Who assumes risk? Not executives.

December 30, 2007

We are told risk is one of the major reasons executives get paid more. In order to attract their talents and contacts and skills and money, businesses have to fork over cash. And “risk” is often also cited as the reason we should get rid of, or minimize, capital gains and other taxes on the rich. The theory here is that the rich need encouragement to invest their money, and if we discourage them in any way we do our economy harm.

But what is the risk that justifies their inflated salaries? Consider Circuit City:

The basic story is that last March, the wise men who run Circuit City came up with the brilliant idea of laying off their more senior salespeople, who get $14-$15 an hour, and replacing them with new hires who get around $9 an hour. It turns out that this move was not very good for business. One of the reasons that people go to a store like Circuit City, rather than buying things on the Internet, is that they want to be able to talk to a knowledgeable salesperson. Since Circuit City had laid off their knowledgeable salespeople, there was little reason to shop there. … The Post reports that Circuit City’s executive vice-presidents will get retention awards of $1 million each. [ Santa Claus Comes for Failed Business Executives, via Boing Boing Gadgets ]

Circuit City executives, seeking an improvement in the bottom line through cost-cutting measures rather than innovation, laid off their most experienced workers. This made Circuit City’s value to customers less. And it embittered remaining Circuit City employees, who learned in the lay-off that experience was considered a handicap, not a benefit. Circuit City became one of the more depressing stores to visit as the embittered employees were not inclined to offer much in the way of customer service, further reducing the value of the store to customers. And now the stores are suffering greatly, many will likely close. And the executives are getting million dollar bonuses this year for not quitting.

Who took the financial risk here?

The people who take the most financial risk are the people on the lower tier. The managed, not the executives. The executives have contract agreements, bonuses not tied to performance, and they get hefty severance packages when they are fired. No Circuit City executive is likely sleep on someone else’s couch because he or she loses his or her Circuit City job. But the experienced, loyal employee — the one that worked for several years to make $6 an hour more than the new hire — gets a little notice, loses health care, and has to go hunting for another low-paying job before the eviction notice arrives or the car he or she depends on to get to work gets repossessed.

When someone who is not independently wealthy takes a job with a company, that person is relying on that company being stable, intelligent, and treating its employees right. If the company fails at this through the boneheaded decisions of an executive team insulated from any true risk, it is the employees who suffer the most. And the executives continue to get bonuses or move to other high-paying executive positions. And an employee can get the ax for speaking rudely to a customer or not selling enough customer loyalty memberships, but an executive who decimates a national chain and makes the share price fall 75%? That person gets a retention bonus.

It hardly seems fair. But fairness is another post.

Posted in Commerce