ObamaCare was watershed legislation for the health industry. The infusion of taxpayer money enriched companies and their executives almost beyond comprehension. When the median income of Americans was less than $30,000 annually many CEOs made more than that daily — before lunch!
To cite just one example, John Martin, made $863 million during the ObamaCare years as CEO of the pharmaceutical company Gilead Sciences.
Read the details here.
(I never know what to think about people who, in one breath, excoriate “greedy” pharmaceutical companies and in the next advocate government funding of health care.)
The rationale for these exorbitant pay scales is that aligning compensation with stock value incentivizes the CEO to focus on corporate financial health. That sounds good – tying compensation to the value of the company will keep the CEO focused on growth and productivity, but it simply doesn’t work.
For one thing, it encourages what Rana Foroohar calls “financialism” in her book Makers and Takers. Foroohar does a great job of making complex financial shenanigans understandable and explains how laying off employees or taking on debt benefits stock valuation, at least in the short run.
Leadership focusing on stock valuation often results in losing sight of the distinctive competencies that made the corporation successful. Companies fail to “stick to the knitting” and drift into banking, real estate and insurance ventures instead of their areas of long-term expertise. Read my recent blog Financialism leads to agony for GE and Sears for examples.
In his landmark book, Good to Great, Harvard business professor Jim Collins examined the role of CEOs in eleven companies that overcame challenges threatening their existence, yet survived to outperform the stock market for at least five years. He identified five CEO traits pivotal to the survival and success of these companies, naming them Level Five Leadership Traits:
- Humility cloaking hard edged resolve
- Ability to articulate threats and vision to win the support of an entire corporation
- Superior organizational skills. “Get the right people sitting in the right seats on the bus to success.”
- They are willing to join subordinates toiling in dull non-glamorous tasks.
- Contributions spring from talent, knowledge, skills and traditional work habits.
None of these sound like traits shared buy CEOs of Sears, General Electric or General Motors, all venerated American companies facing uncertain futures. To the contrary, the CEOs of each of these companies succumbed to the temptation of financialism and now find themselves managing a slow motion train wreck.
Collins gives examples of Level Five leaders turning away from lucrative stock options and instead taking on the arduous task of turning large companies away from disaster. Why do some CEOs chose this path, while others focus on running up the value of their company by any means possible, then cashing in stock options and leaving a mess for bankruptcy attorneys?
Adam Smith was a Scottish economist who established fundamental rules of economics in Wealth of Nations in 1776. Smith came up with the idea of Supply and Demand, stating that rational people work only in their own interests, but by doing so create an economy that benefits everyone. This is the concept of the famous “invisible hand”.
That might be fine for economists, but modern psychologists are challenging the notion of rational actors acting in their own interests. After all, sometimes people work very hard, but have no expectation of reward.
Why do we put effort, and sometimes a great deal of money, into hobbies? Why do we work for free and call it volunteering? Or donate to social causes that benefit people we will never meet?
These are questions the emerging field of behavioral economics addresses.
Pioneered by Daniel Kahneman and Amos Tversky in the 1970’s behavioral economics is now a field attracting social psychologists and neuropsychologists. Kahnemans’ thick tome Thinking Fast and Slow is a summary of his life’s work.
Dan Ariely is a social psychologist with an unshakable interest in exploring why we do things that do not generate rewards that should motivate us. His interest began when a former student visited him with an intriguing question.
The student had graduated and accepted a job with a prestigious investment bank and recently worked on a presentation his boss was to give on a merger and acquisition deal the bank was engaging in. The student worked very hard on the project for a number of weeks. He produced a beautiful presentation with engaging pictures, informative graphs and convincing text.
The boss was elated with the quality of the project and promised the young man a bonus for his efforts, but gently broke the news that the M&A deal was off and the presentation no longer needed.
The question the former student poised for Ariely was that even though he was compensated for the work, received a bonus and praise from the boss, he felt empty. Suddenly he didn’t care about the project he had worked so hard on. He realized he didn’t care much about the other things he was doing for the bank, either.
From a functional perspective, nothing had changed; he was still being well paid, the job gave him enviable social status, and the company paid even his laundry bill. The only thing that changed was that his work would not see the light of day. Why would this cause so much disappointment?
Many years ago, I was a behavior analyst working with intellectually disabled clients. At one point, I was asked to create a behavior plan for a client who was exhibiting sudden violent behaviors at his vocational setting. He had been in the vocational program for some time without incident, but lately would suddenly destroy property and assault staff for no apparent reason.
It took only a few minutes to see what the problem was.
The staff placed a large flat box in front of the client with dozens of little square compartments, each with a picture of a nut, bolt or washer, on the bottom of the compartment. This was a training device for the client to practice sorting parts. The client began pulling nuts, bolts and washers from a large coffee can, examining them closely and then searching for the compartment with a matching picture.
So far so good.
The client was slow and methodical, clearly being very conscientious about his work. However, he was a little too slow and the staff urged him on, making sure that he did not forget about the kitchen timer ticking away on a nearby shelf.
Soon the timer’s loud bell went off, and the client reluctantly leaned back so the staff could examine his work, making a few notes on a clipboard. Then, right in front of the client, she upended the box into a funnel and back into the coffee can. All the nuts and bolts the client so intently sorted were in the same place they were when he started sorting. Then she put the empty box in front of the client and reset the timer for the next trial.
And what do you suppose the client did?
He looked at the empty compartments incredulously, then at the staff. He shot to his feet, grabbed the box, lifted it over his head and smashed it onto the table. Then he went after the staff.
The client had the same experience as Ariely’s former student. Both had worked hard only to see their efforts summarily erased. In both cases compensation was not an issue, and the actions of others was devastating.
Ariely and his colleagues investigated this question at length in dozens of ingenuous experiments documented in Arielys book, The Upside of Irrationality.
One of the first things Ariely found out was that when a task is simple and physical incentives worked well to increase performance. However, when a task was even minimally cognitive higher incentives led to lower performance.
Ariely concluded that higher incentives became a distraction when cognitive tasks are involved. Students often have much higher scores when taking practice SAT tests compared to actual SAT tests, for example. We call it “choking” – when the pressure to perform well undermines our ability to do so.
These results are not exactly earthshattering, but they led Ariely to think about the nature of work. Why do we volunteer or work hard at hobbies that don’t have incentives associated with them? Is there some sort of natural incentive that rewards us for working?
Back in the 60’s animal studies found that rats trained to press a lever for food would continue to press the lever occasionally even when food was freely available. Researchers found that 44% of rats would manually deliver more than half their daily food intake.
Subsequent experiments found this was common in all sorts of animals. Why would an animal prefer to exert effort to get food rather than just allow it to be delivered? Is there something inherently rewarding about work?
It seems there is.
In his book Satisfaction: Sensation Seeking, Novelty, and the Science of Finding True Fulfillment, Gregory Berns tells about an fMRI experiment by researcher Cary Zink.
Zink instructed volunteers press a button when particular shapes appeared on a computer screen. During the trial, a dollar bill would materialize on the screen. In one condition, the dollar was automatically deposited into a virtual bank, and in another, the volunteer had to push a button to make the deposit.
As the subjects were performing these tasks, their striatums were monitored. The striatum is a small structure at the base of the brain associated with the reward system. When the striatum is active, we are pleased.
The interesting thing about Zink’s experiment was that when the subjects were required to press a button to deposit their money their striatum indicated more pleasure. In the Spartan context of the experiment, this constitutes work. Zink concluded that doing something – working – in order to receive a reward was more satisfying than passively accepting a reward.
Much like the animal experiments, Zink’s research suggests that humans experience happiness when earning rewards rather than being given them.
Berns found out something else about the striatum in his experiments on motivation. It reacts to novel information. We feel a sense of pleasure when we run across new things we have not experienced before. No only does the striatum reward us for making an effort, it also reacts to the results of that effort – something new and different from before.
This implies that we are inherently motivated not only to explore novel experiences, but to create them as well. The reward of work is not just the money we receive, but the experience of work as well. That is why we forgo pay to volunteer and spend money on hobbies.
So what is going on with our highly compensated CEOs?
First, when compensation is tied to corporate stock value CEOs are detracted from the distinctive competencies that have driven past successes, and focus instead on stock price. This encourages financialism, which is often the death knell of a company.
The other thing that happens is that like most other animals and humans, the CEO has a drive to change the world in some way. Given the size of his or her compensation, big changes are expected.
By tying large compensation to stock price, Boards are not only distracting the CEO from “tending the knitting”, but also priming them to make these distracted changes in a big way.
It is doubtful we will see any reforms to corporate compensation in the near future, but talking about what needs to happen will make that day come just a little sooner.
Books used in this article:
Ariely, D. (2010). The upside of irrationality: The unexpected benefits of defying logic at work and at home. New York: Harper.
Berns, G. (2005). Satisfaction: Sensation Seeking, Novelty, and the Science of Finding True Fulfillment (1st ed.). New York: Henry Holt.
Collins, J. C. (2001). Good to great: Why some companies make the leap–and others don’t (1st ed.). New York, NY: HarperBusiness
Foroohar, R. (2016). Makers and takers: The rise of finance and the fall of American business (First edition. ed.). New York: Crown Business.
Kahneman, D. (2011). Thinking, fast and slow (1st ed.). New York: Farrar, Straus and Giroux.
Smith, A. (2015). The wealth of nations. New York: Fall River Press.