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March 26, 2013
The Dismal Science
The CEO
by Adam Smith

One of the basic tenets of finance is that people act rationally or in their best interests. Learn what people want and then provide the proper incentive and watch people sprint to do exactly what you want them to do.

For example, it has been assumed for many decades that when someone owns a home they become better citizens. They care more about the city they live in, the schools their kids attend, and are more likely be involved in civic matters. This is the reason for the mortgage deduction on our tax returns. If we buy a home, we get to keep more of the money we earn. The deduction is an incentive for us greedy people to own homes which will make us better citizens. That is precisely what the politicians want.

This can work for all kinds of situations. At one point, only about 30% of the slaves being shipped on a British slave ship survived the voyage. An economist got the government to implement one simple law and that percentage when to 90%. The law changed the way the ship owner was paid from the number of slaves put on the boat to how many live slaves got off the boat.

People are so easy to manipulate with dollars.

CEOs are just like all the rest of us. They are manipulated by dollars. Their main purpose in life is not to make a company grow and prosper, but to put as much money into their pockets as possible. This is normally accomplished by keeping their job as CEO as long as possible. How do they do this? Plausible deniability and nothing is really their idea – unless the idea works.

Let start with the “not my idea” strategy first. Most CEOs of large companies did not create those companies, they inherited them. They were not the ones that came up with the new ideas, brands, or technologies which allowed enormous growth in the company. They are really place holders, living off the work and brains of an earlier generation. But the company has to be moving in a direction right? Isn’t that what the CEO does? Provides the big picture and strategic plan for the company?

Um…..NO.

Who does that then? Consultants baby. Consultants are the lifeblood of the CEO. There are some very well known and respected consulting firms that work with most large companies.

These large companies pay millions of dollars each year to the consultants for their advice. At first this does not make sense. Instead of paying millions of dollars to consultants, why not just hire some of those consultants and then have them make recommendations.

Remember, this is the “not my idea” portion of the article.

CEOs report to the Board of Directors for the company. Consider a CEO that implements a strategy by a consulting firm, McKinsey for example, and the idea works great. The CEO then goes to the Board and tells how under his leadership the company has beautifully executed this new strategy, increasing revenues and profitability, and the CEO is a hero.

Now the opposite is also true. The idea may not work at all. The CEO confidently goes before the Board, downplays the disaster, and then reminds the Board that the idea came from the highly respected consultants. How can he be blamed when the highly respected consulting firm was so sure the idea was a winner?

See how the game is played? Consultants rarely tell a sophisticated large company something they do not already know about the company or the market they do business in. All that money for consultants is used for cover for the CEO. The CEO’s incentive is to make as much money as she can for as long as she can. The “not my idea” is a handy tool in any CEO’s toolbox.

A company I worked for hired a consultant into the company to help with our strategy. I thought this was a great step. Instead of paying millions to outside consultants, we had our own strategy person that would provide some long term strategic guidance and we would save all those millions. What was the first thing this new employee did as the head of strategy? Went out and hired some consultants.

Now for the second strategy -- “plausible deniability”.

Any major problem that surfaces in a company has to be a surprise to the CEO. This also may seem counter-intuitive. But consider the two possible scenarios.

The first is the CEO knows about a potential issue and the issue blows up to become a major problem that puts the company’s sales/profits at risk or even its very existence. The Board is going to go to the CEO to ask why he did not fix the problem. He has failed in his fiduciary responsibility and there need to be changes made at the top of the company.

The second scenario is that when a major problem surfaces, the CEO is surprised and aghast. He tells the Board he had no idea of the potential issue. He had regular staff meetings and no one ever mentioned the potential problem and he will use all of his expertise and management skill to minimize the impact. The CEO survives (though other heads will roll) for another paycheck and, more important, additional bonuses and stock options.

How does this work in a company?

Let’s say that a company relies heavily on its information systems (IS) and that the company, with CEO approval, has not spent enough to keep their system and infrastructure safe from a complete failure. Somebody outside the IS department informally lets the CEO know that the company may be at risk with its IS. The CEO then goes to the person over IS and says something like this: “You have been responsible for IS for 5 years and someone has mentioned to me that we may have some risk. Is that true?”

Implied in the CEOs statement is that if the risk is true, the person over IS has not done their job and is going to get fired. The person over IS has only one possible reply that will allow her to keep her job. “No problem here.”

If the information system collapses, then the CEO has plausible deniability. He can say, “I asked and was told there was not a problem.” Play politics to keep the paychecks coming.

CEOs range in ability from excellent to horrendous. The CEO traits I have mentioned above are found in most CEOs. The really excellent CEOs see big problems and have the ability to address and fix the problems. These CEOs are rare and worth every penny they are paid no matter how extravagant it may seem.

The rest of the CEOs are vastly overpaid. Place holders are a dime a dozen and these CEOs should be compensated appropriately.


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