When the game is rigged in favour of the boss.
Warren Buffett has repeatedly used his "letter" to Berkshire Hathaway's shareholders to complain about pay. The "boardroom atmosphere almost invariably sedates [directors'] fiduciary genes," he observed on one occasion. "Collegiality trumps independence." In 2003, with the scandals of WorldCom and Enron still smouldering, the great investor issued a challenge to directors across the country. "In judging whether corporate America is serious about reforming itself, CEO pay remains the acid test," he wrote. "To date, the results aren't encouraging."
One sign that something is amiss comes from studies that seem to point to a failure of governance. Take research by Marianne Bertrand of the University of Chicago and Sendhil Mullainathan, a Harvard economist. Reasoning that executives should be paid for their own accomplishments but not for sheer good fortune, they investigated whether chief executives were in fact paid for luck.
In the oil industry they found that chief executives' pay always benefits when the oil price is high, but does not necessarily suffer correspondingly when the price is low. Across a large collection of companies, they looked at the effect of changes over which managers have no control, such as shifts in exchange rates. They found that the typical firm rewards its chief executive as much for luck as it does for good performance. The effect cannot be explained simply by the increase in the value of managers' share options: it also shows up in their base salaries and bonuses, which are directly controlled by boards. Revealingly, the rewards for luck were smaller in companies that were judged to be well governed.
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