The Cost of Talent: How Executives and Professionals are Paid and How It Affects America
In 1992, the 1,059 partners in ten of New York’s largest law firms averaged $957,000 as their shares of their firms’ profits. Some physicians affiliated with the country’s leading medical schools received incomes exceeding $1 million. Executives did even better. Among fifty companies recently examined by Fortune magazine, each compensated its leading executive in excess of $5 million, rising to $11 million at Philip Morris and $15 million at General Electric.1 Corporate salaries are commonly augmented by stock awards. The current chairman of Coca-Cola, for example, has already amassed a portfolio of more than $300 million.
Derek Bok, who recently retired after twenty-two years as president of Harvard, is concerned over “the acquisitive, self-centered goals reflected in our compensation practices.” He uses phrases like “undeserved income” and “unwarranted wealth” to characterize the stipends of all too many executives and professionals. While The Cost of Talent is a highly opinionated book, it also contains much valuable information, historical as well as current, about what can be earned in law and medicine, business, and public service, as well as in teaching in schools and colleges.
Whether we look at surgeons or casual laborers, the same question arises: What is an appropriate wage for the services they provide? Needless to say, we all have opinions about our own and others’ incomes. Most usually, these often tend to be reactive ones, stirred on hearing of payments we feel are too high or too low. But after that, it is by no means easy to set up universal standards for determining what a just wage would be. Dozens of factors intervene, from competitive considerations to notions of need and worth and equity. These ambiguities are illustrated throughout Bok’s book. For example, he uses the term “earnings” freely, even when describing payments he deplores. Yet when we speak of money as having been earned we often mean that the amount is merited. Even calling a figure “merited” can be equivocal, since it can express moral approbation or refer to a market valuation. It soon emerges that Bok tends to think incomes should be set by the market. So when he refers to some salaries as “undeserved,” he is commenting as an analyst, suggesting that society could get the same kind or quality of work for less than it is currently being billed for.
As I have noted, doctors can make more than $1 million. But such incomes are not earned in an open medical market, since few patients can pay the high current charges or fees from their own pockets. Bok shows how the rest of us have been subsidizing some physicians, owing to “the willingness of the government and private insurance plans to approve their fees and reimburse them accordingly.” Until recently, doctors have got virtually all they demanded from the repayment system, not least because no price was deemed too high for professionals who “save lives.” Yet this deference is waning, in part because fewer people have a close association with a family doctor. Moreover, if medical incomes do decline, this will be less the result of legislation than of decisions of employers, who are no longer willing to pay a large proportion of the bills. We are likely to see the emergence of a second tier of medical doctors, who work in managed-care clinics or store-front offices. Even so, some specialists have become adept at marketing themselves as having their own mystique, so they will continue to be very highly paid.
Bok has a harder time with well-paid lawyers. Last year, Sullivan & Cromwell billed its clients an average of $750,000 each for work done by the 463 partners and associates on its staff. No doubt equally expert legal service could be obtained elsewhere at lower cost. But companies seem willing to stay with the elite firms since trading down might cast doubts on their own solvency or status. Whether agreeing to pay more than you have to makes sense is an old puzzle. (Think of what we have paid for dinners or dresses only to impress someone who was not impressed.) In a similar vein, top firms give $90,000 to students fresh from law school, even though they could get most of them or people just as good for not much over half that amount. (Each year, some 36,000 men and women receive law degrees; among them there can hardly be a shortage of promising candidates.) But such symbolic sums are seen as needed, if clients are to be persuaded that the firm hires only “the best.”
The Cost of Talent never clarifies whether pocketing what clients freely pay can still be defined as “undeserved” income. The partners of a law firm are owners of a business, in an industry with no shortage of competitors. Since they can claim that clients consent to their fees, they see nothing odd about charging what the market will bear. As with dress designers and other entrepreneurs, profits can come from trading on one’s name as well as providing goods or services. Writers and publishers can prosper in much the same way, thanks to people’s willingness to pay $22.95 for a physical product that—once sales pass a certain point—may cost $1.20 to run off the press.
With executive compensation, even more ambiguities arise. Bok leads off by asserting that, in far too many cases, “pay for top executives has turned out to be a sham and an embarrassment.” He begins by invoking the model of a “perfectly competitive world,” in which “all chief executives would receive amounts approximating what they added to the net profits of their company.” Yet corporate boards often continue to reward managers of companies with mediocre records. Still, a second step must be taken after agreeing that chief executives’ paychecks should be related to performance. To cite one example, General Electric’s profits in 1992 came to $4.6 billion, a notable advance over the previous year’s figure of $2.6 billion. But a decision must then be made whether the chairman’s reward should be $200,000 or $2 million or $20 million. Nor is the last amount fantastical. A Year earlier, the Walt Disney directors gave Michael Eisner $37 million, in gratitude not only for spectacular profits, but—at least as important—for adding $5 billion to the value of the company’s stock. Even so caustic a critic of executive compensation as the economist Graef Crystal considered the figure Eisner received to be earned and appropriate.2 It would be interesting to know if Bok feels there could ever be circumstances that justify eight-digit compensations.
A few pages later, however, Bok suggests a rather different measure of executive worth. Here it is the salary it would take to keep a man or woman from leaving, assuming they are people the company wants to keep. Of course, the only real way to know is to wait until that person receives an outside offer, and then estimate by how much it must be topped. More usually, firms try to keep their key people contented by paying them well. But even here, Bok believes, much more money than is necessary is being passed around, including payments to executives whose market value has never been verified. He also reports that “more than 70 percent of all CEOs are hired from within and that most are not many years from retirement.” Bok seems to be suggesting the possibility that they might even take on the top job without much if any rise in pay. Since the United States cannot grant knighthoods, perhaps honorary degrees could be set aside for executives who would agree to more modest checks and more spartan perquisites.
If we overpay some professions, we are underpaying others. Bok is not alone in worrying that some critical occupations are no longer attracting applicants, or not enough of suitable quality. On the whole, it seems true that if people are given the opportunity to choose, they will select better-paying careers. We know that talented women once settled for nursing and teaching because they had few other choices. Today many of them avoid those occupations in favor of better paying professions. Young people also have higher expectations about the way they want to live. The salaries currently offered to parole officers and social workers cannot provide for the diversions which members of the current generation take for granted. Many will agree with Bok’s exhortation to increase the pay in such fields, but the questionable premises of his argument emerge when he writes:
Compensation has an important effect in determining which sectors of society claim the largest shares from the finite pool of intellectual talent.
In a chapter entitled “Summing Up,” he posits that every society contains only “a limited supply of highly talented, educated people,” and we will set our house in order only if we “begin thinking of talent as a finite resource.”
No doubt wage levels are central to the decisions people make about careers. But it is another matter to presume that the population of this or any other nation contains only a “finite” supply of capable people. So firmly does Bok hold this position that at no point in The Cost of Talent does he allow that the country’s pool of competent people might be enlarged.
There is, of course, another view. Throughout history, most human talents have remained dormant, because the systems under which people have lived lacked the capacity or interest to make use of their fullest potential. The chief reason for the great migrations to America has been the opportunities this country has offered for realizing the abilities people sensed that they had but could not develop in more constricted settings. The exigencies of wartime have also brought out all sorts of skills—including capacities for leadership—that people were never aware that they had. Or we may simply look at countries such as Germany which ask and expect more of factory workers, thus upgrading the aggregate intelligence of their labor force. But Bok seems unimpressed with these and similar lessons. Since he starts from a premise of a circumscribed stock of talent, he sees the problem as one of how to allocate very scarce skills. Perhaps such a position is not surprising in someone who presided over a college which takes pride in rejecting a very large majority of its applicants.
Equally arguable is Bok’s use of “intellectual” to describe the skills and aptitudes society most needs. He tells us that by current measures, the typical law student is at least “the intellectual equal” of doctoral candidates in the humanities and social sciences. This seems an arguable statement, since many graduate students show an affinity for ideas, something one encounters less frequently in law schools. However, we soon learn that Bok considers that grades on college transcripts and scores on multiple-choice tests are a reliable measure of “intellectual talent.” Good grades certainly attest to a willingness to do assignments to a teacher’s liking. And it may also be granted that a certain kind of agility is needed for supplying speedy answers to questions like the one reproduced on this page. Yet it often emerges that temperaments that flounder on such tests still have a strong capacity for scholarship in fields like philosophy, literature, and history.
American Lawyer (July/August 1993), p. 47; Chronicle of Higher Education (May 5, 1993), pp. A17–A18; Fortune (June 14, 1993), pp. 102–111. Under recent Internal Revenue Service regulations, implementing legislation passed last year, firms will not be allowed to claim salary payments over $1 million as a deductible business expense, unless they can show that such remuneration satisfies a "performance-based" plan.↩
"CEO Compensation: The Case of Michael Eisner," in Fred K. Foulkes, editor, Executive Compensation: A Strategic Guide for the 1990s (Harvard Business School Press, 1991), pp. 353–365. For 1993, however, Eisner received only his $750,000 base salary, apparently owing to his boards' displeasure over the losses the company has incurred with its ill-fated Euro-Disney project.↩
American Lawyer (July/August 1993), p. 47; Chronicle of Higher Education (May 5, 1993), pp. A17–A18; Fortune (June 14, 1993), pp. 102–111. Under recent Internal Revenue Service regulations, implementing legislation passed last year, firms will not be allowed to claim salary payments over $1 million as a deductible business expense, unless they can show that such remuneration satisfies a “performance-based” plan.↩
“CEO Compensation: The Case of Michael Eisner,” in Fred K. Foulkes, editor, Executive Compensation: A Strategic Guide for the 1990s (Harvard Business School Press, 1991), pp. 353–365. For 1993, however, Eisner received only his $750,000 base salary, apparently owing to his boards’ displeasure over the losses the company has incurred with its ill-fated Euro-Disney project.↩