WeWork shows the absurdity of American CEO compensation
WeWork, the office space sharing startup that was once a darling of the tech world, is getting a multi-billion dollar bailout. Its business model is a shambles, and reports suggest that, before the bailout, WeWork was about to run out of money as soon as next week. Given the circumstances, you'd think WeWork’s CEO and cofounder Adam Neumann would be shown the door in disgrace, for overseeing a company that's basically nosedived into the ground.
But you'd be wrong. Instead, the terms of the bailout will allow Neumann to walk away from the wreckage with a cool $1.7 billion.
Neumann's case is extreme to the point of darkly comic. But it's also an example of a much wider problem: Compensation for American CEOs simply makes no sense. It's inflated, gluttonous, absurd, completely detached from performance — and arguably coming out of the paychecks of everyone else in the country.
The traditional capitalist explanation for executive pay is that it's the mathematical result of competitive logic: If a company pays a CEO more than they're worth, they'll lose profits relative to another company that doesn't overpay. Conversely, pay your CEO less than they're worth, and the CEO will leave your company for another that pays them more. Then your company, deprived of the CEO's leadership, will fall to competition from the second company. The basic assumption here is that markets are efficient, and efficient markets pay all workers — including CEOs — what they're worth. Like it or not, the fact that CEOs make over two hundred times as much as the typical worker simply reflects how much more real value creation CEOs bring to their companies.
It's a very neat and tidy story. And needless to say, it doesn't stand up to scrutiny.
For instance, research into CEO compensation reveals that executives are often rewarded for industry-wide shocks that are pure dumb luck: Say, a jump in global oil prices leads to bigger profits for oil companies, and oil executives' compensation jumps in turn, even though a functioning competitive market that rewards for performance would do no such thing.
Even more perversely, research also shows that executives are not uniformly punished when bad luck strikes across whole industries. And even more perversely than that, studies have found that CEOs' compensation doesn't just rise together in response to random good luck events when the group you're studying is executives in a particular industry — it rises together when the group you're studying is randomly assigned Harvard Business School classmates in completely different industries.
Here in the states, the ratio of CEO pay to typical workers' pay is often double what it is in other western countries. And the companies outside the U.S. that pay their CEOs the same way we do often have very similar corporate governance setups to ours, versus the other companies in the advanced world that pay less.
Within corporate governance, there are a lot of questionable practices that essentially hide the realities of CEO pay from a lot of shareholders. In fact, U.S. corporate governance is just shot through with problems that result in CEOs being able to take their companies for a ride. There is often an extremely cozy relationship between chief executives and corporate boards, with CEOs often having a major hand in picking the people who are ostensibly supposed to oversee them and discipline them and set their pay.
Shareholders are supposed to discipline corporate board members, and thus exercise authority over CEOs as well. And the capitalist logic of financial markets is that shareholders will constrain CEO pay for their own self-interest — to keep companies profitable and keep their own dividends up. But executives and board members alike are often drawn from the same class of the most powerful shareholders, and it often makes more sense to think of them as a single group that's gained enough institutional power and leverage in the ecosystem of firms to just extract money willy-nilly from the businesses they oversee.
The Japanese conglomerate Softbank owned 30 percent of WeWork shares before the crisis, it's providing over $9 billion in bailout money, after already sinking over $9 billion into the company, and it will own about 80 percent of WeWork when this is all over.
Now, the bulk of Neumann's golden parachute is $970 million in shares that WeWork will buy from him under the terms of the bailout. The official defense of this move is that it gets Neumann out the door: Thanks to the way WeWork was initially set up, Neumann enjoyed a special kind of stock that gave him outsized voting power and de facto control of the company. In other words, Softbank knows he's incompetent, but they can't reform the company unless he's out of the way, and that required buying him out. But that raises the question of how the rules and norms of U.S. corporate governance ever allowed Neumann to amass that kind of power to begin with.
What is even harder to explain is that Neumann's payout also includes a $500 million credit line to repay previous loans, and a $185 million "consultation" fee — while as many as 4,000 WeWork employees lose their jobs. You have to wonder what Softbank and its own CEO, Masayoshi Son, could possibly be thinking.
There are several possible avenues for addressing all this. The U.S. has plenty of laws governing how corporations are to be structured and run, and those rules can be reformed to tighten up companies' internal governance. We could also give workers more power — through stronger unions and labor law and representation on corporate boards — to counteract the power of the shareholder class. One ground-breaking study even suggests that much higher taxes on the wealthy would actually raise the pay going to everyday workers at companies: If extracting money from companies is less profitable because more of it gets taxed away, then executives and their cronies might do less of it. And that would leave more money for actual productive activity, like creating jobs and raising wages.
One thing is obvious. The story about how CEOs are simply being paid for the quality of their performance is nonsense. "[Neumann] lit $10 billion of SoftBank's money on fire and then went back to them and demanded a 10 percent commission," Bloomberg's Matt Levine caustically observed. It's good work if you can get it.