Harry Potter and the $100 million/year manager

Yesterday’s posting raises the question “if an executive can’t do a good job for $2 million/year, will he do a good job when paid $20 million/year?”  The moribund U.S. economy seems to suggest that paying out huge sums to managers is not effective.  The Israel Essay questions whether our current economic slump may not be due to the fact that companies can’t afford to invest profits in technology and equipment because they’ve paid out all of their profits to senior managers.  Today we’ll try to figure out if, even if cash were free, it is a smart idea to make corporate managers as rich as Rockefellers.

Suppose that you owned a small company and had a money tree in the back yard.  You can now pay your managers as much as you want without reducing profits.  Should you advertise for a CEO at $75 million/year?  On the plus side this is more than most American CEOs earn (see http://www.forbes.com/ceos) and therefore you should be able to recruit someone good.  On the minus side, however, think about how focussed on work you’d be if someone handed you a $75 million check tomorrow.  You’d probably move into a bigger apartment and redecorate.  And wouldn’t it be nice to have a few vacation houses?  You know that you’ll be traveling by private jet from now on, but to which of the 50 fractional jet ownership plans should you subscribe?  You’re going to get invited to a lot of fun charity events so you’ll need a new wardrobe.  In short, living like a rich person is very time-consuming.

Getting back to the owner’s perspective…  perhaps an investment would be best managed by a comfortably well-off manager, rich enough to afford a new car that won’t break down and be a distraction from her duties but not rich enough that she spends several days per week shopping for private islands.

Has this experiment been done?  Absolutely.  Consider the Harry Potter books.  As our friend Jin says, it is a mistake to compare Harry Potter to Shakespeare:  “Harry Potter is a fictional character; J.K. Rowling is the modern equivalent of Shakespeare.”  Unlike the Bard, however, J.K. Rowling was not perennially short of funds.  Let’s look at her productivity:

  • 1997:  Harry Potter and the Philosopher’s Stone published; the American rights are eventually worth enough that Rowling can quit her day job (teaching high school)
  • 1998: Harry Potter and the Chamber of Secrets published
  • 1999: Harry Potter and the Prisoner of Azkaban published; all three books are on the New York Times bestseller list.
  • 2000:  Harry Potter and the Goblet of Fire published, movie rights to first book sold; Rowling ascends to the “movie rich” class of authors.
  • 2003: Harry Potter, Book 5 completed.  Thanks to merchandising, Rowling is now richer than the Queen of England.

One year per book while Rowling’s financial condition ranged from struggling to sort-of rich.  Three years per book after Rowling became rich enough to buy castles, private jets, etc.

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Iraqis running the U.S. airlines?

American soldiers uncover nearly $1 billion in cash in Baghdad.  Former leaders such as Saddam probably have at least $5-10 billion more in their Swiss bank accounts (even the minor Arab dictators are among the world’s wealthiest people, e.g., Yasser Arafat is estimated to have a personal checking account containing $1.3 billion siphoned from Western aid).  Meanwhile we were told throughout the 1990s that Iraqi children lacked food and medicine.

Is there an analogous situation right here at home?  Hmm… the Board and managers of American Airlines helped themselves back in October 2002 to $41 million to guarantee their personal pensions while CEO Don Carty was stating that “Shared sacrifice has to lead to shared success…”.  Thousands of workers were being laid off, thousands more taking pay cuts from what in some cases were very modest salaries.  In theory you’re not supposed to start spiriting away a company’s assets or giving them to your pals before you file for Chapter 11 bankruptcy protection from your creditors.  In practice the lawyer’s for American’s executives managed to construct a trust from themselves that would be unassailable and to hide the trust from their workers, creditors, and the public until a recent mandatory SEC disclosure.

http://www.governancemetrics.com rates American’s parent company, AMR, as “above average” in corporate governance.

Meanwhile US Airways emerged from bankruptcy.  The creditors got 2 cents for every dollar that they were owed.  The managers who drafted the reorganization plan decided that their shareholders, the folks who’d paid their salary to manage their investment, were entitled to 0 percent of the new company.  They themselves, however, felt that their hard work and dedication entitled them to 8 percent of the shares in the reorganized enterprise.  The theory here is that it is tough for a manager to do a good job if he or she is paid only a straight cash salary of several million dollars; the manager also needs to get an additional $10-20 million per year in stock.  Business school professors who’ve studied this question find that managers who don’t get any stock or stock options do just as good a job as those who transfer a substantial portion of the company into their pockets.

US Airways likes to pay their executives even when they don’t work.  Three top executives offered themselves $45 million in the event that they decided to stay at home instead of working at a merged US Air/United Airlines.  The merger never went through but the guys took home an extra $35 million for failing.  How did the US Airways workers fare by comparison?  Nearly 20,000 have lost their jobs entirely; the rest have taken pay cuts (a US Airways flight attendant earned between $18,000 and $38,000 per year before the cuts).

How is this situation different from other industries in the U.S.?  Isn’t it very common for managers and their cronies on the Board to steal from the shareholders?  Of course.  But the airlines are different because their executives have bludgeoned their shareholders so badly that there is nothing left to steal.  The airline execs are taking hundreds of $millions in salary out of the $6.9 billion in federal aid that has come out of taxpayers’ pockets since September 11.

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