CEOs with ‘Lucky’ CEO Buddies Make More

Here’s how, according to America’s corporate flacks, the CEO pay-setting process works: Corporate boards sift the known universe for executive talent. To hire and retain that talent, they pay at market-competitive rates. They only raise that pay to reward executives who perform superbly.

Here’s how CEO pay setting really works: Top corporate execs, feeling pretty full of themselves, jaunt off to their college reunions only to discover that their old business school buddies are taking home millions more than they are.

Once back home, these now-disgruntled chief execs twist arms and whine until their corporate boards recognize their true value — with new pay deals that jack up their already lavish compensation.

Apologists for CEO pay excess will, of course, scoff at this deeply unflattering description of executive suite reality. Show some evidence, their rebuttal might go, before you impugn the integrity of CEOs and corporate boards of directors.

Now we have the evidence. Harvard researcher Kelly Shue, in a brilliantly conceived new academic paper, has compellingly documented just how powerfully a “peer influence” in no way related to either skill or performance impacts what corporations pay their top executives.

Shue has extracted that evidence out of her own Harvard backyard, from a database of Harvard Business School grads who have gone on to become top executives at the nation’s top 1,500 corporations. Harvard, as Shue points out, “has historically been a major educational producer of executives.”

Harvard Business School grads have another attraction for researchers. They all belong to easily identifiable peer groups. The Harvard Business School, ever since 1949, has assigned all students into sections, and section members spend their entire first year together in the same classrooms.

By graduation, section members have formed life-long bonds. After graduation, notes Shue, they renew these bonds at alumni reunions held every five years, “extravagant four-day celebrations consisting of formal galas and panel discussions, as well as section-based tents and parties.”

Shue has tracked the impact of these reunions on executive pay. She finds, and her paper shows, “evidence of strong peer effects in executive compensation.”

Her most fascinating finding: the “pay for friend’s luck” phenomenon.

In a nutshell: A top exec in one industry gets a big pay boost thanks to some “shock” in that industry, something like a sudden rise in global oil prices in the energy industry. The executive pals of the lucky exec, who work in industries that haven’t experienced that “shock,” end up with significant pay boosts, too.

This “evidence of pay for friend’s luck,” Shue observes, helps show that “relative compensation within a peer network directly affects compensation.”

“In other words,” she explains, “executives are paid for more than firm performance and even industry performance; they are paid for lucky shocks in their social networks.”

In effect, we don’t have “pay for performance” in the upper reaches of Corporate America. We have pay for pals.