“The history of the world is the biography of great men.” That statement by Thomas Carlyle, a nineteenth century historian, embodies the Great Man Theory of history, in which historical events are explained by the people who led them.
These days, professional historians shun the Great Man Theory of history. Instead, they focus on the social, political, economic, geographic, technological and other forces that shaped historical developments. They believe this offers a deeper explanation for human events. They would agree with Herbert Spencer’s observation on Carlyle’s Great Man: “Before he can remake his society, his society must make him.”
While the Great Man Theory has disappeared from academia, it continues to thrive in popular histories. To the extent people read history at all, they tend to read it in biographical form. We’d rather read stories about people than analyses of abstract concepts, even if that means we’re getting a shallower explanation.
Our preference for people over concepts runs deep in our psyche, influencing our perception of all sorts of events. When faced with something complex and abstract like the “economy,” our brains could try to grapple with the immensely complex global web of interrelated exchanges that comprise our modern economy, but it’s so much more intuitive and comforting to fall back on visions of President Obama pulling levers and twisting dials as he steers the economy. Similarly, when things go wrong, our first instinct isn’t to examine the systemic underpinnings of the crisis, it’s to find us some villains.
So what does all this have to do with executive compensation?
In executive compensation, the CEO is the Great Man. If the company does well, or the stock price increases, we give the CEO the credit and lavish him with the lucre. If the company doesn’t do well, or its stock price decreases, we blame the CEO and organize a lynch mob.
In each case, our instinct to personalize complex and abstract concepts leads us into attribution errors. A company’s performance depends on many factors, only some of which are in the CEO’s control. If commodity prices fall, or if a large customer goes out of business, or if a large competitor stumbles, or if interest rates decline, giving the CEO the credit or the blame probably isn’t analytically correct, but it is so easy, intuitive and satisfying to do so that we do it anyways.
These Great Man attribution errors can be costly, causing us to overpay bad CEOs in good times and underpay good CEOs in bad times. They distort incentives, making it less likely that a compensation program will function as a useful tool. They also distract – after all, investors ultimately want great companies, not great CEOs. A great company should not need a great CEO; its business should be so strong that it should do well even with a mediocre CEO.
Warren Buffett supposedly once described a particular company’s business as being so good that even a ham sandwich could run it. This suggests a different approach to executive compensation: the Great Ham Theory. Under this theory, we’d reward CEOs who made themselves superfluous and punish those who persisted in making themselves essential.
One Comment
We always heap credit on the leaders for the success of their organizations and blame them for their failings.
Take football as an example. The quarterbacks get more of the glory and more of the blame. The cameras are on them. The cameras do not see that the receiver was out of position.
Personally, since they will get more of the blame, I think there should be some extra reward for it. They key is aligning awards to the long term success of the organization and recognizing the value.
One idea that has been floated was aligning bonuses based on performance against peers instead of against the stock price itself. If the company outperforms its peers, there is a reward. Even if that is a negative return. On the other side, a reward is paid on an increase only if the increase outperforms its peers.