Executive Pay solution in 45 minutes

The executive pay hubub that has been in the news of late has recently brought the administration to consider new regulations and government oversight. Certainly the market for executive pay has demonstrated excesses in the past decade, with some exceutives snaring packages that reward them ridiculous sums no matter how the company performs. In this 45-minute paper I will examine this as a market problem - that is, I propose that the executive pay problem is a market distortion, and I will seek to correct that not by rules and regulations, but rather by introducing structures into the market for executives.

So, how do these execs get these lavish pay packages, anyway? Well, there is a whole recruiting process, in which the BOARD enlists the help of a HEADHUNTER firm to locate candidates for the position. The headhunter will present a list of candidates to the board. The board can themselves nominate people to the list, which would include ASSOCIATES OF THE BOARD, or INTERNAL CANDIDATES. Then presumably the board, or a subcomittee of the board, considers the list. It is narrowed down. Interviews are conducted. The COMPENSATION COMMITTEE is consulted for "appropriate compensation rates." Eventually an offer is made, and the FINAL CANDIDATE accepts.

To recap, here is a list of players in this process

• the BOARD - makes all hiring decisions, including selection and compensation
• the HEADHUNTER firm - locates external candidates
• INTERNAL CANDIDATES - existing officers in the company
• ASSOCIATES OF THE BOARD - friends and aquaintences of the individuals on the board
• COMPENSATION COMMITTEE - recommends the compensation package based on "market rates"
• FINAL CANDIDATE - the exeuctive who is chosen and accepts the offer

Now, to look at things another way, lets consider which of these players is involved in the "supply" of executives, and which is involved in the "demand"

Player	Supply	Demand	Notes
BOARD	x	x
HEADHUNTER	x
INTERNAL CANDIDATES	x
BOARD ASSOCIATES	x
COMPENSATION COMITTEE		x

Looking at this chart, a few things are interesting. First of all, the ones who actually pay for the executives, the SHAREHOLDERS, are not in the picture. Also, the BOARD is involved both in the supply and the demand, as they determine the pool of candidates from their associates.

One thing that is not shown in the chart is that the membership of the board are usually composed of executives at other firms. Thus, these people have an incentive to increase the pay of the executive they are hiring because it influences the market price of executives, and thus the price thay are entitled to demand. The compensation committee is itself compensated by the board, and thus has an incentive to recommend higher prices.

So, it is apparent that there are some relationships in this market that have the effect of pushing prices up. What could we introduce into this situation that might have a beneficial effect. Here are some ideas.

1. Involve the shareholders - they are the ones who pay for this, and perhaps they should have a say in such an important and expensive company expense

2. Change the composition of the board - since they are executives themselves, they are incentivized to push up the price

3. Increase the supply of applicants - there are lots of people that have the skills to run a company, mor than the boards friends or other execs.

4. Involve folks from all pay levels in the company in the hiring process - this would introduce some level of sanity in the process.

Note: I wrote this in 45 minutes of spare time