The Winner-Steal-All Society
And the persistence of the
by Jerry Useem
The American Prospect magazine,
October 21, 2002
How much is a CEO worth? These days the
munificent compensation packages lavished on America's chief executives
have about as many defenders as Slobodan Milosevic. The statistics
are simply too obscene: In 1999, the average chief executive earned
419 times more than his or her coworkers, up from 25 times in
1981, while the 10 highest-paid executives have seen their income
soar an astonishing 4,300 percent between 1981 and 2000. If factory
workers' pay had grown at the same clip, their average annual
earnings would now be $114,035 instead of $23,753. Yet throughout
the uproar over what Fortune magazine dubbed "The Great CEO
Pay Heist," one question has lingered unresolved: What's
driving it all?
During the l990s, a frequently proffered
answer was "market forces." As an influential 1995 book
told us, we had entered the age of "The Winner-Take-AII Society,"
in which a few exceptionally talented performers-athletes, entertainers,
business executives-could walk off with the lion's share of the
total rewards. In the view of authors Phillip Cook and Robert
Frank, a Michael Eisner-type (Eisner has raked in $1 billion at
Disney since 1984) was nothing so much as an A-Rod in pinstripes:
the beneficiary of an intensely competitive open market where
talent was bid up to the price it deserved. We could fume all
we wanted to about the inequality of it all, but then we might
as well curse Adam Smith himself.
This supply-and-demand view had the ring
of common sense and the backing of a vocal tribe of academics
(including Sherwin Rosen, author of the classic 1981 essay "The
Economics of Superstars," and Harvard Business School's Michael
Jensen and University of Southern California's Kevin Murphy, who
opined that "top executives are worth every nickel they get").
Yet it also ignored an inconvenient truth: that, in practice,
the market for CEO talent isn't really a market at all.
A new study by Harvard Business School
professor Rakesh Khurana, Searching for a Corporate Savior: The
Irrational Quest for Charismatic CEOs, pulls back the curtain
on how the system of CEO selection actually works-and just how
far it strays from the beau ideal of open competition. When companies
are looking to hire a new CEO from outside, Khurana found, they
seldom consider anyone who doesn't already hold the CEO job at
a high-profile company, personally know one of the directors on
the hiring company's board and look a lot like the directors themselves
(usually tall and WASPy). Qualified but lesser-known internal
candidates are routinely overlooked, largely because Wall Street
prefers celebrity types. And what of the executive search firms
that are supposedly hired to scour the country for candidates?
They serve more like masters of ceremonies, Khurana found, conferring
legitimacy on candidates that board members already had in their
In other words, the much-lamented shortage
of CEO talent-a mantra repeated so often in corporate circles
that it has achieved article-of-faith status-is mostly a social
construction of boards' own making. "The shortage of CEO
talent is a myth," says Jeffrey Sonnenfeld, a professor at
the Yale School of Management who studies CEOs. And no one benefits
more from the persistence of that myth than the top dogs themselves.
If the market for CEO talent is based
on artificial scarcity, it also suffers from a serious information
problem. For a winner-take-all society to work, you need a reliable
way of knowing who the winners are. In baseball that's easy: A
player cannot claim to have hit 60 home runs last season when,
in fact, he hit 16. In the movies, there's the incorruptible accountant
of box-office returns. In business, however, it's remarkably difficult
to assess how much an executive has contributed to an organization's
success- which, after all, depends on a host of external factors
and the input of hundreds if not thousands of employees. A number
of academic studies suggest that a company's performance depends
far more on what industry it's in, general economic conditions
and stock-market trends than on who occupies the executive suite.
Hence Warren Buffett's dictum that when a good manager enters
a bad industry, it's usually the industry's reputation that remains
Yet impressions are easily manipulated.
Take the case of Carly Fiorina, the former Lucent Technologies
executive who was recruited to run Hewlett-Packard in 1999. At
Lucent, she acquired a reputation as a superstar manager. But
commentators have since questioned whether her track record there
was as impressive as it seemed. Not only had she never had direct
profit-and-loss responsibility as a Lucent sales chief-thus making
her efficacy hard to judge-but Lucent's apparent high-flying success
turned out to be based on creative accounting, making it one of
the great business disaster stories of 2001. So where had Fiorina's
sterling reputation come from? According to an account in Vanity
Fair, it was her appearance on the cover of Fortune's "Most
Powerful Women in Business" issue that brought her to the
attention of Jeff Christian, the headhunter retained for the Hewlett-Packard
search. She had become well-known, that is, for being well-known.
(Whether her talents were worth every nickel of the $ 69.4 million
she earned in her first year is, well, another question.)
As for the oft-made comparison between
CEOs and star athletes, another difference is worth noting. When
a big league free agent sits down to negotiate a new multimillion
dollar contract, he's sitting across the table from someone who
wants to pay him less money. By contrast, when a company is courting
a CEO candidate, the candidate is often sitting across the table
from himself. As a precondition to accepting the job, Khurana
found, most candidates insist on taking both the chairman and
CEO titles as well as the right to stack the board with their
cronies, thus ensuring that their future salary negotiations will
be anything but adversarial. Boards usually bow obsequiously.
"The reality is that when you get enough along in the [negotiation]
process, you can ask for pretty much anything you want,"
one candidate told Khurana. "So you ask. And you get."
If all this sounds a bit like Napoleon
crowning himself, it is. Not that all companies have abandoned
the pretense of "market-driven" compensation entirely.
Many hire compensation consultants to benchmark their CEO's pay
against their industry peers. But these consultants' estimates
(often inflated by a highly selective reading of who constitutes
a CEO's "peer group") serve largely as political cover
for boards of directors. In his testimony to the U.S. Senate,
one Enron board member said he "did not worry" about
high levels of compensation at Enron because he checked with a
compensation consultant, Towers Perrin, which told him that Enron
was "right on target" compared to other firms-even though
this meant Enron executives received $750 million in cash bonuses
for a year in which the company's entire net income was s975 million.
It would be one thing if big-name CEOs
produced returns commensurate with their pay packages. Do they?
A company's stock often jumps on the announcement that a star
CEO has been hired, leading to the inevitable remarks that he
or she has already added so many billions of dollars to the company's
value. But most studies find that, with few exceptions (the most
notable being Lou Gerstner's resurrection of IBM), the onetime
pop gives way to long-term fizzle. Michael Armstrong may have
"added" $3.8 billion in value on the day of his hiring
at AT&T, but he has since subtracted s30 billion.
In the meantime, many of those CEOs have
transferred ungodly sums of money from shareholders to their own
pockets. It's a reminder that, when it comes to CEO pay, the grasping
hand usually trumps the invisible one. And it's cause for wondering:
When, exactly, did the winner-take-all society become the winner-steal-all
JERRY USEEM is a senior writer for Fortune.