The Executive Pay Scandal -- Part 1

So, after a year or so of chin-wagging, rising unemployment, a trillion dollar bailout of the "banks too big to fail," we now have a sure sign of repentance from those very same problem-creators; bonuses even bigger than the ones that broke the bank(ing system) in the first place. You have to love these guys: they are so not getting it, but they certainly have world-class chutzpah.

With a straight face, they are now telling us that hundred-million dollar compensation packages are justified by their performance. After all, if it wasn't for them, their institutions might actually have failed. And though we're not just talking about CEO's, they certainly get the biggest checks, as usual. Why? Because they are held personally responsible for the actions that led to that performance. If they hadn't been there, stockholders, bondholders and everyone putting up the money (that's you, reader) would not have saved their jobs and/or lost their investments. Presumably, we should all be grateful.

But Maybe Not. Let's have a closer look, not just at the payouts but at the rationale underlying them. After all, these salaries and bonuses supposedly adhere to one of the most revered principles in management: people should get paid for their value. Their compensation should reflect their contribution to the organization's performance. If it does well, the people who made it happen do well. How American is that!

Well, let's see. We need to peel the onion a bit to see who or what is actually responsible for an organization's performance, and how much of a bonus seems appropriate. If we assume that the distribution of bonus monies reflects the accepted view, we have to conclude that the CEO was by far the single most important contributor. CEO's, for example, get the biggest slice and compensation drops off very sharply after that. So she is held to be largely responsible for success.

As to the second issue, how much is a very successful CEO worth, their current pay is now about three times larger than it was a decade or so ago. In 2005, CEO's of Fortune 500 companies got total compensation, including bonuses, that was 465 (not a typo) times as much as their average worker. Ten years earlier, that ratio was about 168: ten years before that (1985) the figure was 67. By the way, the ratios for other industrialized countries in 2005 ranged between 22 (Japan) and about 40 (UK) and they have risen much more slowly. It's easy to argue with these specific figures, but by any measure, CEO's in the USA get paid hugely well, and it gets even better from year to year, both in absolute terms and as compared to company performance.

So, as this has become widely recognized, a pay czar has been appointed and given the power to adjust the pay of the top 25 executives in companies that are operating with the help of a federal bailout. What should he do? Does this make sense or might there be a better way? Faithful readers (there are a few) will be certain that I will at least suggest one. They're right. Tune in for Part 2 and see.

He's got to be kidding!

The New York Times of Thursday, October 8, 2009, contains a jaw-dropping story about General Motors, whose sins, you may recall, included losing money from every orifice, paying no attention whatever to their problems and persisting in the behavior that got them in the soup to start with. There was, for example, the great private jet show, alerting the entire world to GM's sensitivity to the public and its clear appreciation of their situation.

Times have now moved on, as they have a way of doing, but Fritz Henderson, the new CEO, whose resume looks tailor-made for the job, appears to have been hypnotized by the environment on GM's top executive redoubt (which used to be on the 14th floor, well insulated from the rest of the company), into making yet another public statement that he will probably live to regret. He said, and I am quoting from the Times, "a new product-oriented culture has been put in place," and that GM's new board was "pushing management to speed up decisions on new products" and best of all, planning to "install a culture devoted to pleasing customers."

I love that last part. I can see Fritz or one of his many assistants going to the web and googling "install a new culture" as if it were an off-the-shelf item that, if the price was right and one was in stock, could be shipped by express, so as to ensure that the new culture was pleasing customers starting on the very next Monday mornng. My faithful readers -- both of them -- may know that changing the culture of large organizations is not a task to be undertaken lightly, since it has a solid history of failure. And come to think of it, what do we imagine GM was doing in the last decade or so -- fiddling while the company burned?

But, I hear you say, maybe this time they've learned their lessons and they'll really get down to it. But I say, Maybe Not. This is all too likely to be the next in a series of brilliant illustrations of executive intelligence, such as dissing the hybrids until long after they were successful, dissing the unions after sweet-talking them for 40 years (remember Tarrytown, anyone?) and dissing shareholders, who watched in horror as the company slid down the chute into bankruptcy. But, you say, they're much smaller and more nimble now; they "only" have 280,000 employees instead of 540,000 (in 1955). Well, then, I guess that's alright. Ha!

L'etat, c'est quoi?

I feel like that guy in the movie "Network", screaming out his window, "I'm fed up and I'm not gonna take it any more." I don't exactly remember what he was fed up with, but I personally am fed up with claims that because some inhumane or evil territories are considered "sovereign states", we have to leave them alone.

Examples are legion. Zimbabwe is a basket case, in which millions of people have died because of an aging tyrant who amuses himself by toying with the rest of the world and pretending to be reforming. In Rwanda, upwards of half a million people were murdered in cruel and crazed ways, mostly by their neighbors, simply because they were members of a different tribe. Somalia is universally agreed to be a failed state with a huge displaced and helpless population, Cambodia under the Khmer Rouge systematically slaughtered a quarter of its people, and Myanmar and North Korea are ruled by unelected and transparently illegitimate regimes whose citizens lack most basic needs, to say nothing of freedom. And this is merely a fraction of such cases.

Yet we are told by those who could make a difference (governments, the UN, global NGO's, and people in positions of influence) that there is nothing more we can do because we cannot interfere with sovereign states. Obviously, the USA made a major exception for Afghanistan and Iraq, justifying them as legitimate responses to acts of war. But if millions of people in other countries are being killed or their lives made worthless, we are asked only to pray for them. Do we have to stand idly by when this is happening?

Maybe Not. (I would actually make this stronger; "Bah, humbug" seems more apt.) The very concept of sovereignty needs dramatic reconsideration and adjustment. What, after all, is its rationale? There are many, but the ones most used to excuse our failures to act make little or no sense now. Let's start with a real old chestnut -- the citizens of a state are the ones who should make those decisions, and until they do, we should not interfere. (An important corollary is that we don't want anyone else to try to interfere with our own sins.)

Of course: if country has a functioning political system based on open elections and freely expressed preferences, they have every right to be left to do as they wish. But if they are not able nor allowed to act this way, they have forgone any right to be managed by self-appointed or forcible rulers. There is also a residual cynical real-politik view (Remember Henry Kissinger, anyone?) Leaving other countries alone is OK as long as their problems don't really affect us. In our now complex interwoven world system, highly destructive technologies cannot be contained. Finally, and not least, most countries, and certainly mine, want desperately to avoid any hint of softening this position, which would give others an argument for interfering with us.

We can do better. President Obama has the credibility and, I suspect, the beliefs, that might allow him to raise this issue directly. That would be a wonderful gift to the generations to come.

Are People Rational?

I have recently been reading "Kluge: The Haphazard Evolution of the Human Mind ," by psychology Professor Gary Marcus of NYU. It argues persuasively that our minds, far from being perfect evolutionarily fine-tuned instruments of clear and incisive thought, are more like contraptions assembled higgledy-piggledy out of pieces left over from our earliest ancestors, with whatever adjustments from time to time make the thing work. The result is a mind that, though powerful, is easily confused and cannot be counted on to be rational.

As with the rest of the growing bandwagon of "behavioral economics" studies, this raises important questions about "economic man" ("econs.") Kluge is full of clever experiments showing that people routinely draw conclusions and make decisions that are not expected of econs. For example, most people, given a set of alternatives, often make selections that are clearly more costly or less effective than others equally available to them. Similarly, their answers systematically change when completely unrelated information is also given them at the same time. Marcus (and others) therefore conclude that people often, and predictably, do not behave rationally (that is, like econs) and that their behavior cannot be assumed to represent their most beneficial choice.

But Maybe Not. This is a questionable interpretation, since it omits at least two major possibilities; first, the effect of people's environment on their mental behavior, and second (by far the more important of the two), the effect on their thinking itself of differences in the consequences of that thinking.

Through ongoing evolutionary adaptation, the human brain has developed quite remarkable problem-working abilities. But there is a great difference between work intended to address an imminent and consequential problem (That's a tiger!) and simple play (I'm bored.) We know that when minds are not occupied otherwise, thoughts can run wild. ("The devil makes work for idle hands.") Dreams are probably minds at play, or at least in neutral. Even motors may change speed without a direct command, and computer memories may become momentarily active. To deal with tigers, we can't afford to have our minds completely at rest; they must be able to react fast. Keeping the brain ready for action is an evolutionary imperative.

The experiments described in Kluge may not, therefore, show much about the operation of a mind focused on a significant task. George McClellan, a pioneering psychologist concerned with human motivation, used to demonstrate the power of this imperative in the classroom. He would draw a long chalk line on the floor, set a container at one end of the line, tell the students that they could stand "anywhere on the line", and give them a ball. The task was simply to get the ball into the basket. The results are always the same: where people stand along the line fits a normal distribution, with almost no one standing next to the container, and the mean position at a significant distance from it. Even though success could be guaranteed by standing closer, most people elect to make the task "worthwhile" by making it harder.

In short, people make many surprising decisions but they may be more rational than the behavioral economists think. Their view of rationality is more or less limited to economic costs and benefits, whereas in reality, there are many other entirely rational reasons -- to people, but not to econs -- among which may be many tradeoffs. It would therefore be wise not to limit arbitrarily our view of rationality but to stretch it to more accurately fit people's hopes and concerns.

Boiled Frogs and Scorpions

I love nice crunchy metaphors and powerful images. 

Take, for example, the famous boiled frog story. Put a frog in a pot of hot water and he will jump out at once. Put him in a pan of cold water,  heat it on the stove, and he will be cooked to death because he won't notice the slowly rising temperature. Moral? Let frogs (and people) get used to new things slowly; don't try to change everything all at once.

Here's another frog story. A scorpion and a frog meet on a riverbank. The scorpion, who can't swim, asks the frog for a ride. The frog demurs; "Why would I do that? You'll sting me and I'll die." Says the scorpion, "That would be stupid. I would die too." OK, says the frog and they start across. They get partway and the scorpion stings the frog, who with his dying breath, says, "Why did you do that? Now we'll both die."  The scorpion shrugs; "I'm a scorpion." Moral? Don't trust scorpions (and people) to go against their instincts.

Both of these are powerful images, and the advice they embody is worth noting. But maybe not all the time. First of all, the boiled frog story is surely untrue, simply something made up for the purpose of illustrating a point. I have not done the experiment, but I am morally certain that the frog, any live frog, would jump out of the pot long before it boiled to death. So, another moral to this story is; "Don't assume frogs (or people) will necessarily either resist sudden large changes or accept continuing small ones. 

A similar point applies to the scorpion story. Even though scorpions (and people) have a set of inherent tendencies or routines that are easily triggered, that does not necessarily happen in every case. I am not an expert on scorpions, but I know without question that people can be encouraged and led to act against what appears to be their nature, or their inclination. The real danger is actually the assumption that their behavior is always predictable and unchangeable: "If I do this, they will certainly do that." 

The best way of getting people to accept change is not to try to fool them, or to make rigid assumptions about them, but to get their support, based on their own understanding and your willingness to work with them.

Never doubt that a small group ......

"Never doubt that a small group of thoughtful, committed citizens can change the world. Indeed, it is the only thing that ever has." 

That famous quote is attributed to Margaret Mead, a pioneering anthropologist and student of traditional societies. It is widely used to encourage those wishing to change the world, but because of their perceived powerlessness, doubting their ability to make a difference. I have two problems with this quote, one trivial and the other quite central.

The trivial one is this. I can find no record of the actual source of this "quote," either in the published works of Dr. Mead, or in the record of her speeches and remarks. Virtually every compendium of quotations contains this line, with little variation in its details, so it seems likely that these many references are based on a single earlier statement asserting her authorship, but every reference I have examined lacks a documented source. Of course, that is not proof of anything, and from her reputation and perspective (I actually met her many years ago.) her authorship is not implausible. 

The more important caveat is this. The second half of the assertion itself ("Indeed, it is the only thing that ever has.") is patently false. First of all, most of the genuinely transformative events in this world have arisen fron non-human sources. That is not code for a literal belief in the bible, although many do believe its account of the world's early history. I am referring instead to the very clear record of changes due to powerful and unpredictable natural events far outside of human control or intervention; asteroids, floods, earthquakes, major storms etc, to say nothing of evolution as the ultimate driver of change. 

Even the main thought, that "a small group of ... citizens" can change the world, while true, avoids recognition that most human driven change is far less deliberate than that. Even when it appears to happen, itis almost always the case that circumstances were conducive or even sufficient by themselves to account for the ultimate change. We do like to take  credit for things that happened while we were on the bridge, or at least lurking in the vicinity, but both appropriate modesty and an accurate examination of the change and its history should make us doubt our effectiveness as its agents.

I do not suggest that we are powerless. But I do mean to argue that our abilities may rest more on being able to take advantage of trends already underway or to catalyze a move ready to take place, and less on serving as the "force majeure". Indeed, it is wise to help bring about the necessary conditions and to be ready to pull the plug at the appropriate moment. What is then the precise cause? And if we wish for that outcome, does that question really need to be answered?

"People Are Our Most Valuable Resource"

The title of this post -- "People Are Our Most Valuable Resource" -- is one common version of an almost universal belief, at least in connection with businesses or other purpose-driven organizations. This is particularly true in the US, which is perhaps the most individualistic society on the planet. In the US, it is assumed that the "secret" of organizational success is no secret at all: it is simply the quality of the people associated with the organization, a belief which leads directly to the current trend to hire "talent". Since talent, by definition, will be sought out and fought over, it becomes wise to search for undeveloped or latent talent, which can be developed by and for that wise organization. 

In this view, the organization is simply a container, into which (hopefully talented) people are poured ; the container in itself is not important. Thus, if a company does well, we can be confident that we have an adequate or better supply of talent. On the other hand, if things go ill, in whole or in part,  we must have a few bad apples in our barrel. It follows that we need to root out those untalented or inadequate people and either replace them (a draconian but powerful tactic) or develop them (an enlightened but uncertain tactic.) If this tactic doesn't seem to work, we must be doing it wrongly. In either case, the container has little to do with our effectiveness as an organization.

But Maybe Not. As it turns out, this is an astonishingly misleading and inaccurate assumption. Although it is certainly true that people differ greatly in their natural or distinctive strengths, these may have surprisingly little to do with the organization's ability to function effectively and smoothly. Both research and a little unblinded reflection shows that the container itself has a great and generally determinate effect on the organization's performance, success, competence and value. Think about it for a moment. Imagine what would happen when someone (anyone) is simply replaced, or gone in the morning, and her position filled with someone else that same afternoon. What is likely to happen next?

In a very short time, she will be doing almost exactly what her predecessor would have been doing, picking up on incomplete or continuing tasks almost seamlessly, and attacking problems in the in-box or the emails requiring attention. She will probably also have been given a copy of her job's description and heard a pep talk reminding her of the performance to be expected from her. (This is, in fact, a very common device used to evaluate or assess candidates for a position. It's called the in-box exercise and it confronts a new and uninformed notional new employee with the full in-box left behind by the desk's previous occupant.) 

Under these circumstances, whatever her background and potential, she will literally be forced to carry out the same tasks within the same constraints experienced by every previous sitter at that desk. Almost all the important actions will have already been either required or forbidden by command. The tasks to be done are specified, often in detail, the relationships with other people (in their organizational roles) are laid down, meetings will already be set up and scheduled, with the other members known and on board, reporting relationships and constaints are defined, their physical location is fixed, as before, and measures of performance will be clear. In short, the new person will have little flexibility, because the container itself has set the most important terms of the job.

The likelihood of producing genuinely superior results will accordingly be small. Worse yet, so are the opportunities for her to find and use innovative ways of contributing to the organization. 

Do We Need CEO's?

The uproar over "excessive" and "unearned" compensation packages for CEO's and other senior executives in AIG and other financial giants receiving federal bailout funds calls attention to the role and importance of CEO's. The underlying assumption is that a single all-powerful executive standing atop a pyramid of underlyings is an essential element in modern businesses. That being so, when there is a problem, the solution is clear; get rid of the old CEO and move in a new one. 

But Maybe Not! The main functional reason for such a CEO is that it simplifies and enables crisp decisions. But it makes no sense to expect the CEO, or any other single person, to figure out the alternatives and their implications, and also to pick the "best" one. A CEO is a tie-breaker, a discussion-shortener and a consistency-ensurer. She is a referee. Must she also have all the ideas; certainly not. Does she need to know everything that's going on in her company; in fact, can she? Of course not. Is she automatically the best judge of company direction? Not at all. 

How else can we run organizations? There are other alternatives. Many well-known and highly esteemed orchestras and ensembles have run successfully without a conductor. Corporations, after losing their CEO's, have often gone for long periods under a "caretaker" CEO, with no apparent damage. Moreover, if a famous CEO goes from great success at one company to failure at another, such as Bob Nardelli did in his transfer from GE to Home Depot, what are we to conclude? (Of course, once a CEO, always a CEO; Nardelli went on to take over Chrysler, whose epitaph is being written right now.)

There are also fairly large and very successful companies run with few executives at all. Semco, a rural Brazilian manufacturer of industrial components, has run with a nominal but almost completely inactive CEO, Ricardo Semler (who wrote about his company in "Maverick".) And Procter & Gamble has for decades run large and complex factories as stand-alone enterprises, sometimes without any identified managers at all. And, of course, the opposite is also true. Many old-fashioned CEO's have destroyed the companies they ran, and that includes not only the current financial firms, but many earlier ones. ("Chainsaw Al" Dunlap, for example, destroyed Scott Paper.) 

The bottom line is simple.  There are lots of ways to organize effectively. It may make sense to have a CEO, but her authority, her tenure, her background, her education and her age can all vary greatly. And her compensation should in those circumstances be equal to or only modestly above her usual peers. 

It's time to end the cult of the famous CEO.