Today's W$J offers a chart showing the whopping pay taken home by CEOs of top Wall Street firms.
Interestingly, all of these firms used to be privately held partnerships, but in recent decades have transformed into publicly traded corporations.
As Holman Jenkins points out in today's Journal, this runs counter to economist Michael Jensen's famous prediction that the public corporation was on its last legs.
As Jenkins notes, back in the 1980s, Jensen argued that: "the eternal conflict between managers and shareholders had given rise to a more efficient way of allocating large amounts of capital, through LBO groups that would concentrate ownership in the hands of management and a small circle of closely involved outsiders." (You can download Jensen's 1989 essay, The Eclipse of the Public Corporation, from SSRN.)
Instead, as Jenkins points out the public corporation thrived in the 1990s. Why? Jenkins offers a provocative hypothesis:
Mr. Jensen's prediction -- more of a provocation, really -- was not borne out; the publicly traded corporation was not eclipsed. It engineered its own comeback by rediscovering its intrinsic advantage: a stock price. A publicly listed stock remains the greatest corporate governance tool yet invented, because it creates the opportunity and incentive for all the knowledge in society to mobilize around a company and its prospects.
The usual scolds insist that high CEO pay in the form of stock options is a product of cronyism and self-dealing. In fact, high CEO pay seems to have been precisely the publicly traded corporation's way of re-establishing its primacy over the privately held company. This is illustrated by Xavier Gabaix and Augustin Landier's study showing how closely the rise in pay has tracked the rise in market value of U.S. companies.
Count me a skeptic. While I don't believe the executive compensation system is as badly broken as do some observers (such as Lucian Bebchuk), the system is flawed. As I wrote in my essay, The Compensation Conundrum:
According to Bebchuk and Fried, boards of directors -- even those nominally independent of management -- have strong incentives to acquiesce in executive compensation that pays managers rents (i.e., amounts in excess of the compensation management would receive if the board had bargained with them at arms'-length). Among these are: Directors often are chosen de facto by the CEO. Once a director is on the board, pay and other incentives give the director a strong interest in being reelected; in turn, due to the CEO's considerable influence over selection of the board slate, this gives directors an incentive to stay on the CEO's good side. Directors who work closely with top management develop feelings of loyalty and affection for those managers, as well as becoming inculcated with norms of collegiality and team spirit, which induce directors to "go along" with bloated pay packages. Finally, Bebchuk and Fried argue that those few directors who resist these incentives and seek to put shareholder interests first face a number of obstacles in both the law and practice of corporate governance.
The net effect of managerial power is that CEO pay packets are higher than would obtain under arms'-length bargaining and less sensitive to performance. As a result, compensation of CEOs and other top managers has become a not insignificant chunk of corporate earnings. Yet, Bebchuk and Fried claim, much of that pay has been insensitive to the performance of those companies.
While I caution that the managerial power theory of executive compensation is far from a complete explanation of what's going on with compensation, it has enough validity to leave my doubtful of Jenkin's thesis that it was high compensation that saved the public corporation. (Unless you believe CEOs declined to take their companies private, because doing so would have made them subject to effective monitoring by the private equity funds - such as KKR - that finance LBOs.)
Having said that, however, I share the belief so ably expressed by John Micklethwait and Adrian Wooldridge in their wonder ful book, The Company: A Short History of a Revolutionary Idea, that the public corporation is is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.” Accordingly, I share Jenkin's concern that:
The economic and political battle today is between the corporation and outside interests who've discovered that "value at risk" is an opportunity they can exploit too. For a share price is a vulnerability that opens the door to all kinds of implicit shakedowns -- from trial lawyers and prosecutors and union pension fund chiefs, from peddlers of corporate governance cure-alls, from purveyors of "corporate social responsibility," from the sort of politicians who write letters to ExxonMobil demanding it recant its views on global warming.
Or, as the Paulson Committee recently observed:
Maximizing the competitiveness of U.S. capital markets is critical to ensuring economic growth, job creation, low costs of capital, innovation, entrepreneurship and a strong tax base in key areas of the country. Regulation and litigation play central roles in protecting investors and the efficient functioning of our capital markets, particularly in light of recent, highly publicized abuses. Yet excessive regulation, problematic implementation and unwarranted litigation – particularly when occurring simultaneously – make U.S. capital markets less attractive and, therefore, less competitive with other financial centers around the world.
