Terminate Me, Please!

**Warning: The following blog may cause hypertension, nausea, and/or strong feelings of indignation. If symptoms persist longer than four hours, too bad.**

Times are tough. As we all know, our economic downturn has led many middle-class Americans to lose their jobs, their retirement savings, and even their homes. Many more are hanging on by a financial thread, their income lowered from forced furloughs and pay cuts.

And don't think that this misery is confined to the middle class. Nosiree! According to a recent report by Forbes financial magazine regarding 2009 CEO salaries:

For the third consecutive year, the chief executives of the 500 biggest companies in the U.S. (as measured by a composite ranking of sales, profits, assets and market value) took a reduction in total compensation. The latest collective pay cut, 30%, was the biggest of the past three years (11% and 15% declines in the prior two years). This marks the first time in the past 20 years that total compensation declined in three consecutive years.

So there you go.  These guys are suffering, just like the rest of us.

Or maybe not.  According to the same Forbes report, "In total, these 500 executives earned $4 billion in 2009, which averages out to $8 million apiece."  (You can see the complete list here.  About 1/3 of the average compensation was in the form of exercised stock options.) Though certainly a cut from the average $14 million a few years back,  these CEO's are not exactly in the same dire straits that many of their workers find themselves in.  A study by UCSC professor G. William Domhoff cites some recent data that breaks this down more finely: 

...the median compensation for CEO's in all industries as of early 2010 is $3.9 million; it's $10.6 million for the companies listed in Standard and Poor's 500, and $19.8 million for the companies listed in the Dow-Jones Industrial Average. Since the median worker's pay is about $36,000, then you can quickly calculate that CEOs in general make 100 times as much as the workers, that CEO's of S&P 500 firms make almost 300 times as much, and that CEOs at the Dow-Jones companies make 550 times as much.

Thirty years ago top CEO's salaries were 30 times the average worker's.  In 1992 that ratio had risen to 82 times the average worker's salary,  and in 2004 it was 400 times .  Even with the recent economic downturn, top CEO compensation is still 344 times the average worker's salary.

Oh, and although the CEO's have suffered reductions in their direct compensation, during the latest period their retirement benefits (deferred compensation) have actual gone up 23%.  Well, that's some solace for them, at least.

It is often argued by those who defend this kind of disparity that CEO compensation is justified by the performance of CEO's in enhancing the profits of their companies, and that their pay is linked to how well the company is doing relative to its peers.  Unfortunately that argument doesn't hold water.  Data presented in the UCSC paper mentioned above shows that over the past 15 years the increase in CEO compensation is nearly independent of corporate profits, but instead is closely correlated with the stock market as measured by the S&P 500 Index.  (The average production worker's pay, which has increased only about 4-5% in the same period, isn't related to either corporate profits or the performance of the stock market.)

A number of other analyses reach the same conclusion regarding the lack of connection between executive pay and performance.  A 2010 Business Week article describes the work of  compensation consultant Graef Crystal, who examined last year's pay of 271 chief executive officers. His conclusion was that  "companies don't pay for performance."  According to the article, no matter how he parsed the numbers, Crystal discovered no relationship between shareholder returns and CEO compensation.  Another example is an analysis by business columnist Jeffrey Pfeffer, who has himself has served on executive compensation committees.  Pfeffer reports two key findings from his research:

First, the relationship between pay and performance is astonishingly small. One meta-analysis found that firm performance accounted for less than 5% of the variation in CEO pay, while company size explained about 40% of the variation. Second, there is no evidence that attempts at reform, such as more disclosure or ensuring that the compensation committees of publicly traded companies are comprised solely of independent directors, has had any effect... The problem: nothing in the process of setting CEO compensation produces a pay-performance link.

As disturbing as all this is, there is more to ponder.  As we know, many people have lost their jobs as a result of the downturn.  The average worker can expect a period of unemployment benefits that are barely enough to live on, and thanks to some recent government interventions, a continuation for a while of health benefits (COBRA) at reduced premiums.  Though helpful, this assistance hardly represents a windfall.

For the CEO's we've been talking about, however, termination is often quite lucrative.  One specific case in the news most recently is Mark Hurd, the CEO of HP who "stepped down" after a company investigation of sexual harassment charges against him.  The harassment allegations were not substantiated, but the company found he had falsified expense account records on numerous occasions to cover up his relationship with the woman involved, who was an independent contractor working with HP.  As Hurd admitted when he resigned, "I realized there were instances in which I did not live up to the standards and principles of trust, respect and integrity that I have espoused at HP."  He will lose his $24 million a year compensation package, of course.  But it may be hard for the average person to feel too sorry for him.  Hurd's termination agreement totals about $40 million --12.2 million in cash and the rest in HP stock.  Oh yes, and he'll get the government health benefits, for which HP will pay the premiums.

Although Hurd's termination package is considerably higher than the $5.8 million average for CEO's, it isn't nearly as large as some other high-profile cases.  As the Kellogg School of Management reported in 2007, Robert Nardelli, the former CEO of Home Depot, received $210 million, Disney’s Michael Ovitz received $140 million (after a mere 14 months on the job),  and Conseco’s Stephen Hilbert received $72 million.  Hurd did, however, do better than his predecessor at Hewlett-Packard,  Carly Fiorina, who received only $21 million when she was terminated.

According to the Kellog report,  three reasons why firms grant such lucrative severance packages to CEOs within their initial employment contracts are:  (1) to encourage risk-taking, (2) to provide insurance for an incoming executive, and (3) to compensate CEOs for entering into confidentiality agreements. The argument regarding risk taking is that since CEO compensation is 30-50% stock options, a CEO would hesitate to do anything that might drive down the stock price without a guaranteed cash severance package.  The insurance angle goes like this:  CEO's need to be protected against company downturns not under their control, which of course would lower the stock portion of their annual compensation.  The confidentiality compensation argument is that the terminated CEO may be hampered in future jobs because he or she can't use the specific information about a previous company in their new positions -- the severance package compensates for a possible lower salary due to such restrictions.

These arguments seem to me to imply a rather negative view of the average CEO.  That is, that CEO's are so attached to their salaries they will only work for companies who remove the negative consequences of risk (both risk resulting from their own actions and from factors not under their control), and who promise to compensate them in advance for possible future jobs where their proprietary knowledge might be relevant.  But then BP's Tony Hayward comes to mind, who certainly fulfilled the company's wish for risky behavior.  Hayward's severance package is estimated to be around $18 million.

We seem to have created a corporate world where performance and compensation are unrelated at the highest levels of management, and where those at the highest levels reap the rewards of risk and proprietary knowledge but do not suffer the potential downsides.

I've said before that I believe in meritocracy and that someone with a special, unique talent or skill or knowledge that is beneficial to society can be rewarded extravagantly and I don’t mind.  But this is something else, and it is something that isn't healthy for either our economic system or for the fabric of our society.

Confessions of a Selective Technophile

I was twelve years old when the Soviet Union launched the Sputnik I satellite.  The date was October 4, 1957.  The news shook the world, which was in the grips of the Cold War, and set off the space race.  For me it was mesmerizing and enthralling.  I remember lying in bed unable to sleep, listening to the signals from Sputnik being broadcast over the radio as the satellite passed over the U.S.  It was incredibly exciting to think that there was an object made by human beings circling the earth miles above my head.

By today's standards Sputnik I was a puny payload -- about the size of a beach ball and weighing 189 pounds.  But in those days that was huge, and suggested that the Soviets had powerful rockets that could also launch intercontinental ballistic missiles.  Then they upped the anti by launching a second satellite just a month later which was not only heavier by far, it also carried a live passenger -- a dog named Laika.  The U.S. had been working on a satellite, but had to rush to get it into orbit.  The first attempt in December ended after two seconds with an embarrassing explosion, or as the spin doctors described it, "rapid burning."  Success came on January 31, 1958 with the launch of the 31-pound Explorer I.

Fast forward fifty+ years.  The U.S. eventually won the Space Race and the Cold War, with some stunning technological achievements along the way, including landing a human on the moon.  We all can appreciate the moon landing and other manned missions because of the demonstrable element of danger and our personal identification with the astronauts.  But for me some of the unmanned missions illustrate the greatest technological achievements precisely because they were accomplished without humans on board.  There are many examples, such as the Mariner 2 probe to Venus,  the Lunar Surveyors,  the Mars Pathfinder and Mars Rovers, and the remarkable Voyagers I and II, which have been operating for over 33 years and are still communicating from 14 and 17 billion kilometers away.

But the one that still leaves me awestruck is the Galileo mission to Jupiter, mainly because of the difficulties that were overcome during the mission and because the probe was so resilient -- an interplanetary Energizer Bunny that kept going and going no matter what.  The Galileo probe was launched in 1989, and took 6 years to arrive at its destination.  Several technical problems developed on the way, but engineers managed to overcome them.  Once at Jupiter Galileo fulfilled its intended two-year mission, then continued to operate for another six years,  far surpassing its design parameters and surviving some of the harshest conditions imaginable from radiation around Jupiter's moons  It was intentionally crashed into the planet in 2003,  providing valuable scientific data right up to the end.

Galileo Photo of Ice Flows on Europa

 The scientific achievements of Galileo were very impressive.  On the way to Jupiter it flew close to two asteroids, Gaspra and Ida, the first spacecraft to visit an asteroid.  Galileo discovered that tiny Ida had an even tinier moon.  As it neared its destination, Galileo was able to observe and photograph in great detail the collisions of fragments of Comet Shoemaker-Levy with Jupiter.  During its six years in the Jovian system Galileo discovered strong evidence that Jupiter's moon Europa has a melted saltwater ocean under an ice layer on its surface, and found indications that two other moons, Ganymede and Callisto, have layers of liquid saltwater as well. Other major science results were observations of varied and extensive volcanic processes on the moon Io, measurements of conditions within Jupiter's atmosphere, and discovery of a magnetic field generated by Ganymede.

Galileo Photos of an Active Volcano on Io

The problems Galileo faced began early on, when its high-gain antenna failed to open fully.  This forced mission engineers to use the low-gain backup antenna, which reduced the data transmission rate to only 8-16 bits per second (sloooowwww),  later increased by various work-arounds to a still-glacial 160 bits per second, about 1/1000 of the high-gain speed.  This limitation made the data that was returned, especially the approximately 14,000 photos that were sent back, even more impressive.  And the signal was transmitted with only 20 watts of power!  Another problem that occurred before Galileo reached Jupiter was with the onboard tape recorder (parents, explain to your children that back in the olden days we actually recorded data on long strips of tape....)  that stored data for later transmission back to earth.  The recorder became stuck in rewind mode and damaged a section of tape near the end.  Engineers overcame the rewind problem and instructed the recorder not to use the damaged section of tape.  The recorder was also damaged late in the mission by high radiation near the moon Almathea, but this, too was overcome.

Other difficulties from radiation exposure were encountered, but none of them stopped the Bunny:

The uniquely harsh radiation environment at Jupiter caused over 20 anomalies in addition to the incidents expanded upon above. Despite exceeding its radiation design limit by at least a factor of three, the spacecraft survived all the anomalies. Several of the science instruments suffered increased noise while within about 700,000 km of Jupiter. The quartz crystal used as the frequency reference for the radio suffered permanent frequency shifts with each Jupiter approach. A spin detector failed and the spacecraft gyro output was biased by the radiation environment. The SSI camera began producing totally white images when the spacecraft was hit by the exceptional 'Bastille Day' coronal mass ejection in 2000 and subsequently on close approaches to Jupiter. The most severe effect was a reset of the computers (a CDS despun bus reset) that occurred when the spacecraft was either close to Jupiter or in the region of space magnetically downstream of the Earth. Work-arounds were found for all of these problems. (Wikipedia article on Galileo)

Ok, you get the idea.  To me, the Galileo mission  represents an awe-inspiring combination of technological know-how, applied science, ad-hoc problem-solving, and creative ingenuity which provided a close up view of strange new worlds and greatly increased our knowledge of the universe.  In this age of news filled with stories of greed, incompetence, political and social strife, environmental degradation, and economic collapse, it is tempting to become misanthropic and conclude that humans are just no damned good.  But then we do something like this and through such a wondrous technological expression of the human spirit, raise the possibility that maybe there is a glimmer of  hope after all.