking for.
And yet somehow people still cleave to the idea that stock-based compensation aligns interests. Why?
It’s clear enough why CEOs themselves are fans of the system. The reason, according to Martin, is rooted in the fact that stock prices only reflect the market’s collective expectations about a company’s future performance. That means in order to boost stock prices (and hence their own compensation) CEOs merely need to boost expectations. So, says Martin, that’s what CEOs have learned to do: manage stock analysts’ expectation, rather than managing actual performance. If analyst expectations are low when stock options are granted, and high when they get cashed out, a CEO stands to make a lot of money, independent of what that variation means in terms of actual performance.
But of course, says Martin, CEOs have realized that you can’t play that game for very long. So, they learned to look for opportunities to play a hit-and-run version of the game: get in, play hard, and cash out. That, he says, is the real reason why the average tenure of CEO is so short these days.
Is this malfeasance on the part of CEOs? Not really, says Martin. It’s just CEOs doing what they are payed — incentivized — to do.
Now, says Martin, compare this situation to the way quarterbacks are payed in professional football. Professional quarterbacks, he says, are paid for real, on-the-field performance. Additionally — and this is crucial — they are forbidden from profiting from outsiders’ expectations of how they will perform, i.e., from gambling on the outcome of the games they are playing in. Why? Because professional football leagues realize that letting quarterbacks gamble would give them all kinds of perverse incentives. The corporate world, it seems, has something important to learn from the world of pro football when it comes to incentivizing key personnel.
In the corporate world, says Martin, the only ones with something to gain from having stock-based executive compensation are CEOs and hedge funds. Both, he says, benefit from volatility of stock prices.
Martin’s prescription: performance-based compensation is fine. But don’t reward CEOs based on stock prices. Reward them based on real performance, in terms of something like earnings or sales or market share — different systems will make sense for different companies with different strategic objectives. But the point is to reward them for something more real than merely meeting the expectations of analysts.
It’s a provocative thesis, and a bold prescription. To say that stock-based compensation is “standard” is an enormous understatement. And Martin acknowledges that change, if it comes at all, will not come quickly. But given how widely-agreed-upon it is that current modes of compensation are not working, bold prescriptions may just be what is in order.
Ethics & Economics, Part 1
This is the first of an occasional series on the relationship between ethics and economics.
Although I’m not an economist, I do find economics both important and interesting. It is far from its reputation as “the dismal science.” Its reputation as dismal likely comes from the fact that the stuff it studies is often dismal, for it studies things like scarcity and competition, things that are most often experienced as negatives. But those things are unavoidable facts of the human condition. In this regard, economics is no more ‘dismal’ than physics. It’s a bummer that I cannot fly unaided or teleport or be in two places at one time, but those facts don’t make the study of physics particularly dismal.
So we shouldn’t avoid economics. And understanding at least a bit of economics is crucial to a deep understanding of many issues in business ethics. You can’t effectively critique the market, or the institutions that populate it, without understanding at least a bit of the theory behind how they’re supposed to work. That’s why I often start my own Business Ethics course by having students read a bit of Adam Smith’s Wealth of Nations, as well as commentaries on Smith by Nobel Prize-winning economists Ronald Coase and Amartya Sen. A bit of economic literacy goes a long way.
The definition of “Economics” that I typically use in my own teaching is this one, cobbled together from various sources, is this:
Economics is the social science that deals with the production and distribution and consumption of goods and services and their management.
In particular, I usually add, economics tends to involve the study the ways in which behaviour within systems of production, distribution, and consumption is driven by incentives. The other things that I take to be typical of the work of economists, if not part of the definition of the discipline:
- Economists tend to be particularly interested in the way people respond to incentives of various kinds;
- Economists care a lot about actual data. They care in particular about the actual consequences of various policy decisions, rather than just the intentions behind them.
- While economics is nominally a descriptive discipline, its descriptive theories (about, e.g., the conditions under which markets operate efficiently) tend pretty quickly to generate policy prescriptions (for what governments can & should do to foster such efficient operation).
Here is another definition of economics, which Thomas Sowell, in his textbook Basic Economics, attributes to the late British economist Lionel Robbins:
“Economics is the study of the use of scarce resources which have alternative uses.”
I like that definition quite a lot, since it highlights the intersection with ethics: justice, one of the central topics within ethics, is primarily about the fair distribution of scarce resources.
I’ll end there for now. But watch here for other entries in this series, on how ethics and economics overlap and/or conflict.
In the interest of promoting economic literacy, here are a few books about economics that I recommend. All of them are aimed at non-economist audiences.
- Economics Without Illusions: Debunking the Myths of Modern Capitalism, by Joseph Heath
- The Undercover Economist, Tim Harford
- The Rational Optimist, by Matt Ridley
- Predictably Irrational: The Hidden Forces That Shape Our Decisions, by Dan Ariely
The Business Ethics Blog 