Steven Clifford Says You Don't Need a Compensation Consultant

is going to be quite a fascinating conversation. Uh. This is not the usual screed from the far left of the political spectrum. Clifford is a former CEO. He's been a board member on numerous companies. This is somebody within the corporate corporate firmament who has just recognized how completely absurd executive compensation has become. Uh. He criticizes his fellow board members, He criticizes the so called independent outside advisors.

He has lots of things to say about the consultants, calls them some pretty uh nasty names, says they're completely compromised and don't work for shareholders. And he discusses the impact of of just the gross excess pay not only on shareholders, which he says is unfair, but the impact on companies themselves. The more highly paid an executive is very often the worst the company has done, as well as the economy and society at large. Excessive executive compensation

has ramifications. Listen, what's ten or twenty million dollars to a multibillion dollar company doesn't sound like a lot? Well, it turns out there are reverberations from that throughout the company, the economy, and society at large, and their substantial and significant. And not only that, but Clifford suggests that it has

a very significant negative impact on future economic growth. So, with no further ado, here is my conversation with CEO and board member and now expert on executive compensation, Stephen Clifford. My special guest today is Stephen Clifford. He is the former CEO of King Broadcasting Company and National Mobile Television. He has served on the boards of directors of dozens of public and private corporations, and he was special depth the Controller of the City of New York during the

city's fiscal crisis in the nineties seventies. He is the author of the ceo pay Machine, how it trashes America, and how to stop it. Stephen Clifford, Welcome to Bloomberg. Honored to be here. So you're a surprising person to write a book about executive compensation, to write a critical book about executive compensation. You were the CEO of multiple companies. You've sat on numerous boards, You've advised on executive compensation to the companies you worked with. How did this come about?

It came about because I was working on boards. Uh, these are smaller companies, these aren't Fortune five hundred boards. But we were using the same system that the consultants UH put in it all companies. And as I was sitting there and serving on the comp Committee, I said to myself, Yeah, this system doesn't make any sense. This is a crazy system. And so too um. I said that to some members of the comp Committee and they said, oh, no, no, you don't understand. This is just how comp has done

in this country. This is consultants have it all worked out, this is how it's done. Trust us. So I started, So I started doing some research on my own to bring my fellow comp Committee members around. And the more I got into it, the more I realized it wasn't just a stupid system that gave the CEO the wrong signals and uh lad the CEO to do wrong things, wrong incentives, perverse incentives. But it was also terrible for the for the country, it was bad for the economy.

And so I started doing even more research. And everything I did told me this system is insane and it's hurting a lot of people. Let's let's put some flesh on of bones and and and this data comes from from your book. Since CEO pay in America has grown ninety times faster than the pay of the typical worker. Go back to eight the average large company chief executive was paid about twenty six times more than the salary of the average worker. Today it's somewhere between three hundred

times and seven hundred times. How on earth did that come about? It came about because the pay consultants started in roughly the or so, and as they started to get clients, they realized that they had data on what other CEOs were paid. Now, until this time, CEO pay had been established really on the basis of internal equity. How the CEOs pay uh compared with everybody else in the cup Penny and that's why that ratio twenty five

state stable from through the late late seventies. But they came in, they had this data and it was a great sales tool. So they said, now you got it all wrong. CEO pay should depend on what other CEOs make, and so U what we'll do is we'll establish a peer group and we'll tell you what other CEOs and these comparable companies making. Now let me interrupt you here and ask why should what other CEOs make be relevant to what we're gonna pay our CEO in our It

should have no relevance whatsoever. So how is that sales job affected? Well, the sales job is effective because when you go through all the steps here, what it does is it greatly increases the CEOs pay. So of course they want to hire these consultants. CEOs want to hire the consultants. The boards kind of want to hire the consultants because the boards don't really they're happy when the CEO gets paid more. Uh why is that why the they're all golfing buddies or why do they really Well,

let's start with every most boards. The majority of people on the board, our CEO s or x CEOs themselves Uh, so there's a little bit of tribalism. Is a little bit of tribalism. Uh. Secondly, they like to be able to hide behind the consultants and say, hey, we we we hired experts. You know, we had we had the best people in and they went through all the data and this is an objective measure. Now, the interesting thing about this is the way they get paid has nothing

to do with the market. These are people that they love the free market of the market. For the labor market for chief executive exactly, there is no in fact, there isn't much of a labor market for chief executives. U When you look at chief executives. To be an effective chief executive, you have to know a tremendous amount about a single company. You have to know it's finances,

it's marketing, it's competition, it's personnel, etcetera, etcetera, etcetera. Most of that knowledge is not worth much outside that company, right, so you see you companies rarely rarely go outside higher Another CEO of fortuneos were internal promotions. Really that's amazing. And so in other words, the skill set that an executive has probably isn't all that transferable to a different company unless it's in the exact same and that they are not Lebron James. Lebron James can take his skills

to any NBA tail and improve it. Uh CEOs camp and you know there're only two of the fortune CEOs were previously CEOs of a public company. That's interesting. CEO is jumping between one large company and another happens about once a year, and when they do, they usually failed. The failure rate is quite high. You know, your reference to external equity reminds me very much of what took place during the real estate boom. Everybody the appraisers used parables.

So what starts to happen in a rising market? It becomes the self fulfilling spiral and everything goes up because other houses are going up. Is the same thing taking place. That's exactly right, except it's a built inspiral. It's not just that it starts. What happens is you start with your peer group. Okay, I told you they assemble the companies. Well, surprise, surprise, companies choose peer groups that have highly paid CEOs. It's not an objective data say, it's not an objective data set.

The book is filled with some fascinating data points. This one really stood out to me. Between two thousand and eleven and two thousand and fourteen, there were four CEOs who earned more than a hundred million dollars a year. These companies could have paid d CEOs less and gotten the exact same performance from them. How do we end up in a situation where people are making hundreds of millions of dollars on the backs of shareholds. Well, you have what I have termed the pay machine. And each

year the companies crank up this machine. And as I as I mentioned, it starts with a peer group of of of highly selected other CEOs making a lot of money. Then the company quote benchmarks their CEO. So where does your CEO rank? Well, we're a good company, So everybody benchmarks their CEO at the seventy five percent diial of this group just random Well, no, we're better than those companies, so our CEO should be make what's the basis of assuming you're in the top quartile of what I assume

is a fairly competitive market, simply corporate pride. There is no simply corporate pride. We're good, okay, there's there's never any performance They don't have to perform at seventy percentile at all. It's just corporate pride. One would think there would be some correlation between, Hey, if we're declaring ourselves in top quartile, then we should be top quartile and profit growth top quartile and revenue gains top portoial and market share gains. Yet those seems things never seem to

come up. They don't come up at all. They don't come up at all. It's just corporate pride. So so this to me looks like a wealth transference scheme from shareholders, two managers and insiders. It I wouldn't I wouldn't use the word scheme because that's as if it were deliberately and conspiratorially designed. What happened is the consultants came in and step by step this machine was built and different

different things we're ad and it's a very complicated system. Now, on the face of it, most of these apps in here by themselves seem to make sense when you put them all together. They guarantee with mathematical certainty that the CEOs pay will escalate and I regardless of performance, regardless of performance. So I to me, this is more something

that evolved, but it evolved with two rules. One, the individual part of the machine had to have a certain surface logic, and to it had to increase the CEOs pay. And so each of those were selected for an evolution. So now you have a machine that guarantees that CEO pay will rise eight nine times faster than the average workers pay. That's amazing. I really like this quote from your book about stock price and profits quote, the price of your stock will tell you whether to maximize today's

or tomorrow's profits. Explain that, well, that comes from Jensen, who you know, is that the father of the shareholder value school and the terrible idea which has been pretty

thoroughly debunked over recent years. It has been debunked, but this is still the basis of CEO pay to really so so for those of you who may not be familiar with share how holder value, it's an idea that really got its biggest push from Milton Friedman and the Chicago School of Economics, which essentially says that instead of worrying about various constituencies clients, suppliers, employees, etcetera, um a corporation sole job is to maximize profit. Maximized shareholder value.

Fair fair statement. Absolutely absolutely, and I think and that that school said, Okay, stock price is the only thing that counts, So every decision you make should be made by what will maximize the stock price. So you know you may have to trade today its profits for tomorrow's profits. Well, how much should you do that? Well, look to the stock of your look to the price of your stock. That will tell you how to do it. So so the idea is not necessarily thinking long term, but it's

whatever you can do to raise profits, raise stock prices today. Well, the the theory behind that is that the market looks long term. So your your your stock price today. And in the Chicago school, everything is completely rational. Every actor is completely rational. So your stock price today is the discounted value of dividends plus the stock price ten years out, et cetera. And it's all perfect. And so the market

looks long term. So that's why you can That's why you don't have to really look long term, because the market will do that. For that sounds so backwards. The way I had always learned what public companies should do is focus on long term health of the company and the stock price to take care of itself. That's right. This stood it on its head. This said that today's stock price tells you how good you are long term, and you could see why executives who are compensated with

stock options. I love that concept. Well, the worst the worst thing about this is what how it focuses and misallocates company investment. Give us an example in between in the last ten years, S and P five have spent three point seven trillion dollars buying back their own stock. Now they buy back their own stock, fire it, retire, but they buy it back to keep the price high. Uh, they're not buying it back because it's undervalued. They're buying

it it's already high. They're buying it back to keep the price high. Uh. What do they spend on R and D over that same period? Well, I can tell you they cut R and D by over that same period. They cut plant and equipment by over that same period. And I'm going to use something stealing from your book because I thought it was so stunning when I talk about three point seven trillion, trillion is a hard number

to get your head around. Reading your book, you had an example that a trillion seconds is thirty two thousand years and that to me, that that tells you how much a trillion is and you've got three point seven trillion dollars that could be It could have been invested in product development, R and D, new technology, UH, job training, all these things for for long term health. And instead of doing that, they bought back their own stock. I mean, this is eating This is America's eating the seed or

an American industry is eating its own seed corn. Let's talk a little bit about how this impacts uh inequality in the country, not just for employees, but across across the whole board of society. And I want to start with some again more data from the book you reference that this is a fairly uniquely American phenomena. In Japan today, the average ratio between CEO pay and worker pay is sixteen to one. It's a little higher. In Denmark, it's forty eight to one. It's about eighty five to one

in the UK. How is it more than five hundred to one in the US. It's so incongruous with the less rest of the corporate world. Well, there are two explanations. One is that US CEOs are thirty times more valuable and productive than Japanese CEOs. That would be one. That's a little bit of a stretch. Another explanation is something's gone terribly wrong here. That seems more likely. Let's look

at how this impacts, uh, the overall economy. You actually say that this isn't just a function of within the corporation there's pain equality. You suggest this effects work of morale. You suggest this effects research and development, This affects how we actually build a society. Expound on that. Well, it clearly hurts the companies. I mean we've talked, we have talked about how they've cut R and D and cut

investment to keep their socker price high. UH A bigger guy, and they of course waste tens of million dollars on the CEO pay. But that's how the bush back is, Oh, that's company does billions of dollars. Who cares? I mean, so they so they waste that. That's a small part of the cost. A bigger part of the cost is

the effect on company morale. I mean, when CEO is making five times what you make and he comes out and he says, there's no I in team, and we're all in this to other, it's pretty tough for you to swallow. And I mean this has been proven by study after study that the more the gap, the worse simmerale. How significant is the correlation between companies that spend billions on share buy backs and the reduction of things like R and D and plant investment, etcetera. Well, it's it's

a one to one correlation. The more you spend, the more you spend on share buy backs, the less you have to put into R and D or put into RhE finite pie and and you've got you got so much money. And the more they're using fift of their net income is used to buy back chairs. The share

buy backs are twice what they pay on dividends. The data point I thought you were going to go to from the book was that when you look at a company like Dell, I don't mean the E M C version of Dell today, but Dell, the direct built to order PC maker, over the course of that company's history, they spent more on stock buybacks than they ever made in profits the entire company's history, which, if you think

about it should be impossible. It should be impossible, and somebody should have woken up and sure, did that stalk very well? It eventually had some real difficulties to it, and it wasn't necessarily apple. But let's let's bring this back um to income inequality. There's a data point I have to reference again. Since c. Ninety eight CEO pay Rose tan X, the median salary in America rose from forty eight thousand to fifty three thousand over the same

time period. This is obviously inflation adjusted. That's a less than half a percent a year. What is this due to uh an economy? Well, it is very bad. This level, the level of inequality we income inequality we have in this country is very bad for economic growth. Why is that? Well, to start with, have any percent of our g d P is consumer spending? When the consumers don't get much money, it's hard to spend it. It's the thing I have

to pay my workers exactly. And now the money when the money goes to the one tenth of one percent, as it has, let me stop here and say that about since nineteen of all the gains and growth of the economy have gone to the one tenth of one percent. Now that's a hundred and twenty four thousand households. So the reason the average American hasn't gotten a raise. All the money has gone to a very small percentage of people. They don't spend that. I mean, how many yachts can

you buy? You know, after you have your fourth, you're not going to buy your pretty much done right, the power boat, a sailboat. Number one, you don't get the consumer spending Number two. Inequality imposes uh, a lot of hidden costs us healthcare as you're in come goes down to your ability to pay for your healthcare goes down. Uh. It imposed. It makes the country less healthy overall. Is that what you're implying it does? Incarceration rises, crime rises.

We've seen crime falling over the same period when CEO, although we's even as crime is fallen, we've seen incarceration continue to rise. I could go to a study, but the company it's I think it's too complex to explain the study that says, well, crime would have fallen a lot more if there has been less in equal that makes sense. Let's talk a little bit about the impact of corporate board members and what they have done to pretty much rubber stamp this again. Another data point from

the book that that I find is so fantastic. Board members at the company qual Calm quote from two thousand and nine through two thousand and fourteen authorized the repurchase of two hundred and thirty eight million shares at the cost of thirteen point six billion dollars, and at the same time, total shares outstanding increased two How on earth

can that happen? Well, they were printing new shares to give to their executives, but two hundred and thirty six million shares was not enough to reduce the share count. The facts speak for themselves. That's astonishing. So another words, based on these prices, they gave away fourteen billion dollars and options to their That that is what the mathematics would say. So what is a board member who has a fiduciary obligation to a company? How do they process

that information? What leads them to say yes, I think that's a good idea. What leads them to say that? As they say, first do they get stock of Well, they get stock depends on the company, but they tend to get stock. They get a fee overall and get a gig like that. That sounds like it's a great gig overall at good companies. That science of QualComp you'll be getting three or four thousand dollars a year in stock and cash for attending six meetings. Very nice side gig.

And the way you justify it as you say, well, I'm not on the compensation committee, but these are my fellow members, and they've studied it and they have the good consultants, and so whatever the compensation committee proposes almost gets rubber stamped because you don't want to question your board members. And by the way, if you bring up a lot of questions about CEO pay and the other board members, uh, you're not gonna be asked on too many other boards. And as we've said, they're they're a

nice gig. Uh. And then you can justify it by saying, well, look, it's what the real problem is. What all these other companies are doing. They're paying their CEO so much that we have to follow. We've got no option. We're forced to follow them. It's not our fault because if we don't, they're just gonna hold their breath till they turn blue and not come to work. Well, the the what they say is, oh, if we don't pay them, they'll go someplace else, which is nonsense. They won't go someplace else.

They got no place to go that that that's astonishing. So I'm curious what sort of pushback have you gotten on the book from your fellow board members or or executives. I have gotten zero from uh from them, because why would they want to make noise about this? Uh? They have no effective They just do it. They just ignore it, go away. Here's a quote that I love. This is this is terrific. A good corporate board is like a

club where you work on interesting problems with intelligent, congenial companions. Travel, good restaurants, amenities are all provided free of charge. Best of all, instead of paying club dues, the club pays you. So that sounds like a sweet gig. It is a sweet gig. When I was when I was coming close to retirement, I've decided that there was a very good gig and lined up a lot of board spots. And it's been I've I've enjoyed it. It's been wonderful. I've

been well paid. Uh I, And yet you're biting the hand that feeds you. I believe that corporate boards have been incredibly irresponsible when it comes to CEO pay. I tried to be as I learned something about this. I tried to be more responsible. Some boards didn't like that. A couple of boards I was able to convince to move to a different system of pay. Other boards just

ignored it. So here's an interesting quote. In theory, shareholders elect board members to represent them, but in actual practice, corporate boards are self prepared, actuated well. Corporate boards nominate who is going to be on the board uh absent a proxy fight or sometimes some egregious UH corporate behavior, the dominations go out and nobody opposes him. Nobody says, oh,

I'm going to run for that board seat. And so every nominee, I would say the re election of boards is roughly the same as the re election of the North Korean polit bureau. That if you're nominated, you're gonna be Let's put some flesh on those bones. In two thousand and twelve, seventeen thousand and one corporate directors were nominated for board positions. Of that over seventeen thousand nominees, only sixty one. We're not approved, less than one half

of one percent. As I say, we arrived, we arrival North Korea. That that that is just astonishing. So let's talk about independent directors on compensation committees. Wasn't that supposed to be, Hey, we're gonna use outside board members, we're gonna use independent experts, and therefore they don't feel um obligated to to grease the CEO. There's some objectivity. Why hasn't that worked out? Well, it hasn't worked out because really, what has changed. It's not that the it's not that

they're people are not independent. Doesn't mean that the fundamental dynamic of the CEO being your friend. The CEO may have asked you on the board, but you're still independent. The fact that you have these in built in pay machine systems that guarantee that the CEO that's the status quo, that's the status quo. And so you're an independent director. You come on and this is what you do. This is how it pays hand gold in. The CEO gets

a fift increase every year. Why would you, as an independent director start to make all sorts of ruckus about this? Nobody else is Let's talk about the Old Boys Club, the Old Boys Network. The average age of board members is sixty three, and women accounted for less than twenty percent of total directors. Minorities and the reappointment rate was why is it so problematic to get a more diverse board? And and the question that also comes up from this, why do we have so few women as not only

board members but CEOs? Well, actually you have a more as board members than you have as CEOs. If you're looking at Fortune five hundred, less than five percent of CEOs are women. And uh, I think if you're looking for the number one characteristic of a CEO, you look like one tall, good hair, are all good hair, and good voice, good presence. Uh they're all They're all cast in Hollywood exactly. And so competency doesn't really seem to

make that much. You know, if if you look at it, you'll find it looking like what is probably more important than competence. That's incredible, it is incredible. But but they are taller, they are in average, there are a few inches taller, three inches taller. They're in better shape, they work out their trim. Uh I gotta get busy, and uh am I too old for human growth hormone? Of this? I you know, I don't know. I haven't kept up my So let's talk about who the shareholders are these

days and their impact. Mutual funds essentially owned the vast majority of equity stock. Why aren't mutual funds saying hey, you guys, are are you know given away the store? And we have a fiduciary obligation to our investors to make sure you don't. Well, of course, it's it's not just mutual funds, if you know, as you know today, Uh, index funds are you know, they're half the market now, it's still a smaller percentage than active funds, but it's

growing rapidly. And Bill McNabb is, the CEO of Van Garden, said they were setting up um committees to essentially reach out and be proactive with corporate management on some of the more egregious practice. Well, I think I think Vanguard has always been one of the leading companies and one of the most responsible companies in that field. But you have huge investors, you know, the hedge funds almost always just vote straight management. Big big investors t I a craft,

people like that. They almost always back management. Uh, it's very rare for these, for hedge funds or big institutional investors to vote against management. The rule had always been if you don't like what's going on, sell your stock. Don't try and make sense. Well, what about the opposite. Let's talk about activist investors who basically go to a company and say, you guys are doing it wrong. You manage team is terrible. You've got to make some changes.

What is the impact of activist investors on compensation. I haven't seen it. I haven't seen compensation be the major issue of activist investors because, as we say, let's say you're wasting you know, you paid your CEO a hundred million dollars and you should have paid him ten million dollars. Well, frankly, ninety million dollars is not enough to raise up an

activist investor campaign. I mean, you've not going to move the needle on a earnings pre share basis, right, So you've got to you've got to say that it's it's generally that the stock is terribly undervalued, and you can think, well, if I split off this division or split off this I can get a huge pop on the stock. That's when you go in and try and do it. We have been speaking with Stephen Clifford, author of the CEO

pay Machine. If you enjoy this conversation, be sure and stick around for a podcast extras where we keep the tape rolling and continue discussing all things executive compensation. Be sure and check out my daily column on Bloomberg View dot com. You can follow me on Twitter at rid Halts. We love your comments, suggestions and feedback right to us at m IB podcast at Bloomberg dot net. I'm Barry rid Holts. You're listening to Masters in Business on Bloomberg Radio.

Welcome to the podcast, Stephen. Thank you so much for doing this. I find this topic to be fascinating. I've I've read about and written about this over the years because it just seems to be so abusive and so unfair to shareholders, and yet there's so much built in inertia. The new compensation machine is very difficult to thwart it. It's become part of the firmament, and I assume it's

going to continue for a while. In the book, you talk about a trinity Michael Jensen, Bill Clinton, and Milton Rock who who together or separately, helped create the climate that we have. So first, who is Michael Jensen? What did he do? Michael Jensen is a professor of He was long time at the Harvard Business School. UH. He was kind of the founder of the theory of founder and UH evangelist of the theory of shareholder value that

the only thing that matters is the stock. He was a student of Milton Friedman when he went he went to Chicago during the Freedman esque. Uh, you know, the market is always right. And then Milton Rock, Milton Rock was the first pay, first big pay consultant. And unlike the rest of the pay consultants, who I say are are essentially corrupt hours Uh he not. Milton Rock wasn't that way. I mean, Milton Rock was was I think

very serious. What Milton Rock never considered was how the system would work once everybody used to pay consultant, and so how the how this spiral would inevitably start once they were all using the same sense. He saw it long before it began. I mean he retired early. Yeah, he retired early eighties, and and I've got he he happened to be a pay consultant. He didn't consider, Gee, what if the whole world use these pay consultants, well, that we everybody would get a raise every year. We're

all in the exactly. And then Bill Clinton. Bill Clinton campaigned, uh in he saw this as a political issue, and he said, I'm going to tax everything over a million dollars. He got elected in terms of actual dollar I'm sorry not tax Excuse me, i am not going to allow tax deductions for all over a million dollars. Well, he yeah, cash, stock anything. So he got in, he got in office, and then he was lobbied by the business groups that said, well, this is this is critical for American industry to pay

for performance. And so they revised it and said, uh, if it relates to performance, then it's tax deductible. So and therefore stock options, the stock options by the by themselves were an unlimited amounts. We're uh any you know, so anything that related to what you can make anything and say it relates to performance. Ironically, this this is the thing that truly opened the floodgates to CEO pay

going crazy. This was part of the bill Clint, the budget reconciliation bill that had the big new taxes coming in. It passed without a single Republican vote. Really, that's amazing. And then which is which is really surprising when you see what it ended up doing for the money class and the executives. There was a wonderful NPR Planet Money podcast on this exact topic, and it really fleshes it out. So let's talk a little bit about the inertia and

how entrenched the CEO compensation machine has become. Are there any hopes that that we can get out from under the scheme or is this going to be with us for the foreseeable future? Boards? Uh and rectors will not reform this system. Uh by themselves. You have this new say on pay, which I don't believe will make much difference. Now, say on pay under Dodd frank Up, every at least every three years, a corporation must have it offer its shareholders the ability to have a non binding vote on

whether they approve or disapprove of the pay system. What's happened is that two or three or four the most egregious pay systems and the most egregiously overpaid ceo s, there's a campaign on say on pay, and often it's effective and it will affect that uh, those three or

four CEOs. The problem is they're all egregious, and so just focusing on anyone just doesn't get it done right, right, I mean, you've got you've got every one of these, Uh CEO is ridiculously overpaid and the whole system is causing so much harm to the to the country that UH hoping that say on pay is going to make any difference is uh, you know, it's like swatting swatting a few flies. So so we can't talk about executive compensation without bringing up Yahoo and Marissa Meyer. She she

joined the company. It seems like less than ten years ago. UH, revenue has gone down, profits have gone down, market share has gone down. The thing of value at Yahoo is their steak in Ali Baba, which Merissa Meyer had nothing to do with. And she's been compensated to the tune of just about a quarter billion dollars. How on earth does something like that make any sense? Uh? This is most of CEO pay turns out to be paid for luck,

not pay for performance. All. All of the studies have shown that, UH, CEO compensation and performance, no matter how you define it, is at best weekly weekly, correlated and a worse negatively carlate, which means the more you pay the CEO, the worse you perform. Now, Marissa Mayer was an example of this. She was there five years. By every measure her, the performance of the company was poor. Now maybe that's all her fault. I don't think it's all her fault because I think that the CEO is

is not responsible for everything that happens. You know, the CEO has limited abilities to move a big ship. So Marissa didn't do a great job. Does she get singled out because she's a woman, and then making her the post a girl of over compensated? Well, I could give you executives who have been equally overcompensated. Who were men. Let's let's name a few. Well, i'll just take your name. You certainly name names in the book, Well, you know

the book. What I did was I took the four highest page CEOs, the people named the highest paige CEO from two thousand and eleven to two thousand and fourteen. I didn't select them because I thought that they were examples of overpaide CEOs. I just took the highest I just took the highest page. So let's say you wanted to look at baseball players, and I took the baseball player had the highest batting affage for the last four years.

Uh Now, when I got into that, it turned out that the first of all, if I took the base four baseball players with the highest batting AVU, you would have heard of them and there's only so many people can hit a hundred mile basketball or or a hanging curve ball. It sounds like lots of people can do with these various executives. It would appear to me that executive baseball players, let's say, seldom go from superstars two bums in a single season. This happens all the time

with CEOs. I mean, we've seen we've seen CEOs crash and burn. You know, they're brilliant, they're they're the new poster child for for CEO, for top CEOs. Next year, they're out of a job. Most of Look, I was a CEO for fourteen years. When I was in the right place at the right time, I was a genius.

When I was in the wrong place at the wrong time, I was a more Most of success is being in the right place at the right time, or something called fit, meaning that your skills, the particular skills you have, fit for what that company needs at that time. So let me take an icon of American business, Henry Ford. Henry Ford was a superb fit for the automobile industry when

mass production and manufacturing efficiency were what was critical. When it became a question of customers styling Henry Foker is terrible fit any color as long as it's black, exactly. So you know when you're when you're fit, when you have the right fit for the right time in the company. You look pretty good when your skills are So I'm I'm a serendipity and luck really pay a big, big role. The race is not to the swift. So let's let's talk a little bit about consultants. I referenced them in

my book. You spend a lot of time talking about consultants. And I have to begin with a quote, as I so often like to do, from Charlie Monger. I would rather throw a viper down my shirt fronts than hire a compensation consultant. So Charlie is not a big fan of them. Why do you think that is? Well, because compensation consultants are part of the ore. Are a parasitic profession. Uh,

you'll have to put a little detail to that. Uh. Compensation consultants come in and say we're going to give you all sorts of studies in an objective way to pay your CEO. And uh, they're very anctious and and you'll pretend to be very serious and basically, what the what the CEO knows they're going to do is juice is pay. That's that's all. That's all these compensations. You don't even have to wink and nod. You just look

at the record. And this is a big business. I was stunned to learn from your book management consulting industry. I would have guessed it was a couple of billion dollars. It's a two billion dollar industry. Oh yeah, now I'm not. I'm I don't paint all management cons aultants with the same brush. I find compensation consultants. Uh how big of that? Too much billion? To all pie are the compensations. I could not find a number on that. There's nothing, there's

nothing public. Uh I would you know all of all of these companies have, all big companies have compensation consultants, and you know they're paid a million to ten million dollars at these places. Um, and really the only thing, the only thing they do is give you a big report and a lot of slides and a big power point and goose the CEO s pay. It's that simple. So here's an idea for any billionaire who wants to

pursue it. You know, we've seen the way the thing tanks managed to push ideas out into the world, even though they may not be great ideas such as a shareholder value. Someone needs to for him in executive compensation think tank. They need to dog all of these consultant companies and essentially debunk every time they put out a slide deck to study something, and eventually, by doing that, someone will find a way to um put into the ether,

put into the media and the conversation. Hey, these guys are wildly overpaid and for everything they say, you have to come up with the opposite, and I nominate you to do that. Well, and the book is a good start. I I don't I don't think that would work. Why not? Look does media pressure impacted comprit Directors would have to be brain dead not to know that their CEOs are wildly overpaid. I mean, how can you realistically go to you know, attend a meeting and say, oh, yeah, okay,

so we're paying Joe this. So Joe has made forty million dollars this year. Well that's all right, because you know his peers are all paid. Let me give you an example. Suppose in nineteen eighty we had insurance consultants and they came to the boards and they said, hey, we got a great new way to do insurance. See, we're gonna have a peer group. We're gonna see what

all your peers are paying for insurance. Okay, and then we're gonna have you pay at seventy at the seventy because you're well, no, no, this is a great idea that that you're a good company, you'll pay there. And by the way, because you need premium insurance your top court, top quart tile. And by the way, then um, we'll set for the for the insurance company. We're gonna set performance goals and if they hit those goals, will will double our our premiums cost. So so you accept that,

you say, the company accepts that. It's now two thousand seventeen, you're on the board and you say, hey, I've been looking at our insurance. You know the cost, the real inflation inged cost has gone up a thousand percent, ten times uh and with how many our coverage is worse? Why? Why did? Why are we listening to these consultants? That's the position there in with CEOs, But they won't ask

that question. So what has to be done to pressure board members, either through the media or what have you to my view, and this is this will be uh is that you need a blunt instrument, need a very blunt instrument to to wake these guys up. A law or I mean the Dodd Frank rule that requires the say on pay and the publication of this that hasn't seemed to thwart it. What what my because nothing else has worked. I'm saying you need a very blunt instrument.

And what I'm saying is you need a luxury tax. I'm taking a page from Major League Baseball, a luxury you know, the Major League Baseball says, look, if your payroll gets over x, you gotta pay at tax. So I'm gonna say, if you pay your ceo everything over six million dollars to any executive, you gotta pay a tax to the federal government dollar for dollar. And by the way, I'm going to include everything. What you know, these number jets, the club got the biggest, the biggest thing.

You know, when a CEO cashes in his stock options that's not reported as pay. Yeah. That so let's talk about fasby a little bit. There was an ongoing debate, primarily driven by Silicon Valley, which was do stock options counts as compensation, and one would think they should count as compensation, but they don't, well what they They finally forced them to say, yes, it's compensation. So this is the way. Then the accountants and the companies got around that.

They said, well, when when we barry, we're gonna give you a million options at twenty. Stock is currently twenty now, so those million options will run it through a black Shoals model or something like that, and we'll say, okay, each option is worth is worth a dollar today. So we say you've got compensation of a million dollars. You got a million options. Now seven years later, the stock is at fifty. Not because you've done a good job,

just because the market really well. Right, So you now cast in your million options for a gain of thirty dollars in option, you pocket thirty million dollars. That's not considered compensation. That is when when you read these ratio is three company have to go out when you exercise the option and replace that stock. It either has to replace that stock or print more stocks, or it's it's

either dilutive or expensive. The shareholder loses. Uh. But according to the company, this uh, this money came from the tooth fairy. He just came in in the middle of the night put thirty million dollars under your pillow, and uh, very nice of them. And you know you left out the other half of that story, or the other possibility of that story, which is the stock doesn't go to fifty. The stock goes to ten, at which point the board

reprices the stock options down to ten. There are no I don't even know if there's taxed, because you paid tax at twenty and clearly that calculation was wrong because it's not worth twenty, it's worth ten. And so you might even have a little fun with your tax amendment,

do you amending your previous return. And then if subsequently that stock runs up, the companies in the same situation, it goes back to twenty and all of a sudden, you're mate, you're making money because because it's been repriced, because we had to give you the incentive. Now, this is this is one of the worst parts of it, the idea that these huge uh option packages at various other pay packages are necessary to motivate you. Now, CEOs

are highly motivated to start with. You don't get you don't get to be a CEO if you know if you show up at eleven o'clock every morning. UM, A pay system is should only channel the motivation properly. Now, financial incentives at the CEO level, UH tend to have because they're so powerful, tend to narrow your focus completely. You're a ceo. You can make thirty million dollars this year if you increase earnings per share by x per cent. Let's say your whole bonus is based on You're gonna

make that. You're gonna make that. You're going to make that. I mean, look, as you know, I could always make earning experience. I jump up and dance the mac arena with a you know, a few accounting changes. But but you're gonna make that. I don't care what you have to do. You're gonna make that. You are going to neglect everything else. You're gonna focus totally, totally on the Suppose I suppose I said, Barry, your performance measure next year is, UM, how many headlines your your radio story

makes in the New York Post. Okay, you're gonna get thirty million dollars. If you make You're gonna be interview anybody. You'll make a headline. You don't care what right I mean, thirty million dollars is a powerful, powerful motivator there, right, you can ruin your show, but it's thirty million dollars and executives do the same thing. It's so powerful that that.

And by the way, this has been shown in study after study and an experiment after experiment that for all, for all, um all, except repetitive, repetitive tasks or really distasteful tasks like you know, knocking on doors and selling magazines. Financial incentives tend to harm performance your your You perform best, and I'm sure you perform best when you are motivated by your conception of what a job well done is just pride and workmanship. I know that's old school, but

I think it's important. It's it's, it's, it's it's not old school, in fact, is what how humans perform um And so you're saying stock options are motivating CEOs towards one thing, which is stock price. Yes, yeah, it's it's, it's and that's why. That's why. And you combine that with the theoretical justification of shareholder value, and this is one of the I think the is one of the worst things that's happened to American industry. So there are two issues that raises and and a shorter one and

along the one. Let's start with the shorter one first. I've read numerous times people said, well, when you give stock options to executives, their interests or aligne with shareholders. But that doesn't make sense. They haven't taken any risk, they haven't put up any money, they're not thinking long term. To them, all they need to do is have um the stock price go up, whether they're responsible or not. How on earth does that align them with the interests?

It is amazing. I look at these company proxies and you know, they have forty pages on executive compensation and the word alignment is used at least twenty or thirty times in each proxy. And you're absolutely right, there's no alignment at all. I mean heads heads I win, tails I break even with an option unless there's a repricement in which even tails went right, which even tails I win.

So let's talk about the bigger issue, which is what I think the compensation that is attributed to stock options get so wrong. When you are giving a huge pile of stock options to an executive, you're essentially compensating them not for how well their company does relative to their peers, not for how well they do, but you're compensating them based on how well the stock market does. Absolutely, as as as you know, sevent of a company stock movement has to do with the general stock market or the

industry and the sector. Right, the two of those are at least not more. The company itself is responsible for about a third if that much, if that much, and so hey, if you're in the right industry, in the right market, you're going to get big stock option gains, even if you perform much below your peer group. This is another thing that that stuns me. We say we're gonna they always say, okay, we're gonna pay according to

a peer group. And then they say, but you're you're going to be paid at the seventy five percentile because we're a good company. They never ever test that you have to perform at the seventy five percent dial or you have to beat your peers at anything. That's shocking. There is never, there is never that test in everyone I've ever looked at once. Once you set your base at seventy peer group, you are not held for any performance.

You're that you may have a uh your compensation may be linked to your stock price, it may be linked to earnings per share, but nothing about beating these peers, right the old line as I'm astonished but not surprised. So so here you raised the question that that uh I was thinking of, which is how did this company

do relative to revenue? For is their peers relative to market share, relative to patents filed, relative to product introduction, relative to market penetration, relative to geographic expansion relative You could come up very easily with a dozen or hundred different metrics that you could use a loan or in combination with each other that would fairly say, hey, how has this company done relative to other companies in the space, relative to other companies of the same size, relative to

any reasonable pier and those gains are the basis for our bonuses and compensation. You could although that would that would be that would be highly complicated. I I prefer much simpler system, which would be my simple. My My system is you get a salary pretty good salt, you know. Do you get a salary two three two million bucks and you get restricted stock? How can I live on two million dollars? Well, you know, maybe you know what the dudes are at the golf club. It's and I

don't even play golf, but still it's very expensive. To let me tell you, I've I've lived very well. I've lived very well, and I belonged to a very nice golf club. Uh and I've never made two million dollars a year. That's a that's a book title scraping. So uh, I say restricted stock, and then there's one restricted stuff, not an option, but restricted stock. How long do they

have to hold that stuff? To hold that stock until about five years after they've retired, after they've not even after they've left the company, after after they've left after I'm sorry, after they've left the company. So in other words, you're making them think long term plus five and there's only one performance requirement. M hmm, long term plus five. That stock has to perform better than the SMP five really lose half of it. So in other words, half

the SMP five hundred is gonna underperform. One would think, I mean the distribution. So I'm just saying, look, you get you get a lot of stock in the company, so you're you're a shareholder that and your your interests truly are aligned. Your interest truly are aligned and you're a long term shareholder because you can't even get out the day you quit the company. Uh. And there there's a complicated way of how you can reduce this over

time and um. And your test is that during that period you have to form better than the other guys are half your restricted share is goot forfeited And you mentioned blunt instruments. The way to make this work, one would imagine, would be to create a tax incentive if you use this plan, and a higher tax if you don't. That's right, right, that would I didn't I didn't have that in my book. But I think that's an excellent idea. Well, the the only way to get anybody to adopt something

is to give them incentive or disincentives. And the current plan. Should you combine your you were three quarters away there your luxury tax with you don't pay the luxury tax. If you do it this way, you had both completely We we should have I should have had this interview before I read this. Well, can these are your ideas? I'm just add the luxury tax with this. I think it's an excellent idea. It's it's a way to make sense.

The second edition will have it in there. You go, you can you can you can edit that UM before we go to our our standard questions, our favorite questions I had UM. I had one last question I had to ask you, which I thought was hilarious. A board member once asked you, how do you measure the first year's progress on a three year turnaround? So, in other words, people have bonuses and incent of every year on what was supposed to be a three year turnaround. How can

you legitimately measure where you are? One of the problems is with the bonus system. You get an annual bonus as if everything important falls nice calendar within a calendar year. And the analogy that I used to show you how absurd an annual bonus system is. The analogy as he used in the book, is think of setting a bonus system for generals in wartime because we need to motivate them. We need not self motive. They're not self motivate, and we need to you know, they'll perform better if we

give them a bonus. Well, that's the same that you have. I mean, it's so absurd, but although invade easy targets, they won't fight exactly exactly. It's pretty crazy. I mean, if if the Soviet Union, I'm Soviet univer that shows out my age. If if Russia wanted to truly debilitate the army, the military, and the United States, it would introduce an annual bonus system. That's amazing. So so let's talk a little bit about some of our standard questions.

And these are the things I asked all of my guests. Um, tell us a little bit about your background that people don't know about you. Uh, well people don't. I doubt your listeners know anything about me, so they will after this, okay. Um. The first the job I had the most fun at was when I was Deputy Controller of the City of New York during the financial crisis. That was pretty interesting, was fascinating. I mean the cast of characters I was working with, uh and the issues I was working when

I was a kid. I was thirty four years old, so that that was that was a lot of fun. My father in law used to own the New York City General Obligation bonds and when I think they had a coal function in two thousand something like that, and I remember he came came to me and said, all right, I have these bonds that are called in New York City geos. He was buying them for years in the seventies. They've been playing twelve four? What can you get me

to replace him? And I said, I could get you some treasuries at four and a half five percent if you want muni bonds, they're just a tiny bit riskier, but it's tax free and they'll pay about four percent. And he's like, what the hell am I going to do with that? Were you there during the that was quite quite a period of time. My father in law, who is no longer with us, correctly surmised New York City UH is still gonna be around. So that was

a yes to say the least. Tell tell us about some of your early mentors who affected um the way you approach being a CEO or a board member. You know. I would say that two early mentors I had were

when I was in government UH in New York. One was a fellow named Bob will Ers, who is now longtime CEO of M ANDT Bank and the most As a matter of fact, his bank, which I think is about the twentieth biggest bank in the country, has the very fast growing recently has been the most successful bank stock among all banks that's grown at about twenty a year from forever. And then, uh, I just had lunch

with him. And I just had lunch with another one of my former mentors, Jay Golden, who was the controller of the Brilliant Brilliant Guy New York City or New York State, New York City. I definitely recognized the name who affected your thoughts on executive pay. Again, you're not a typical CEO slash board member. What steered you? Who steered you in the direction you move? You know, I'd have nobody steered me. I just kept, as you know, I was doing this at a company level to try

and to say, look doesn't make any sense. I mean, the incentives are all wrong in their perverse and they're going the wrong way. And then as I got into it and into it, I said, this is an outrage. And you know, I like to write, and so I started to write about it. But no, no, but no, I steered myself. That's that's interesting. Um. This is uh a listener question that that we've adopted every week, and it's it's actually one of the most popular questions we get.

Tell us about some of your favorite books, fiction, nonfiction, compensation related or not. Okay, In the last three years, I would say my two favorite books were Daniel Kahneman's Thinking Fast and Thinking Slowly and I'll tell you a story about that. Uh and um, Why Nations Fail? That's a that was a big book that came out a year or two ago. Two M. I T. Professor hard one Harvard won M I T. I guess what was the author name of that? It's I know that. I'm

gonna pull that up right now. Hold on a second. Let me tell you a fascinating story about Daniel Cokay, I read. I read his book, Thinking Fast and Thinking So I love the book. But I thought he had one Darren Asmo Glue, who was a recent UM guest on the show will be broadcast later uh this month. Well, he's a brilliant, absolutely brilliant thing. Well by the time this broadcast, it will have been last week or so. Okay, So Daniel Koneman, Nobel Prize winner, wrote this brilliant book.

I thought he had one thing wrong. I thought he had made I thought he I had a better explanation for one of his examples than he did. So I don't need to go into it. I sit down and I this is at ten o'clock Seattle time. Ten am. It's one o'clock Princeton time. Where he is. I write him up an email. I said, dear Mr, I mean I enjoyed your doctor. I enjoyed your book. Uh, but I think you got one thing wrong. Ten minutes later, one ten Princeton time, I get back an email saying,

thanks for the kind comments about your book. Uh, your explanation, uh would would seem to be pretty good. However, we checked before we did this, and here's why our explanation is right and yours is wrong. And I said, here's a No Bill Prize winner one ten answering an email from somebody he's never heard. I just found out astonishing. He's a fascinating guy. When I'll tell we don't have time for it, but I'll tell you a funny story about him, which I actually relate in that podcast. But

he's really a fascinating guy. Um. So that's one book. Uh why why Nations Fail? It was to me, come pleat eye opener. Uh, fascinating. I never thought I love a book that all of a sudden makes you think the way I've been thinking all my life is wrong on this particular serspective changer. Yes, yes, I mean just what they call it paradigm. So what else? What else is give me one more book? Well, unless you have more, uh, I would have to you know, the most influential books

that I've ever read. I would say that Richard Dawkins a selfish gene, probably influenced my thought more than any other book I've run across. That's that's fascinating. Um, So what do you see as the next shifts in the world of executive compensation? Is this going to continue on this trajectory with no ability to change it? Or are we going to start to see some changes? Uh? I don't think we'll see any changes until it becomes a

political issue. I now, isn't isn't it a bit of a politicalitial already with with the incoming equality and or is that still a minor factor. I don't see it as a politic I don't think boards are scared. Boards are going to have to get scared and say to themselves, you know, if we don't reform ourselves, somebody else is going to. That's when it will start. They're not in that position now, nobody. You don't see anybody threatening legislation.

It's got I think it's got to get to the point that where they say, you know, if we better do something. That Bernie Sanders won the election, they might have been a little more nervous, exactly exactly. And if you get you know, if in the next Democratic primary you get another Sanders type candidate who who's not quite to the you know, a little to the right of Bernie, but starts saying, if elected, I'm going to do something about this, then populous. Yeah, then I think boards might.

But not until then that that's quite that's quite fascinating. So tell us about a time you fail, old and what you learned from the experience. We could be here a long time if I was just going to tell you about all the times I failed. And I looked at that question and I thought, I'm not sure I learned anything. Uh. Here, I failed because I was too bold, and then I failed because I was too timid at

different times. So less I've failed when I when I didn't consult enough people, and I failed when I consulted a lot of people. So I've had as a CEO, you're going to fail a lot. So it's the luck and the fit issue more than anything, I think. I think the one thing I've learned be in the right place at the right time always helpful. UM, tell us what you do to keep mentally and or physically fit? What do you do to relax outside the I get

tremendous amounts of exercise. Uh, And I find as I at your age, I'm seventy four and look well, thank you. I'm I'm thirty six, and I looked terrible as you as you age. Uh, physical exercise is the absolute key. It sends messages somehow to your body that hey, you gotta stay alive, you gotta stay alert. So I do a lot of exercising, uh, jim or anything in particular. Well I do I know? Well, I work out. I do about forty minutes on the elliptical every morning as

I read the newspaper. Then I do about a forty minutes strength uh, stretching, strengthening, And then I played nine holes of golf most days. Really yeah, but I played. No, I'm not that I've actually I'm at at age seventy four and playing the best golf of my life. But what I do is the courses I live in in the city of Seattle, but I belonged to a course. It's about five minutes from my house. I play either by myself or in a twosome and we do it in an hour using a car. To you walking, I'm walking,

And who's carrying your bag? I'm pulling it. Really that's pretty good. Um, alright, our last two questions, these are our favorite questions. I know we have to get you out of here in a few minutes. So what sort of advice would you give to a millennial or someone who's just starting their career as it relates to compensation. Uh, well, I'd have to repeat, avoid the wrong place at the wrong time, be in the right place at the right time,

always good advice. And and our final question, what is it that you know about executive compensation and stock options and boards today that you wish you knew twenty or thirty years ago. You know, if I had known all of this twenty or thirty years ago and seeing it at the start, I might have been able to do something to uh, to arrest it at that time before it got amazingly out of control. I mean, it's so blatantly insane. I I say, it's this is it's kind

of like doctors who used to bleed people. Why did they? Why did why did they didn't know better? Well, no, because everybody bled people. I mean, this is what doctors did. So this is the way a lot of people think about. Well, this is what this is how we do compensation, this is this is how a board is supposed to work. Thank you so much for being so generous with your time. Well, thank you for having me. This has been I've really

enjoyed the talk. Here. We have been speaking with Stephen Clifford. He is the author of the CEO pay Machine. If you enjoyed this conversation, be shure and check out all of our other such talks. You can see the nearly hundred and fifty or so over the past three years at Apple, iTunes, Overcast, Bloomberg dot com and SoundCloud. I would be remiss if I did not thank my head of research, Michael bat Nick, and my recording engineer, Medina Parwana.

Taylor Riggs is our producer slash Booker. We love your comments, feedback and suggestions right to us at m IB podcast at Bloomberg dot net. I'm Barry Hults. You're listening to Masters in Business on Bloomberg Radio,