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Symbolism can be substance

David Levine, professor of business administration | October 26, 2009

For a generation, American executives have benefited from soaring pay.  At the same time, these executives have been put in a difficult position: A significant share of their pay is linked to actions that destroy value for shareholders and society as a whole.

To understand this difficulty, recall that at most large American companies  executive pay largely depends on quarterly accounting profits and on the stock price now and in a year or two.  Unfortunately, these incentives reward executives for pumping up accounting profits in the next quarter or year, even if that short-term gain is followed by larger losses.   That is, these  pay packages reward executives who cut training expenses now, at the expense of the workforce’s productivity; break promises to suppliers now, at the expense of future innovations; engage in accounting chicanery today, at the risk of future scandals; reduce the quality of goods and services today, even if sales decline in the future; and take risks today, even if there is a good chance of vast losses in the future.

Not surprisingly, many (perhaps most) executives respond to the incentives in their pay packages.  The results are predictable, including both long-term problems with slow productivity growth and short-term problems such as the current financial crisis.

America’s “pay czar” is in no position to solve all of these problems.  At the same time, I applaud his decision to shift a few executives’ compensation away from short-term results and towards long-term value creation.  I hardly expect it, but I hope the example set by this single government employee can lead much of the private sector into revising executive pay to provide incentives for long-term value creation, not short-term accounting profits.

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