Monday, July 27, 2009

Management Compensation And Anchoring

One of the perennial issues regarding management is compensation levels, and the usual assumption is that they're way too high. Value investors tend to echo those complaints, seeing high compensation levels as evidence of management chicanery and/or fecklessness. There's also some talk about the good old days, when top management was happy to grow a public company at five figures annually.

I realize I'm breaking somewhat with the consensus on this issue, but I wonder how much of the presumption that management is generally overpaid is the result of anchoring bias.

Let me bring in a example in the same timeframe, but from a different career. Back in the day when a CEO was happy to work for $50,000 a year, plus perks like the unwritten right to be the only employee to drive a fully-loaded Cadillac and status goods such as an imposing office plus a taboo-surrounded exclusive address, it was tough financially to be in professional sports. A player had to be in the top league to have a serious chance at making middle-class-level money from his skill. It wasn't uncommon for players to work other jobs off-season. The biggest ice hockey star of the 1950s, Maurice "Rocket" Richard, had a base salary of $15,000 a year in the early-mid 1950s; it was later dropped to $12,000 a year. The most he ever made in a year (including bonuses) was $25,000.

In other words, the biggest ice hockey star prior to Gordie Howe made, at best, about as much as a senior vice-president of a large company. A more normal compensation level for him was middle-management range.

Professional sports stars are heroes to many, and we like to believe that they were woefully underpaid back in the olden days. Not so for management: much of the charge of overpaying is anchored in 1950s salary levels.

It's a pity that the 1950s aren't studied more closely by those management critics who invoke the salary levels of those times. Critics of management culture back then pointed out that the "Organization Man" had to always be on his toes, had to carefully conform to the corporate image, even had to marry in a company-compatible way, had his [yes: back then it was "his"] choice of home circumscribed by an unwritten pecking order, and had to be careful to show due deference to the boss and to top management. The boss that wanted to be everybody's friend was quickly sized up as a potential tyrant, if rubbed the wrong way. One of the rules of organization survival was, "if you play the boss [especially the top boss] at golf, better make sure he wins." It was a time when a union man could cause a scandal, and become a folk hero, simply by buying a Cadillac and driving it to work.

Anyone studying the writings of corporate critics in the Organization-Man era would have to conclude that, along with the relatively modest paycheck which a CEO drew, the top boss had a large psychic payment in terms of status. The two definitely hung together, and the explosion in CEO pay could be seen as monetizing that status.

Unfortunately, many of today's critics of management lack a sense of history. Many of them also live on our anchoring bias. It's hard to swallow the conclusion that 1950s [and 1960s] management were woefully underpaid in terms of money, a conclusion that also follows from the top-management salary explosion of the last thirty years, but the point about status suggests a trade-off was in place too. Perhaps the "outrageous" salaries of today's management represent the better of the bargain, especially since the prestige of top management has eroded to the point where activist investors have a fighting chance against management over any issue. In the 1950s, none of them did; none of them. Not even Benjamin Graham himself.

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