Henry V, the Tea Party and Glenn Beck

D. Eris of the Poli-tea blog has responded to my claim that the Tea Party ought to work within the two party system. Relying on the skepticism of David Hume, Poli-tea argues against "charismatic authoritarianism", which in turn is based on the claim that power must be consolidated. As well, claims Poli-tea,

"The historical argument...is negated by the very existence of a third party and independent political tradition in the United States..."

David Hume said that skepticism did not prevent him from making merry with his friends. For truly believing radical skepticism otherwise would paralyze him. Hume's skepticism denies the possibility of science. We all know that science works. Nor would Hume say that it couldn't work, rather that it is based on non-rational assumptions. As Aristotle said about ethics:

"(W)e must be content, in speaking about and from such things, to indicate the truth roughly and in outline, and we must be content in speaking about things that hold for the most part and in drawing conclusions of the same sort from such things."

The Tea Party lacks leadership not out of historical necessity or because of a law that authority must be devolved upon a dictator but rather because on a real-world level no leader has stepped forward who has the capacity to lead and who is suitably independent of the GOP's national leadership or the media, both of which ought to be viewed as tainted. Without such a leader, the Tea Party will at most be an influence on the two party system.

That is not a necessary law but a practical assumption based on the past 200 years of American history. It is possible that a spontaneous, anarchic movement could transform the yahoos in the hinterland, but I doubt it. It is a matter for practical deliberation, not logical deduction.

Finding a leader is a supply-and-demand problem. We don't generally demand great leaders, and people with leadership potential are often diverted to other pursuits. Hence, there is a leadership shortage when the demand does appear, and it is not easy to fill.

Why leadership is necessary is not well understood by anyone. The human mind has limited rational capacity. To focus a movement of millions of people requires a focal point that is easily grasped. It requires a symbol. Few Americans know who their state assemblyman is, but most know who the president is because the president is an easily understood human symbol. We are all limited beings. A leader identifies the movement or organization. He or she provides a personality.

The two videos above, of Martin Luther King and Kenneth Branagh as Henry V in Shakespeare's play, exemplify charismatic leadership. The leader must match the movement and be able to articulate a vision that matches the broad concerns that motivate the movement.

The inability of the Tea Party to generate such a leader is likely linked to the important role of television. Television is powerful because it provides a human face to ideas. But the people who operate it lack ideas, so they allow special interests to dominate their content. Many Americans rely on television, and the quick and easy way is to rely on the leadership that television presents. But television fixates on the existing establishment, which is antagonistic to the Tea Party. Moreover, there is no incentive for television to present leaders who represent the Tea Party, whose concerns are directly antagonistic to television's corporate owners.

So where will the Tea Party find its leader?

Necessarily in the rank-and-file of the Tea Party itself. The Tea Party should do as General Savage in the classic war film 12 O'clock High. It should scour the organization for anyone who can lead a mule to water. It should find the Ben Gatelys, the future King Harry's who can present a vision like the famous speech at Agincourt copied above or Martin Luther King in his wonderful "I Have a Dream" speech.

To do so the Tea Party needs its own media. Television and the print media are not enough and cannot be trusted. Without its own media, the personalities necessary are much more difficult to discern. So far, the Tea Party has not begun to take the steps necessary to institutionalize itself.

Glenn Beck, the one television personality who may prove supportive of the Tea Party, needs to focus on introducing his audience to a wide range of potential leaders within the Tea Party movement. He should demand that they be well informed about issues like the Fed and the bailout. A wide range of consistently exposed potential leaders will greatly facilitate the Tea Party's ability to think for itself.

In sum, there is no antagonism between working with the GOP and trying to establish the Tea Party as a separate movement. The two can be done in tandem. It is much harder to establish a separate movement than to influence the existing two party system, which has always been flexible to change.

It is possible that because of the influence of special interests the two party system has been unable to change. It may have become brittle. In that case, a new party may be necessary. But party building should not come at the expense of influencing the two parties. Both strategies should be vigorously tried.

Charisma in History

Charisma is sometimes suggested as a source of value. Great leadership can stimulate effort. Katz and Kahn argued that leadership can provide an increment of effort. But is charismatic leadership the true source of economic growth?

The answer is no. Economists recognize that technology and capital investment are critical sources of economic growth. Charisma existed throughout history. Ramses the Great claimed to have defeated the Hittites at Kadesh and Shakespeare commemorates Henry V's victory at Agincourt as he exhorts his outnumbered army:


"This story shall the good man teach his son;
And Crispin Crispian shall ne'er go by,
From this day to the ending of the world,
But we in it shall be remember'd;
We few, we happy few, we band of brothers;
For he to-day that sheds his blood with me
Shall be my brother; be he ne'er so vile,
This day shall gentle his condition:
And gentlemen in England now a-bed
Shall think themselves accursed they were not here,
And hold their manhoods cheap whiles any speaks
That fought with us upon Saint Crispin's day."

To what extent can charisma create economic value? It would seem incrementally. The major advances in economic history occurred because of innovation at the individual and firm levels. They occurred in the 19th and twentieth century, especially during the period of laissez-faire from the 19th to the early 20th century in England and America.

There were many examples of charisma throughout ancient and medieval history, but the economy did not progress. Fundamental progress is due to technological breakthrough, capital accumulation wisely administered and understanding of customer value. In countries where the state predominates, such as the Soviet Union, China, Cuba and Sweden, there has been little economic advance. Just like the medieval world (according to which it is conceptualized), socialism is an ideology of economic stagnation and decline. State capitalism is less socialistic and so sees less decline. The socialist economies that do function, such as Sweden's, do so in the context of globalized trading with market economies. Without globalization the Swedes would still be serfs in the bruks and communistic shared fields.

What is the role of charisma then? It provides interest, stimulation and incremental motivation. It is rarer in business than in the military or other walks of life. But there has been much more progress in business than in other institutions, except for science. And charisma is notably absent from scientific endeavor as well.

Review of Pay without Performance: the Unfulfilled Promise of Executive Compensation

Pay without Performance: The Unfulfilled Promise of Executive Compensation
Lucian Bebchuk and Jesse Fried
Cambridge, Mass.: Harvard University Press, 2004
278 pages

Pay without Performance is a well-written book that provides a post-'90s update to Graef Crystal's 1991 In Search of Excess. Bebchuk and Fried recast the 75-year old debate about executive compensation that began with Berle and Means's 1932 Modern Corporation and Private Property into two alternative models: the arm's length bargaining and the managerial power models. Their assessment, which is similar to Crystal's, is that managerial power has guided executive compensation practices and led to excesses that the authors catalogue, updating Crystal's book. Their book is more theoretical than Crystal's, but it is theoretical in an accessible and elegant way that is a pleasure to read.

Like Crystal, Bebchuk and Fried argue that top managers' extraction of rents has not been and will not be resolved by spontaneous market forces. In other words, top executives have found loopholes in the structure of the American corporation and have learned to use the loopholes to their financial advantage. The amounts of excess compensation that executives extract are probably too small per shareholder to concern the shareholders. This is so even though executives extract large sums.

Bebchuk and Fried do not discuss the broader social implications of the separation of pay from performance, but it is probably serious. Public support for the market system and belief in hard work is likely eroding because of the example that CEOs have set.

Also, Bebchuk and Fried do not discuss the role of both macroeconomic factors and human resource management factors that would potentially address the problem of excessive CEO compensation. First, with respect to macroeconomic factors, low interest rates make this issue more salient than it would be in a free market environment without loose Fed monetary policy.

As Bebchuk and Fried point out, managers have taken advantage of general stock market returns that have been boosted by low interest rates. That's not the sole cause of excessive compensation because managerial compensation is not very well-correlated even with general stock market returns. However, declining interest rates cloak shoddy management by boosting stock prices. We have been living in a twenty-five year old stock market bubble caused by increasing money supply. Any bubble is characterized by excesses in fields like executive compensation. When interest rates rise, top pay will subside. Top manager self-dealing and pontification will always exist, but it will seem less disturbing as the worst-managed firms go under and the amounts shrink.

I don't believe that improving the design of incentives will alter the pattern of self-dealing to the degree that Bebchuk and Fried believe. There is an unresolved paradox in the executive compensation literature. First, Jensen and Fama (1983), for example, claim that the hiring of insiders as directors and the informal hiring processes that characterize selection of board members can be explained by the quest to optimize board expertise. "(I)t is natural that when the internal decision control system works well, the outside members of the board are nominated by internal managers. Internal managers can use their knowledge of the organization to nominate outside board members with relevant complementary knowledge."

In fact, Jensen and Fama's contention diverges from decades of research with respect to employee selection. Formal selection methods such as structured interviews, IQ tests, job knowledge tests and work samples are superior (in psychological parlance more valid) than informal processes such as impression or subjective evaluation. Anyone with real world knowledge of the corporate world knows that executives "manage" impressions about their competence.

Moreover, there are agency problems involving board appointment such as quid pro quo, the hiring of board members who are unlikely to rock the boat and interlocking appointments. That agency theory was oblivious to the distortions of the abstract model of board governance, and the open secret of "ol' boy networks" in board appointments seems hard to believe in the post-Enron world.

The paradox is that at the same time that agency theorists have argued that "ol' boy" network board hiring practices result in more capable boards, they also argue that because of special failings of CEOs, such as risk-aversion, that result from the practices, executives deserve higher pay. As Bebchuck and Fried note, top managers tend to be risk averse and so need to be motivated with stock options. Jensen and Fama, Murphy and others claim that supply of qualified executives is wage inelastic because there are so few qualified executives. This seems contradictory. If current executives have problematic personality traits such as risk aversion, just what about them is so desirable that their supply is wage inelastic? More importantly, no one in the executive compensation literature seems to have been eager to ask these questions: What are the specific competencies, if any, that qualify executives? Where are the studies that validate the supposed competencies? Why aren't corporations falling over themselves to identify this obviously valuable information? Why, instead, do corporations insist on the secrecy of selection methods, competence information and validation of board member and executive selection?

In the book Good to Great, Jim Collins (2001) points out that the best executives focus on teamwork, set up their successors for greater success than they have achieved, display compelling modesty, are self-effacing and understated, focus on sustained results, and attribute success to factors other than themselves but take full responsibility for failure. Collins notes that these traits are not rare among the general population. They are just rare among current top managers! In other words, boards have failed to even begin to apply systematic methods to top manager selection. This would seem to be related to the character weaknesses that Bebchuk and Fried find commonly displayed in top managers' indifference to their fiduciary duties. Collins notes (p.39):

"I believe that (such) leaders exist all around us, if we just know what to look for, and that many people have the potential to evolve (into great leaders)."

If Collins is right, then there are important staffing issues. Why these aren't discussed in the compensation and governance literature is a puzzle. Where are the competency studies to identify traits necessary for directors? For CEOs? Are there systematic approaches to selecting directors, or do CEOs hire to boards guys with whom they play golf or shoot pool? I wonder how many firms use objective selection criteria in choosing a CEO or director before they are interviewed.

In 1990, Lex Donaldson (1990, paid access) criticized organizational economics and agency theory, which holds that interests of principals and agents diverge; that their interests can be aligned through incentives; and that shirking or non-compliance with ethical or contractual obligations needs to be addressed with efficient contracts and rewards. Donaldson argued that agency theory puts too much methodological emphasis on individualism. In the management literature, Donaldson pointed out, agency theory is known as MacGregor's "theory x". MacGregor argued that people who believe in theory x believe that workers cannot be trusted, that they need to be motivated by financial incentives and that they need to be monitored. In contrast, people who believe in "theory y", which MacGregor advocated, believe that people can be trusted, that they are naturally creative and that they aim to achieve.

Donaldson pointed out that most of the time people need to be motivated with a combination of theory y and theory x, but agency theory is too narrowly focused on theory x. "Organizational economics creates a theoretical scenario in which managers act opportunistically."

Donaldson argued that stewardship theory is an alternative model to agency theory. Rather than a conflict of interest between principals and agents, stewardship theory would propose that managers are team players and that "the optimal structure is one that authorizes them to act in the owners' interests". Donaldson argued that many of the governance reforms that Bebchuck and Fried propose, such as having increasingly independent directors and allowing shareholders to select directors independently of the CEO, would contradict the prescriptions of stewardship theory. Donaldson was concerned that both agency theory and stewardship theory might be too broad.

Things seem to have deteriorated since Donaldson's article. In the 1980s, there was talk of what William Ouchi (1981) called Theory Z: high trust human resource management and tight organizational culture. Ouchi argued that such arrangements are optimal because they reduce transactions costs. Similarly, until his death in 1993, W. Edwards Deming (2000) the creator of many of the ideas behind total quality management, argued that long term thinking, driving fear out of the workplace and elimination of performance appraisal were essential to good management.

Current CEO pay practices seem to have thrown the "stewardship" theory out the window. Bebchuk and Fried do not even consider that organizational culture and high trust necessitate current pay practices. If not, then it would seem that the best hopes of management theorists like MacGregor, Ouchi and Deming have been dashed. Rather than behave as part of a coherent, organic organization in which social relationships with employees and with society play a paramount role, today's executives in Bebchuk's and Fried's view function as manipulators who can be influenced by incentives, if only their tendency to outsmart the incentive plan can be overcome. This is very far from traditional "stewardship" management theory.

Instead, Bebchuk and Fried contrast the agency model with the managerial power model. According to the agency model, CEOs may engage in (p.16) "empire building, which can increase their prestige, perks, compensation and other private benefits...They may run companies in ways that are personally satisfying or convenient even if they come at the expense of shareholders. They may be tempted to pursue pet projects, for example, or they may fail to take actions that are personally costly, such as firing mediocre subordinates who also happen to be their friends." According to agency theory, directors (p.17) "take an independent position vis-a-vis executives" and bargain at arm's length." In order to counteract such tendencies, firms need to link pay with performance. But because executives are characteristically risk averse, linking pay to performance means that pay amounts must increase.

Bebchuk and Fried argue against the agency model of arm's length bargaining. Executives do not (p. 23) "instinctively seek to maximize shareholder value" so there is "no reason to expect a priori that directors will act in this way." In particular, directors of the thousand largest firms earn $116,000 just for serving on the board. They would not want to jeopardize their compensation by fighting over the CEO's pay given that the CEO is largely the one who appoints them. Moreover, most boards emphasize collegiality, so even if money is not the issue, the cultures of corporate boards involve norms that inhibit questioning the CEO's pay demands. There are also factors like friendship, reputational risks and, if the directors are themselves highly paid CEOs, cognitive dissonance.

Shareholders have a few ways to intervene, such as through law suits, voting on option plans, or resolutions, but these methods turn out to be ineffective. Likewise, takeover bids are unlikely just because of executive compensation. The 40 percent premium that takeovers require are usually too great for the one to three percent effect on stock prices due to excessive executive pay to justify.

The relatively weak correlation between executive pay and firm performance; the reissuing of stock options at lower strike prices; the use of camouflage whereby true pay amounts are not admitted or are disguised through the use of pension formulas or by failing to disclose the tax effects of deferred compensation all suggest that the exercise of managerial power rather than arm's length bargaining determine executive pay. Bebchuk and Fried do not consider the possibility that these behaviors are part of the adaptive corporation that Alfred Dupont Chandler (1962) described in Strategy and Structure. Such a claim would be far fetched.

Bebchuk and Fried present research findings that suggest that CEO power plays a role in determining pay. CEO compensation increases in tandem with the size of the board. The probability of getting a golden parachute is greater when more board members have been directly appointed by the sitting CEO. Lower institutional ownership leads to higher and less performance sensitive executive compensation. Managerial power seems to be linked to pay.

Bebchuk and Fried do an excellent job of cataloguing the different ways that boards camouflage pay through retirement pensions, deferred compensation, post-retirement perks, consulting fees and loans. They also point out that (p. 121) "managers have used their power to secure pay without performance." Cash compensation has at most weakly correlated with performance. It is, however, associated with cash windfalls that firms receive, for instance when they win a lawsuit or terminate a pension plan with excess assets. In those cases executives get a nice piece of the windfall. Executives of acquiring companies are often paid bonuses, even though acquisitions almost always result in a decline in the acquiring firm's stock price. Only 30 percent of share prices reflect corporate performance with the remaining 70 percent due to market factors like interest rates. Yet, almost all executives are compensated on the raw share price rather than on a sector-adjusted share price.

The authors, like Crystal (1991) argue against restricted stock. I take issue with that particular argument. If the value of the restricted stock is adjusted so that executives are equally well off, I would think that restricted stock is better than options. The reason is that options might encourage excessive risk taking. A large holding of stock (and nothing else) would seem to put executives in the same position as shareholders. Of course, the parenthetical "and nothing else" is the devil in the deep blue sea.

The authors conclude with a convincing set of recommendations that focus on the issue of compensation. As I have already noted, my claim is that the problem may be one of executive and board selection rather than governance and compensation.

Overall, this is a very good book. It is clearly written, practical, theoretically sound and a joy to read.

References

Collins, J. 2001. Good to Great: Why Some Companies Make the Leap and Others Don't. New York: Harper Business.

Chandler, A.D. 1962. Strategy and Structure. Cambridge, Mass.: MIT Press

Deming, WE. 2000. Out of the Crisis. Cambridge, Mass.: MIT Press.

Donaldson, L. The Ethereal Hand: Organizational Economics and Management Theory. 1990. Academy of Management Review, 15:3. 369-381.

Ouchi, W. G. 1993. Theory Z.

Jensen and Fama. 1983. "The Corporation and Private Property." Journal of Law and Economics. 26:2