How can supply have all the power and demand have none?

A New York Times article on director scrutiny for executive pay joined the twitter this morning. The lack of examination of executive pay’s precipitous rise over the past two decades, as well as accountability for company’s boards of directors in these matters was pushed into the spotlight.

The Times notes that “the exchange’s” (NY Stock that is) “board took at lot of heat for that” (executive pay to Dick Grasso) “controversy,” according to Sarah Anderson, a Washington based expert on executive pay. The House committee on “Oversight and Government Reform” (could any title be farther away from the wheels of commerce?) looked at pay practices before the explosion of insolvency drew their attention away towards a new shiny penny.

We still lack clear opinions and leadership in this matter, especially in media and in government. Executives are not entitled to private jets, nor are they entitled to pay for Bat Mitzvah’s where Aerosmith performs, with pay earned for running “public” companies. Generals in the United State’s Army earn a touch over $200,000 per year for service and seem to stay happily in their jobs. If you ask student’s at Harvard Business School (which is the mac Daddy of business schools, no?) if they would be happy to earn $1 million per year, it is likely that a resounding percentage (think purity level of Ivory Soap 99.44% maybe?) would say damn yes!

What happens along the way from youthful exhuberance to this surreality?. The headlines keep claiming that the top people will go “elsewhere” if they are not paid $10 or 20 or 50 million dollars per year. The question I have is “Where?”

There are 500 public companies that are listed in the Fortune 500. Hundreds of thousands (perhaps millions really) of executives have credentials worthy of note, and could easily serve in their area of expertise for many companies (including the one they currently work for). When a CEO, CFO or other top company official dies, replacements are always found, even for founders whose will, personas and visibility would render them legend (Sam Walton is a wonderful example).

So how is it that the supply (the top level employees) have all this power and ability to hold the line while demand (companies that are powerful, influence politics on multiple continents, have strong allies in government, and have billions of dollars) have none?

The whole concept of Supply and Demand was coined in the 1700’s by James Denham Stewart, and is perhaps the most well known idea behind the study of economics. Governments have regulated against “collusion” (the practice of acting in concert to unfairly impact one side of the market to favor the other” so the equity of the market seems likely, yet somehow the CEOs must be paid tens of millions (or hundreds of millions if you don’t mind) of dollars for manning the controls.

The CEO of GE (currently Jeff Immelt, on who’s watch as much as 90% of the market value of the company disappeared) is a credentialed executive. He should earn a salary and a cash bonus if the company does well again. He should be penalized for his performance during his tenure, and the board of directors should be mindful that if the company’s stock rises from its low of $6.00 to $25.00, Mr. Immelt should not be thanked for quadrupling shareholder value, nor should his options be re-priced with such a low baseline price that would allow him to earn in the face of shareholder’s losing (1) the longest running dividend on Wall Street and (2) billions of dollars on his shift.

It makes no academic sense. The supply (the number of jobs running Fortune 500 companies) is fixed, and demand (number of guys and gals with credentials (MBAs, Ph.Ds and so on) is rising (especially as the health and age of able workforce rises). This would on a simple level create a strong argument that the prices for those workers should drop, especially on an adjusted real dollar basis. Ask any farmer who has a bountiful, frost free winter in the orange groves how it works, and they’ll explain why prices fall when supply increases. Somehow in the face of the immutable reality of many educated executives, the pay of workers, providing the unit price labor in the company’s offering shrinks, while in real and adjusted dollar terms, CEO pay soars.

If you asked why Russia minted so many billionaires in the last 20 years it would be simple; the former communist party guys took the state’s assets for themselves (as opposed to just siphoning off a percentage back in the Politburo days). CEO’s did the same. They asked board members to grant massive amounts of options, which are riskless (to them) rights to buy stock at a given price, and then did the things to drive the stock prices up quickly within the option periods, which were not necessarily to the company’s benefit in the long run.

If you run a car company, as an example, you might act like this: The stock is trading at $10 per share and making $1 per share. You take over and get $2 million dollars per year, retirement benefits, stellar perquisites like a plane and five star travel, and 3 million five-year options to buy stock at $10. The company needs new plants and equipment and workers all joined up because the company had a pension plan (company paid) and health insurance and other benefits. You don’t invest in new plants, but seek a partnership with an off balance sheet subsidiary you formed to handle issues surrounding plant investment and made a deal to allow the investors in that entity (bondholders) to have higher interest and payment six years from now in exchange for lower payments today. You brought in investment bankers who examined the pension fund (does the term “trust” funds mean anything to anybody anymore?), and decided it was “overfunded.” You purchased an annuity from an insurance company to provide “minimum benefits” to pension retirees and used the excess money to buyback stock to “enhance shareholder value by increasing income per share.” The Company earns $2 per share next year and the price increases to $25 (the investment bank recommends it based on growth), so the options are worth $45 million dollars. Five years later the higher fees kick in and the insurance company annuity you bought doesn’t work and the company is losing money and the stock drops to $.20 per share. No penalty, no accountability and completely legal, believe it or not.

These are defensible actions that will result in increased bottom line, increase in your warrant value but may not enhance shareholder value in the long term (see how Toyota, Nissan and Honda’s balance sheets look and the levels of their executive compensation.) Certainly most companies that bought back stock could use the cash to run their businesses in the broken capital markets environment we have today.

So how can we pay these guys? Well there are some ideas: (1) a cash bonus. Lawyers get a cash bonus at every firm in the United States and none of them seem to leave, (2) Lend them money, (an amount that they can pay commensurate with their salary and wealth) at the lowest rate a company can borrow at and let them “buy” shares, or (3) a pat on the back and a hearty “thanks” from the board and the shareholders. If that doesn’t work, studies show disgruntled employees don’t do good jobs anyway.

Stop lying; and take a stand experts. There are so many men and women that could take the roles in sales, operations, marketing, finance and management at the large companies that if they stood on top of each other we might be able to touch the outer rings of Saturn. The great universities turn out more each year and there is no lack of “supply.” Public companies are for the “shareholders,” not for the executives. Stop the excesses, the greed and the madness and go back to 1950s America, where a CEO lived in a nice 6 BR home in a great area, belonged to a country club and drove a nice car.

If that model doesn’t bring the greatest Americans resumes to solve the difficult problems facing us, its great. Those great Americans will start businesses, and because we’ve established their greatness (as we agree we have), jobs will be created, and the economy will benefit. I will never argue that these CEOs turned entrepreneurs will be entitled to the money from building their own enterprises, which their brilliance and risk they will take will afford them; assuming that they actually take that risk of course. If they don’t, they will earn a couple of million dollars running the powerful companies they run and the rest of the formally excessive compensation they earned will be left to hire people, expand and rebuild their businesses. They need lots of rebuilding. It’s win-win.

Be mindful, be careful and good luck!