CHAPTER SEVEN

The Road Ahead: The Design of Incentives to Unlock Real Value

It is difficult to get a man to understand something, when his salary depends on his not understanding it.
—SINCLAIR LEWIS

DONELLA MEADOWS wrote the book on systems thinking, literally. In Thinking in Systems: A Primer, she says that a system is “a set of things—people, cells, molecules, or whatever—interconnected in such a way that they produce their own pattern of behavior over time.”¹ She lays out the leverage points for systems change, from least important to most important. The key takeaway from her work is that the greatest leverage exists in the design of the system, the setting of intentions—influencing the mindset.*

In business, the ways we educate, orient, and reward executives are a signal of what matters most. Education and dialogue can be a pathway to unlocking intentions and behavior. To ensure that intention has room to grow—to give it gravitas, to enable it to gain influence and reach a tipping point—requires what is measured and rewarded to be aligned.

CEO pay is much discussed and analyzed in the United States because of stratospheric levels of compensation in a number of publicly traded companies and hedge funds. However, a more important reason to focus on pay is the role it plays in system design. What are we paying executives to do? When chief executives say they are committed to their “stakeholders,” do the financial rewards align with their goals?

The massive shift toward equity-based pay that began in the 1980s has produced runaway CEO pay and a premium for stockholders at the expense of employees and long-term investment. Placing the stock price at the center of compensation undermines the new rules and the call to CEOs to lead on issues of consequence for the benefit of both the business and society.

The CEO matters; how she thinks, or what he values, is a critically important starting point for change. We need to redesign pay to catch up with the intentions of executives to serve society.

But before we wade into the murky and complex domain of executive compensation, it may be useful to take a closer look at the CEO’s mindset. It’s not a logic model or business case that influences how a CEO thinks or convinces him or her to take a bold step; it’s often something that cuts deeper to the bone. We can’t engineer that kind of experience, although sophisticated NGOs are pretty good at it, but we can ensure that the signals they receive from boards and long-term investors reinforce the behaviors and decisions we hope for.

In the late summer of 2019, the CEO members of the Business Roundtable signed on to a statement that spoke powerfully to the complexity of managing their companies. The needs of a range of constituents were paramount; they rejected the idea that public companies must prioritize the shareholders. A chorus of voices responded—many enthusiastic, some cynical, others critical. The Council of Institutional Investors called out the statement for what it was, a chipping away at the primacy of shareholder interests.

The forces that led to the statement and give power to the new rules that are influencing decision-making are irreversible: the growing importance of intangible sources of value; radical transparency and the power of social media and employee voice; and the relative decline in importance of financial capital. The urgency of climate change and species decline, and abiding concern for inequality and injustice, are a rallying cry for co-creating generative processes and valuing workers and community.

These forces must prevail; will business respond before it is forced to do so through even more explosive social movements or the ballot box?

“The American dream is alive but fraying,” Jamie Dimon, CEO of JPMorgan Chase, said when he issued the statement in his role as chairman of the BRT. “These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.” Alex Gorsky, CEO of Johnson & Johnson, said the statement “better reflects the way corporations can and should operate.”

With all their power and influence and command of resources, what do these CEOs aim to do now? How will they employ their license to operate—and know if they are on track? Where do they get their cues?

We are in a race against time.

THE PROBLEM WITH FACTS

Among those who penned a response to the BRT’s call to action was Marc Benioff, CEO of Salesforce and an outspoken critic of shareholder primacy. In an opinion piece published in the New York Times, he counseled business leaders to look at the facts: “Research shows that companies that embrace a broader mission—and, importantly, integrate that purpose into their corporate culture—outperform their peers, grow faster, and deliver higher profits.”²

Benioff s intentions are good, but there’s a problem with his advice: facts rarely, if ever, influence the actions or priorities of a leader wired for a different reality. Data may help break through what one of our fellows called the “mud layer of middle management,” but it rarely resets the intentions of key decision makers.

In fact, after decades of experimentation, perhaps we should question whether ubiquitous metrics-based ratings and rankings of companies across industries are actually doing anything useful when it comes to changing behavior below the surface.

The architecture of systemic change is built through direct and meaningful experience, not metrics. Take, for example, the decision of CVS to stop selling cigarettes. It emerged from a fresh look at the fundamental purpose of the enterprise. Did their stores enable health and well-being, or not? Delta’s progressive profit-sharing plan was born of deep crisis and the prospect of total failure; in order to emerge from bankruptcy able to build a better future, the company needed to enlist everyone involved—and find a way to motivate pilots and everyone else who had to absorb significant pay cuts.

We can look to a meaningful number of customer service enterprises, including Panera Bread, Costco, Market Basket, QuikTrip, the Container Store, Starbucks, and Southwest, who have broken with convention to offer higher pay and benefits and who respect workers as the heart of the business plan. Data and examples reinforced the business model; they were not the impetus.

Chip and Dan Heath, in their best-selling book Switch: How to Change Things When Change Is Hard, describe this phenomenon as the difference between the actions of the elephant and its rider.⁺ The rider is operating from reason; he has the knowledge and the plan. The elephant is all instinct and emotion. It might be hungry, tired, or fearful. It stops along the way or may suddenly change direction or refuse to stop. Moving along the path of change requires both the rider’s plan and the momentum of the elephant. Getting started on the path, however, is more about the instincts of the elephant brain than the reasoning of the rider brain.

The wake-up call to the CEO comes with a swift kick in the rear from an aggressive campaign, or an encounter with an employee in the cafeteria or parking lot, or a provocative question at the all-hands or from his kid at the kitchen table. These personal experiences take executives to the heart of the matter; they enable change in how he or she perceives and calculates value—they have the power to change what one believes.

INFLUENCING THE MINDSET OF LEADERS

Lee Scott was CEO of Walmart in the 2000s. With roughly 1.5 million part-time and full-time workers in the United States, Walmart was then, and is today the largest private employer, running neck and neck with the federal government. The company has close to 5,000 stores across the country and more than 11,000 worldwide. Its supply chain is vast, its global footprint unmeasurable.

During Scott’s tenure, Walmart was buffeted by a campaign that coordinated pressure from labor unions and environmental NGOs. The well-supported operation was designed to draw the public’s attention to the social and environmental consequences of a business model that adheres to “Always Lowest Price.” It challenged whether the company was giving as much as it was getting from host communities, suppliers, and workers. It began years earlier, but within a short time of Lee Scott’s becoming the CEO in 2000, the ground campaign had enough success in some regions of North America and Europe to make it almost impossible for Walmart to plan for new distribution centers in service of new stores in Germany and in parts of Canada, New England, and California.

Then, in 2005, Hurricane Katrina hit the Gulf of Mexico and went on to wreak havoc on New Orleans and along the Gulf coastline. Lee Scott and Walmart kicked into action, responding to the emergency with the same operational efficiency that kept shelves stocked across the country.

Overnight, Walmart sent a score of tractor trailers loaded with blankets, water, food, and diapers to the epicenter of the storm, while local store managers gave away stranded inventory to help neighbors in need. A photo of Walmart trucks made it onto the front page of virtually every newspaper in the country; they were lined up as far as the eye could see along Interstate 10, waiting for the National Guard to reopen the roads into the heart of New Orleans. This singular image offered the best press the company had seen in a decade.

During a listening tour to understand the company’s critics and engage its managers and employees. Scott posed this question: “What would it take for Walmart to be that company, at our best, all the time?”

The answer, gleaned from feedback across hundreds of encounters, came in a remarkable speech by Scott to his employees in October 2005—a little more than a month after the storm abated. Released publicly under the title “Twenty First Century Leadership,” it set extensive and aggressive goals that Walmart would pursue to move well beyond the charitable acts that were so visible in the wake of Katrina, to engage the business itself in leading change.

Scott called the conduct of business as usual a “Katrina in slow motion” and pledged to enlist the company’s massive supply chain in operational changes and new standards for procurement that the company believed would drop straight to the bottom line—from greater fuel efficiency and dematerializing packaging to increasing sustainably harvested products in the product mix and preferences for suppliers able to match Walmart’s goals on the reduction of greenhouse gases.

Scott also spoke to the human face of their operations. Relative to the precise signals on the environmental front, Scott’s 2005 message on investment in low-wage earners in stores and distribution centers feels tepid. Some important changes have taken place since that moment, and while Walmart continues to be criticized for moving slowly on worker pay, Scott did open the door with a call for a higher federal minimum wage—a goal that the current CEO, Doug McMillon, has the opportunity to directly influence as the new chairman of the Business Roundtable.

The Lee Scott moment was a game-changer. Walmart invited product sellers to come to Bentonville, Arkansas, to meet with the buyers and to start the process of building alliances with key suppliers, including many that are massive companies in their own right.

The Walmart story is not a fairy tale. Some of the changes have been easy but many have not. The story is still unfolding. In 2015, the company’s chief sustainability officer, Kathleen McLaughlin, reflected on its progress against the aspirations of a decade earlier, stating, “We have celebrated some important milestones and accomplishments and have also struggled with obstacles and failures. We have learned a lot about what works and what doesn’t when it comes to achieving lasting change.”³

When your business model is built to deliver on low price and convenience, it’s complicated to lead on higher product and labor standards. Walmart is the single largest seller of many products we depend on, and like its chief competitor, Amazon, it enables the consumer’s magical thinking about low prices without consequences. But Lee Scott’s epiphany and the journey that began with Walmart’s suppliers in the wake of Hurricane Katrina was a shot across the bow for the business community. Scott’s leadership of Walmart in 2005 was evidence of a fundamental shift in mindset; it started new conversations in more boardrooms than we probably give him credit for.

Metrics mostly document what we already believe to be true. Facts can support the changes—but they rarely cause the change.

In his provocative book Winners Take All: The Elite Charade of Changing the World, Anand Giridharadas, an Aspen Institute Henry Crown Fellow, tackles inequality and the rules of the system that enable the winners to continue to gain ground at the expense of the middle class. He challenges what he calls Market World—“the concurrent drives to do well and do good, to change the world while also profiting from the status quo.”⁴

Giridharadas criticizes those who call for concrete solutions to big social problems but fail to challenge enablers such as preferential taxes on capital over labor and shareholder-centric measures that reward the outsourcing of jobs or keep wages low. Giridharadas questions the net value of philanthropy and so-called social enterprise. He posits that it’s not enough to do something good—i.e., you can’t ignore the negative consequences of a business decision by being generous with some of the profits.

Giridharadas raises pointed questions about those of us who elevate business as positive agents of change and points back to the underlying questions of what a business, at its core, is designed to do.

Business is not by any means the whole answer, but we can’t ignore it either. I am remembering the words of Nitin Nohria in the preface to this book: “None of the major problems confronting the globe today— sustainability, health care, poverty, financial-system repair—can be solved unless business plays a significant role.”⁵

CAN BUSINESS LEAD?

If we can’t depend on every executive having a road-to-Damascus experience like that of Lee Scott or Phil Knight of Nike a generation earlier, what is needed now to achieve a real shift in the mindset of leaders? And what keeps the old rules in place?

Many members of the Business Roundtable concluded that it was right—even easy—to sign on to a statement that supplanted “shareholder primacy” with “stakeholder management” because they believed they were already doing what was required.

Businesses that grow to the scale of the membership of the BRT do care about their employees, support their host community, and scrub the supply chain for noxious labor and environmental practices. And yet, inequality grows and the planet is warming. The real story is told in the growth in share buybacks, in contracts with advisory services to maximize tax avoidance, and especially in how we compensate executives.

WHAT ARE WE PAYING EXECUTIVES TO DO?

In 2018, companies began to publish new data about pay—fulfilling a mandate laid down by Congress in the wake of the 2008 financial meltdown. Each year, publicly listed corporations analyze and release a comparison between the CEO’s pay package and a measure of the median pay for the rest of the employees.

The new data offers a complicated yet, ultimately, revealing picture of the culture and values of public companies. This comparison of the CEO’s pay with the median, along with the requirement that the company periodically poll shareholders about the pay for the chief executive, is designed to elevate the CEO’s pay as a matter of debate.

But the results from these so-called Say on Pay votes suggest that investors don’t care if the CEO makes 100 or even 1,000 times the income of the median worker, as long as the stock price is rising. Laborers are also mostly silent on executive pay; they care much more about their own share of the pie than if the CEO is compensated at a level that is almost impossible for most Americans to take in. And trends suggest that greater transparency about what other CEOs make has an unintended consequence: even higher pay thresholds.

In one case I recently learned about, the CEO’s pay had increased fivefold in the 20 years since the company went public, while the average factory worker’s pay declined by a fifth. Is this CEO overpaid? Not in conventional competitive terms, or even through the lens of cost-benefit analysis—that is, if the measure of benefit is the stock price. This executive’s pay would never make a list of the highest-paid CEOs. Even if it did, the pay at the top barely matters when it comes to overall profits. There is only one CEO in a company—except in the most outrageous examples, it’s a minor cost factor in the overall scheme of things.

The United States is a global outlier when it comes to pay levels for the CEO and executive team. At the top end of the scale, earning a CEO salary is like hitting the lottery year after year after year, with the pot growing most years, while worker pay on average is flat; this is a source of political discontent, decline in trust in business, and greater inequality than we have experienced since the 1920s. The people who make the product, handle customers, and do the unseen jobs that support these efforts haven’t seen a raise in decades, even as rates of productivity increased.

A recent theme in the growing conversation about what to do about CEO pay says that you don’t fix inequality by attacking CEOs— you need to address the problem bottom-up. (Surely both are needed.) But reducing “quantum,” as the market jocks call the CEO’s earnings, is only one part of a bigger problem rarely discussed by directors who defend the CEO’s pay as a function of competition.

But there is a bigger issue at stake.

Even more important than the amount of pay is the design of pay— the intentions that underlie the structure of rewards and incentives. Incentives, of course, should align with the goals and expectations of management, but in spite of all the discussion of stakeholders, the pay-for-performance system that dominates boardrooms and classrooms is still heavily weighted toward shareholders—i.e., share price. Executives are given stock grants or stock-based incentives to assure that the management team stays focused on share value—or is justly rewarded for higher stock valuations, depending on your point of view.

There are at least two reasons for the stickiness of shareholder value as the dominant signal in pay. One is agency theory, a seductive but flawed idea designed to keep managers beholden to their shareholders. Ensuring that the managers of your enterprise are truly your “agents,” working on your behalf, made sense when a group of investors were financing a railroad or building a factory and bore all of the risk.

But the stock market no longer works that way. Professional managers of global enterprises are not working for the shareholders in any practical sense of the word. The board, which hires the executive, has a fiduciary duty first and foremost to the long-term health of the enterprise, not the holders of shares of stock. Weighing down executives with equity-based incentives keeps the system tethered to shareholders. To reward executives principally in stock is problematic for the reasons detailed in this book and by a chorus of critics in business and beyond. In addition, there is a practical problem: which shareholder are we talking about? Shareholders as a class actually don’t have much in common—their interests and time horizons are very broad.

The second reason executives are paid in stock is that in spite of a growing conversation about the need to be attuned to all of the inputs for long-term success, the share price is still the master of the realm in public company boards. Proxy advisory firms like Institutional Shareholder Services (ISS) and Glass Lewis issue recommendations to asset managers and mutual funds. Most follow their advice, which hews to whatever is needed to enhance the value of the shares. One of the classic ways to do that is to ensure that the stock price is the loudest signal in the pay package. The protocols of boards and their advisers who benchmark pay against other public companies reinforce the status quo.

How does pay for performance work in reality?

Equilar is a private advisory firm that benchmarks CEO pay. From its 2018 public release, we know that the CEO of a typical large public company now receives only about 10 percent of his or her compensation in cash, and the balance in stock and equity-linked incentives. In addition to high CEO pay, the focus on shareholder value and the massive shift toward equity-based pay that began in the mid-1980s go hand-in-hand with growth in share repurchases resulting in a premium to stockholders—who take the share of the pie that used to go to the employees. The principal beneficiaries include the executives themselves.

The system of incentives and rewards is perfectly aligned to produce what we see in play today: high returns to shareholders and low investment in productive uses of profits to spur innovation and public goods—i.e., investment in workforce development, wages, R&D, and quality assurance on the shop floor and through the supply chain.

The historic link between wage growth and productivity growth is now broken. In low-wage industries like retail, the contrast between share repurchases and wages is illustrative of systemic failure.

In the restaurant industry, for example, researchers from the Roosevelt Institute and the National Employment Law Project found that between 2015 and 2017, share repurchases (or share buybacks) measured 136 percent of profits.⁶ Their findings mine the connections between stock-centric executive compensation, tremendous growth in share buybacks, and sluggish economic growth and low pay—a national embarrassment during an era of massive wealth accumulation.

THE COST OF SHARE BUYBACKS

The largest share of the distribution to shareholders is accomplished through companies buying back their own shares to bump up the stock price, a practice that naturally enriches those with the most stock. Cases of companies borrowing to buy up more shares are commonplace—and explain how a company can distribute more profits in a given year than it actually earns. While it might make sense for a company to buy its own stock when management is convinced that the stock is undervalued for some reason, this rationale doesn’t hold up under scrutiny.

Until the 1980s, the practice of share buybacks was prohibited as a form of market manipulation. Today, taking special measures to boost the stock price is the point.

The individual who has probably done more than anyone to bring our attention to the national plague of share buybacks is William Lazonick, a Harvard-trained economist who earned his PhD in 1975. Lazonick teaches economics at UMass Lowell, situated in the historic mill town whose concentration of textile factories in the 1800s earned it the name, “cradle of the American industrial revolution.”

As a researcher, Lazonick was originally drawn to economic development and investment in innovation. He became interested in the relationship between the “productive economy” and the “financial economy” after shareholder value theory began to take management theory by storm, beginning at Harvard in the mid-1980s and spreading quickly from there to other scholars and institutions.

Lazonick ultimately created the Academic-Industry Research Network, to link like-minded scholars and industry experts. The Network researchers looked at the data between 2008 and 2017 and found that share buybacks had increased to the extent that 94 percent of profits were distributed to shareholders in the form of buybacks plus dividends over the course of the decade. In March 2019, Senator Tammy Baldwin reintroduced the Reward Work Act—to curb buybacks and give workers a greater say in decision-making at their companies—and asked Lazonick to appear at a Senate hearing as an expert witness for the bill.

Rick Wartzman of the Drucker Institute and Lazonick looked again at the numbers in the wake of the Trump tax cuts, which were sold to the public as a reinvestment in American productivity and the American worker. They determined that the trend was continuing.

The 2017 corporate tax cuts reduced the statutory rate from 36 percent to 24 percent. The actual rate paid by companies that year, on average, after the application of credits and various schemes to reduce tax exposure, was 9 percent. The long wait for a lower tax rate was over. It no longer made sense to shield the cash in offshore locations to avoid high tax rates at home. Companies were now awash in cash.

JUST Capital, which began polling Americans about their attitudes and expectations of corporations in 2015, began to track statements by companies in the Russell 1000 as the tax windfall began to hit. For the first 145 companies that announced their intentions, the benefit to workers amounted to 6 percent of the tax relief; most of it was in the form of onetime bonuses, not permanent pay raises. Companies were also expected to utilize tax savings to invest in job creation, but the pattern was already clear. Stock buybacks that rewarded wealth would swamp investment in work, again.

Current CEO pay levels for many public companies make those companies look like an airline, where the only person who matters is the pilot—not the ground crew or the flight attendants or reservation clerks, or the quality control tinkerers, and certainly not the men and women who work behind the scenes: who wrangle the ore and fuel from the ground, forge the parts, tighten the bolts, and solder the frame—or serve the food in the cafeteria or clean the restroom late into the night.

In tech and other industries, a growing segment of the workforce is now hidden, employed by contractors who make it easier to cut wages and benefits in the name of competitiveness.

Pay for performance directly undermines the spirit of the BRT’s revolutionary statement on stakeholder value. When the company prioritizes the stock price, the productive capacity of the firm is undermined, and whether it happens at Apple, Citibank, General Electric, or Merck, we all lose—not just workers.

Boards seem complicit—or at least compliant. They take signals from investors, and in one sense they are doing what they are asked to do—and increasingly are paid to do. Directors, like the CEO—are often given stock grants or rewarded with incentives tied to the stock price.

And what is the result of decades of focus on the shareholders?

• Low employee engagement scores and productivity gains that no longer reward the employees who produce them

• Unions in decline, viewed as a drag on competitiveness and efficiency

• Low levels of investment in retraining despite the massive shift in job content due to technology and growth in artificial intelligence

• Decline in the US share of global business R&D

• Levels of inequality, according to World Bank data, that place the United States on par with Argentina and the Ivory Coast, and well above norms throughout Europe, including the Baltics, the UK, and Scandinavia

• Communities fractured by a lack of economic opportunity

These consequences have opened a new conversation about how we pay executives. The conversation is about the connections between an employee of the company and a contractor with a similar job but with no benefits or job security. It is about the balance of financial and nonfinancial goals, from targets on reducing greenhouse gases to greater diversity. It is about transparency, about aligning pay with purpose, and about long-term focus. It is about fairness.

UNLEASHING CREATIVITY IN THE DESIGN OF PAY

An important strand of this conversation is taking place among scholars, executives, and professional advisers who believe that stock-based compensation impedes sound judgment and carries unintended consequences.

From the science of behavior and research into motivation we know that goals can be powerful incentives, but they don’t work as intended for positions that require critical-thinking skills. Michael Dorff, corporate governance scholar and author of Indispensable and Other Myths: Why the CEO Pay Experiment Failed and How to Fix It, explains that incentives work best for rote assignments and piecework, but not for jobs that rely on judgment and EQ.⁷

We also know that long-term rewards lose their power over time. The mantra about using stock to reward long-term behavior is also a myth. Incentives are most effective when they are felt immediately. So while good managers can influence the stock value over the long term, it’s not because their incentives tie them to the grindstone. To the contrary; recent examples, from Valeant to VW, Wells Fargo to Boeing, illustrate how paying executives in stock drives short-term behavior to “make the number.”

Finally, the notion of “felt fairness” is at risk when too great a disparity exists between layers: when the gap gets too big, teamwork, engagement, individual agency, and creativity begin to shred.

There are companies and executives who believe in the logic behind felt fairness and have experimented with new norms, even when their competitors reached pay ratios between the CEO and the average worker of 100 to 1, or even 250 to 1.

Intel was pursing greater productivity, employee agency, and teamwork when it set a goal in 2009 to keep the CEO’s pay within a range of 1.5 to 3 times that of the EVPs. Peter Drucker strongly believed the CEO should make no more than 20 times the rank and file. Ben and Jerry’s, when still led by its founders, committed to multiples so low as to be untenable. Paul Polman at Unilever hired a “global head of reward” and directed him to look at fairness from top to bottom.

In July 2020, the Bloomberg Pay Index released their CEO pay numbers for 2019. Robert Swan at Intel, at $99,022,847, made up mostly of stock grants and options, was ranked number seven.⁸ It appears that felt fairness is no longer a priority.

But in other companies, the economic disruptions of COVID-19 are enabling a very different conversation.

To comply with changing norms amid the pandemic and in defiance of the conventions of proxy advisory firm ISS, Lloyds Bank in the UK announced in 2020 that they would pursue a new pay model for its top executives: switching incentive pay to long-term restricted shares. The CEO’s maximum pay would actually decline, from 8.3 million pounds to 6.3 million ($7.7 million). ISS, however, still recommended a no vote on the plan, and over a third of the voting shareholders accepted the ISS recommendation and registered disapproval.

Why would ISS, which represents a range of institutional investors, recommend a vote against more reasonable pay?

The answer has to do with the old hobbyhorse of pay for performance—i.e., the degree of alignment with the stock value. The new pay scheme at Lloyds looks more like a long-term bonus plan than a true incentive plan, and ISS measures success in the most limited fashion: is the board paying the executives to put the stock value ahead of other considerations—even in a year in which branches are being closed and scores of employees laid off? Even when bailouts are required to keep the doors of many enterprises open?

How will the change take place?

We need a different approach. And it requires more than tinkering with the pay-for-performance system that got us here. What if we looked at the health of the enterprise and its many parts rather than the chief executive?

When we shift the lens away from the CEO and instead focus on the company, new measures and metrics come into focus: employee engagement and retention, measures of productivity and customer service, and key risk factors buried in the supply chain.

Today, internal pay equity or fairness may still seem like an antique idea, but it is designed to build a strong and resilient culture. The reliance on measuring the CEO’s pay against so-called peer groups of other CEOs helps to justify outsized pay packages but ignores the people who matter most—the CEO’s own direct reports and managers—and then down the food chain to workers and employees who create the goods and services and engage with customers. To rightsize the system, it works equally well to adjust from the bottom up.

Focusing on the employees who make up the enterprise may not resolve all of our questions about CEO pay, but it’s a useful place to start—a thought experiment that can restore some common sense and creativity to a system that has become formulaic and stale.

MODERN PRINCIPLES OF SENSIBLE AND EFFECTIVE PAY

Executive pay has again become a lightning rod for criticism—a lens on business and the social contract.

Can the tsunami of change from COVID-19 and a surge in voluntary pay cuts by executives be the moment we have been waiting for? Will it open the door to a fundamental rethinking of how we reward executives—of pay for performance? What would executive compensation look like if it were designed to build the internal organizational health of tomorrow’s corporation—rather than benchmark and compare executives against one another?*

It’s hard to break the norms of the current system without buy-in from within—a core of leaders working together who share the commitment to change. We need to engage and cultivate a small group of directors and executives, or many groups—even dinner-party size to begin with—to discuss first principles and reset the norms in the wider system. We need case examples rooted in what we know to be true; executives may not be traded like baseball players, but they share their love of the game. The good ones focus on building a solid, long-term foundation for teamwork.

It will not be easy to identify directors who have the courage and conviction to move against conventions in the boardroom, but the need is clear. In their Harvard Business Review article “The Error at the Heart of Corporate Leadership,” Joe Bower and Lynn Paine talk about how shareholder value theory “narrows management’s field of vision” and how alignment of incentives with share price is, in fact, a moral hazard:

When the interests of successive layers of management are “aligned” in this manner, the corporation may become so biased toward the narrow interests of its current shareholders that it fails to meet the requirements of its customers or other constituencies. In extreme cases it may tilt so far that it can no longer function effectively.⁹

Function effectively to what ends?

Tim Cook, of Apple Inc., leads one of the most influential companies on the planet. With a pay package of $133 million in 2019, he is also one of the highest paid—a function of large stock grants ($122 million), plus a $7.7 million bonus, a $3 million salary, and $884,000 in perks. Cook ranked among the top 10 earners for two of the preceding three years as well.

In 2018, after the corporate tax cuts were enacted, Apple, then the largest company on the New York Stock Exchange, announced its intention to buy back $100 billion of stock, rewarding investors for their confidence in the company and its earning power, bolstering the stock price, and further concentrating wealth in the hands of those with the most stock. The price of Apple stock has quadrupled over the five years leading up to 2020. Stock repurchases topped $400 billion in that same period.

Cook readily admits that he doesn’t need the money and said he would donate his massive earnings to charity. He would likely run the company the same way paid $10 million or $100 million. Could we imagine a different scenario for our most highly respected leaders of Silicon Valley?

Private enterprises like Apple have their pick of engineering talent and knowledge workers. In a world of hurt—a warming planet, disenfranchised workers, growing nativism, and disintegrating infrastructure—is there more we should expect from the company’s license to operate?

What could Apple do with its gains? How might Apple and its peers pay it forward for the benefit of their own workforce and contractors, community, and country—and beyond? The tensions between private inurement and the public good are playing out in real time.

The examples of co-creation discussed in the last chapter offer compelling examples of what is possible when disparate voices that represent different parts of a broken system convene around a common goal. From rethinking electronic waste to retooling workers for the next decades, what is Apple uniquely equipped to do that will secure the long-term health of the business and the ecosystem on which the company is dependent?

Fixing pay and the incentive systems that undergird the system focused on share price is the next, critically important step along the path of real value creation. The best companies and executives will not fixate on unwinding the old system; they will build something new.

* Meadows is well known for her early work with colleagues, The Limits to Growth: A Report for the Club of Rome’s Project on the Predicament of Mankind, which opened a debate in 1972 that continues today about the capacity of the Earth to support population growth and economic expansion.

+ Jonathan Haidt was first to use the metaphor of the rider and the elephant in his book The Happiness Hypothesis (2006).

* In 2020, in partnership with Korn Ferry, the Aspen Institute Business and Society Program released a set of questions and principles under the title “Modern Principles of Sensible and Effective Pay” to help boards and executives consider new approaches to the design of rewards and incentives. One of the five principles is about fairness.