I have been reading with great interest William Caferro's biography John Hawkwood: An English Mercenary in Fourteenth-Century Italy
. It interests me both because of my longstanding interest in military history and because, as Caferro notes:
Mercenary bands were corporate in structure. The captain stood at the head of his brigade in a manner similar to the way a modern CEO stands at the head of his firm. When the captain decided to leave, the company did not disband but retained its name and elected another man. (Kindle Locations 1511-1513).
And here's a really interesting fact about those companies: the most famous and successful condottieri got paid a very substantial multiple of what the common soldiers made.
The famous Italian mercenary Giovanni d’Azzo deli Ubaldini earned an impressive salary of 500 florins a month in Sienese service in 1381. But his cavalrymen earned only 6 florins a month .... (Kindle Locations 1665-1667).
Granted, a multiple of 83 to 1 is lower than the multiple earned by many of today's top CEOs. But it's still a very dramatic difference.
What's going on here? There are two basic theories of executive compensation: managerial power and arms'-length bargaining:
The so-called principal-agent problem arises because agents who shirk do not internalize all of the costs thereby created; the principal reaps part of the value of hard work by the agent, but the agent receives all of the value of shirking.
Although agents thus have strong ex post incentives to shirk, they have equally strong ex ante incentives to agree to contractual arrangements designed to prevent shirking.Wherever a principal-agent problem is found, we thus expect to see a mixture of carrots and sticks designed to constrain shirking. The sticks include ex post sanctions, up to and including dismissal. The carrots include incentives that align the agent's interests with those of the principal.
...
In theory, these divergences in interest can be ameliorated by executive compensation schemes that realign the interests of corporate managers with those of the shareholders.
Stephen M. Bainbridge, Book Review Essay Executive Compensation: Who Decides?, 83 Tex. L. Rev. 1615, 1620 (2005), reviewing: Pay without Performance: The Unfulfilled Promise of Executive Compensation
, Cambridge, Ma: Harvard University Press, 2004. Pp. Xii, 278. $24.95. (Draft available here.)
In the arms'-length model, "compensation schemes are claimed to be 'the product of arm's-length bargaining' between managers 'attempting to get the best possible deal for themselves and boards seeking to get the best possible deal for shareholders.' As a result, financial economists loyal to the arm's-length-bargaining model assume compensation schemes are generally efficient, while courts generally defer to decisions by the board of directors." Id. at 1623.
In contrast, the managerial power model claims that:
... 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 that management would receive if the board had bargained with them at arm's length). The first of these incentives flows from the fact that 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, directors have an incentive to stay on the CEO's good side. Second, Bebchuk and Fried argue that directors who work closely with top management develop feelings of loyalty and affection for those managers, and they become inculcated with norms of collegiality and team spirit that induce directors to go along with bloated pay packages. (Id. at 1624-25)
...
The net effect of managerial power is that CEO pay packets are higher than would obtain under arm's-length bargaining and less sensitive to performance. (Id. at 1626.)
A condottieri's pay ought to be the product of arms'-length bargaining rather than managerial power. In the first instance, the condottieri's pay is set in the condatta (the contract between the city-state employer and the condottieri), which presumably is negotiated more or less at arms' length (of course, the condottieri has a considerable degree of bargaining power in the form of the military band at his disposal).
In the second, unlike public corporations where the owners of the business are dispersed and relatively powerless, the condottieri is elected by his employees. In theory, employee ownership should obviate the agency cost problem that drives up CEO pay.
Interestingly, however, the modern evidence suggests that employee owned enterprises should have much lower ratios of CEO to worker pay. In the famous Mondragon cooperative, the permissible ratio of the highest paid to lowest paid employee has gradually risen but only to 8.91 to 1. (Jones, D. C. 2013. The Ombudsman: Employee Ownership as a Mechanism to Enhance Corporate Governance and Moderate Executive Pay Levels. Interfaces, 43(6): 599-601.)
Why then did the condottieri's pay so greatly exceed that of the common soldier? One likely explanation is the tournament theory of executive compensation.
As the story goes, tournaments are a mechanism for reducing agency costs by providing incentives through “comparative performance evaluation.” In a promotion tournament, the principal ranks its agents by their performance relative to one another. The best performing agents are promoted to positions with higher pay and/or status.
Stephen M. Bainbridge, The Tournament at the Intersection of Business and Legal Ethics, 1 U. St. Thomas L.J. 909, 911 (2004). (Draft available here.)
Caferro's book offers some support for this hypothesis:
The pay structure provided obvious financial incentive for cavalrymen and officers to seek advancement to the leadership of companies. (Kindle Locations 1673-1674).
But why would the common soldier tolerate the vast disparity in pay? What did the common soldier get out of working for a condottieri who made more than 80 times what he did? Interestingly, Caferro informs us that:
There was surprisingly little connection between the wages of cavalrymen and those of the captains for whom they worked. Service for a renowned mercenary did not result in higher pay. The famous Italian mercenary Giovanni d’Azzo degli Ubaldini earned an impressive salary of 500 florins a month in Sienese service in 1381. But his cavalrymen earned only 6 florins a month, the same as those in the employ of the obscure mercenary Riccardo Dovadola, whose own monthly stipend was 24 florins.
But it turns out that soldiers in the mercenary companies were not paid by salary alone:
The appeal of working for a well-known captain lay in his ability, through victories, to bring earnings beyond salaries in the form of spoils of war and, perhaps, through his reputation, to increase the likelihood that an employer would pay wages he promised. (Kindle Locations 1664-1669).
So it turns out that the winner of the tournament does have coattail effects on those below him in the hierarchy.
I'm not sure if this has anything to do with modern corporation CEO pay, but it does suggest new ways of thinking about CEO pay in workers cooperatives, employee-owned corporations, and maybe even law firms.
Social Media