CEOs Are Not the Same as Sports Superstars
The Harvard Law School Forum on Corporate Governance and Financial Regulation posted a weak rationalization of CEO pay this week. The piece by compensation consultant Frank Glassner contends that public sentiment that CEOs are overpaid is misplaced and focuses on that tired trope that CEOs are like sports stars and should be paid accordingly. Specifically he notes that, “Basketballer Stephen Curry earns more than $40 million a year — and the reason is not that he sweats a hundred times more during a game or that he trains a hundred times harder than a less talented basketball player. He earns so much because he has a rare ability.”
Sorry, I’m not disputing Curry’s rare ability but the analogy of athletes to “elite executives” simply does not work.
As a fan of 2019 World Series champion Washington Nationals, I couldn’t help but think of Bryce Harper with this analogy. Harper’s singular talents were supposed to get the Nats in the playoffs, but it never happened. Harper was hired away by the Phillies this year for a 13-year, $330 million contract. (At the time the Washington Post’s Jena McGregor listed 24 CEOs who’d been paid more over a similar period of time.) Many gave up on the Nats hopes for this season. Prognosticators thought their prognosticating was justified when the Nats had only 19 wins compared to 31 losses at their season low point. But maybe the players were fans of old musicals about having heart. Like, when the odds are saying you'll never win, that’s when singing baby shark* should start. The Nats, of course, won the World Series — more on that later. First I want to highlight several of the specific ways the analogy fails.
A very significant difference between athletes and CEOs is that despite suggestions to the contrary, skills required for executive success are not necessarily transferable between companies. Michael Dorff became interested in the broken executive compensation system when he observed it first hand as a member of a compensation committee. I highly recommend his book, “Indispensable and Other Myths.” He often points to the absurdity of the idea that a CEO at a defense contractor would make a good CEO at a pharmaceutical company. One study he cites in his book notes that of nearly 2,000 CEO replacements at Fortune 1500 firms between 1993 and 2005, 86 percent of new CEOs came from companies in the same industry.
Compare this to the story of an elite athlete. The rules of baseball are the same across the leagues. There’s no regional expertise needed, no additional training required for a free agent who changes teams. In that case talent is much more transferrable. If you play great baseball for one team you are likely to play great baseball for another team.
Another important distinction between the sports star and the overpaid CEO is that we can measure the individual contributions of the former. Baseball is a game of numbers, acronyms, and statistics. Players names will be followed with a string of slash line numbers and you are just supposed to know what they mean. (These are BA/HR/RBI — batting average, home runs, and runs batted in.) We can be confident that these metrics are measured the same between teams.
Every proxy statement attempts to justify executive compensation with numbers, but they are self-selected and not consistent. Every CD&A highlights some measure of performance. If the stock is doing well and top-line numbers look good we will read about that. If it isn’t, you might find the company’s performance compared to peers, or to prior years, or transitions will be lauded. To be sure, there is a standardization of some numbers through Generally Accepted Accounting Principles (GAAP), though too often we are seeing bonuses based on non-GAAP figures.
Most importantly here, however, is that all of the balance sheet number measure company performance. There are not similar measurements for individuals. Equity is the largest single component of executive pay. As Dorff observes, “There are two conditions that must prevail for equity-based pay to result in higher stock prices: equity-based pay must improve CEO’s performance and the CEO must have the power to raise their companies’ stock prices. The best evidence is that neither of these conditions hold true.”
Glassner writes that “the fact that manager salaries are determined by supply and demand on the market for top executives is not at all widely understood.” That’s strike three right there. The market for CEOs is neither open nor fair, but rather opaque and heavily influenced by external factors including consultants, ratcheting peer groups, and the role of directors.
I believe the supply of potential CEOs is much deeper than many CEOs themselves would like to admit. At every company there are multiple executives all the way down the chain that hope to sit in the corner office someday.
Another big difference is who sets the market. The market for sport stars is set by baseball-loving owners of teams. If these big-boy billionaires want to try to buy enough talent to win the series that is up to them. In a twitter conversation today, Douglas Chia noted, “While I don't think it's analogous, I think athlete comp is just as out-of-whack. Teams usually overpay because they are locking guys up at the peak of their careers when their production is about to go downhill. Or, they are rewarding guys for past performance.”
However, public companies should operate differently, answering to shareholders. Boards of directors should be negotiating compensation packages at arms’ length. Yet there’s been a great deal written about how directors have often overly-collegial relationships with top management.
Pay for athletes is what the market can bear. I don’t begrudge these young men taking what they can (and they are young men because female athletes are not paid at this level). Particularly, as they typically have short careers and often come from under-privileged backgrounds.
Likewise, maybe there are CEOs who adopt a similar attitude, short-timers who want to get what they can before they need to leave. A key distinction here though is that by definition, their role as CEOs are not to be primarily concerned with their own interests. CEOs are leaders within their companies. As leaders, they themselves play a key role in setting and approving compensation throughout the company. They can advocate for the short- or long-term, for fair or exploitative wages.
It is important to add that the compensation system for baseball is broken too, with minor league players making an average of $7,500. In a great analysis of how analytics have changed baseball, Kelly Candaele and Peter Dreier note that, “The average career length for a major league player is a little over four years. Rather than sign players to long-term contracts, teams increasingly view them as contingent workers who can be shuttled between short stints in the major and minor leagues, similar to employees in the growing gig economy.”
Glassner concludes his essay by staying that CEOs are paid based on “how much value they add to their companies.”
The only thing more difficult to measure than individual skill is team contribution. Baseball takes a shot at it with WAR (Wins above Replacement). Apparently, this claims to measure the number of additional wins a player is worth over the course of the season, as compared to the contribution of an average (replacement) player. I’ve read that Harper performed fine with that statistic. He hit at his normal level, which is pretty amazing, and played good defense. He was even a finalist for the “golden glove.”
Despite Harper’s contribution, however, the Phillies aren’t the World Series Champions. And this takes us finally to an area where I believe there is a great deal of similarity between CEOs and sports stars: the role of the ineffable and unmeasurable. To me this is the glorious lesson of the Nationals World Series victory. There are attributes that defy quantification — spirit, camaraderie, wisdom, patience, and of course miles, and miles, and miles, of heart. They are worth more than money can buy.
*Baby Shark became the unofficial theme song of the Washington Nationals when Gerardo Pardo made it his walk up song. Watch the Washington Post’s explainer here.