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The Third Rail of Management: Safety Guidelines for CEOs

Contributor: Sydney Finkelstein
Posted: May 14, 2017

As a Ph.D student in the 1980s, I studied corporate proxy statements to research how much senior executives were paid. I pored through these documents to identify the highest earning managers in a company. I usually found the data in an easy-to-read table listing salary, bonus, and stock options.

Try doing that today. The simple table is long gone, as pressure for better disclosure has given rise to numerous columns of data on things like restricted stock, performance units, supplemental grants, post-employment compensation, and even such quaint artifacts of a bygone era: salary and bonus. Then there’s a separate table for stock options (granted, exercisable, timing, exercise price, etc.), as well as a list of peer companies so shareholders have a relevant point of comparison.

While all this additional reporting was meant to provide better data to shareholders about the companies they own, it also resulted in an outcome that did not do the shareholders themselves any favors: CEO and other executive compensation has skyrocketed, increasing 725% over the last 30 years in the United States and 350% in Germany during the same time period.

Welcome to the world of unintended consequences. For every great plan, there are unforeseen events, mishaps and sometimes a result that is completely opposite to intentions.

Unintended consequences are the third rail of management. No matter how seemingly sensible our intentions, unexpected things will happen, almost all of the time.

Laying bare the many forms of compensation accruing to CEOs has not reined in giant pay packages, but rather has done quite the opposite. It turns out that when data on compensation is openly available, it’s easier to compare what other CEOs are earning to what you’re getting. No one believes they should be underpaid and companies continue to compete for top executive talent, so pay ratchets up.

This is also true when you look across countries. The pay premium earned by U.S. CEOs relative to executives in other developed countries declined in the 2000s, the same decade that several European Union countries adopted disclosure rules for compensation, including the U.K., Norway, and Switzerland. From 2003 to 2007, for example, the U.S. pay premium (relative to other countries) dropped from 58% to 2%. As boards and CEOs become aware of what others are getting paid, they will be motivated to ensure their own pay matches the going rate, apparently even across continents.

Surely these problems are not exclusive to the world of business. A town in eastern Canada had a problem with its municipal rubbish pickup. To complete their routes, workers were racking up overtime hours, at great cost to the town.

So the city council came up with a solution: All rubbish collectors would be paid for eight hours of work, regardless of how long it took them to complete their task. If they were done quickly, they still got the full day’s pay. If they took longer, they got the same eight hours pay.

What do you think happened?

Not quite what the city council expected. First, complaints went up. Rubbish didn’t always make it into the truck as workers hurried from house to house. Then, speeding tickets and accidents increased, as drivers rushed through their routes. 

It’s up to managers to think and rethink in order to avoid blunders. It’s a bit like the Hippocratic Oath, the first principle of medical ethics: Do no harm. When we change the rules for how people work, we mustn’t worsen conditions.

Easier said than done.

Problem: Medical residents, for instance, are working excessively long hours, compromising care and even creating medical problems for themselves.

Solution: Cut back on hours.

Reality: The source of many medical errors is the “handover” between residents or physicians, when the outgoing resident transfers key information to the incoming shift. With shorter shifts, you inevitably get more handovers and with more handovers you get more mistakes. How could that be? Shockingly, doctors are not much better at communicating during handovers than they are at other times, leading to incomplete information-sharing on patient status.

In fact, one recent study indicated that residents who worked shorter, 16-hour shifts actually made more medical mistakes than residents who worked 24 hours.

Tight budgets complicate matters further. Just because residents are working shorter shifts doesn’t mean you get to add more residents. So, much of the work completed in a 24-hour shift gets packed into 16 hours.

Changing the rules that govern how people do their jobs — whether it is collecting trash, interning as a medical resident, or determining CEO compensation — turns out to be a risky proposition.

The next time someone suggests doing so at your organization, remind him or her of the Hippocratic Oath. And then get ready for turmoil.

Sydney Finkelstein is the Steven Roth Professor of Management and Director of the Leadership Center at the Tuck School of Business at Dartmouth College. His latest bestselling book is Superbosses: How Exceptional Leaders Manage the Flow of Talent (Portfolio/Penguin, 2016).