Yet again, the Canadian Centre for Policy Alternatives released a study of CEO Pay in Canada that misleads readers. A quote: “Just as most Canadians are wrapping up lunch break on the first official work day of the year — 1:11 p.m. on January 2 — the average of the 100 highest paid CEOs will have already pocketed what it takes the average Canadian an entire year to earn. All in a day’s work.” If you thought that meant that the average Canadian CEO earns in about 4 hours what the average worker earns all year, you’re mistaken, but I don’t blame you. In reality, the average CEO pay is 171 times higher, which means that it takes CEOs about a day and a half to earn what the average worker earns in a year. The idea is that the CEO was paid for Jan. 1 as well. I don’t see the point of being unclear about this. CEO pay is extreme enough that there is no need to make it look worse. Perhaps the mention of “January 2” was meant to add some clarity, but it doesn’t help much. Only more...

When we enter into ventures with others, it's important that our interests are aligned so that we're working toward the same goal. This is true whether you're selling your house or investing your life savings with a financial advisor. Figuring out when intersts are well-aligned can be tricky. When you sell your house and pay a real estate agent a percentage of the house price, it may seem that your interests are well-aligned, but in reality they are not. One way to look at this situation is that the more you get for your house, the more the real estate agent gets paid. But this is too superficial. The real estate agent's main concern is her pay per hour worked. Selling your house for an extra $25,000 is much less important to her than selling it quickly. For you, that extra $25,000 makes a big difference. The agent's ethics may keep her working toward your best interests, but her compensation structure pushes her toward making sales fast even if the pric...

I saw an interview on the Daily Show recently where the guest claimed that leading up to the recent credit crisis, people on Wall Street “fooled themselves”. While this may be true, I think the dominant driver was the self-interest of people at the expense of their companies. To illustrate what I mean, imagine that you play a game each day on your company’s behalf where you toss 4 dice and your company collects a million dollars if they don’t come up all 1s. If they do come up all 1s, your company must pay $5 billion. The expected payoff of each roll is a $2.86 million loss, a terrible deal for the company. But, what happens if you play anyway? For a few years you make a million dollars for your company each day. All this apparent profit seems wonderful. The company pays you, your colleagues, and management big fat bonuses for generating so much “profit”. This continues until the fateful day when the worst happens and the company goes bust having to come up with $5 billion...

Outrageous CEO compensation is a serious problem. Many CEOs manage to create incentive structures for themselves that make them rich even while investors lose money. I’m usually happy to see media reports that shine the light on this issue, but a recent article is so silly that it distracts from the real issue. On the weekend, I read the following headline: CEOs beat employee's annual wage in 4 minutes, study shows by Eric Beauchesne (the web page with this article has disappeared since the time of writing). This sounds fishy. Only 4 minutes? I know these CEOs make a lot of money, but this is crazy. Before reading the article, I did some simple mental calculations. Let’s say the employee makes $40k/year. If the CEO makes this much in 4 minutes, that’s $10k/minute, or $600k/hour. Based on a 40-hour week, that’s $24M/week, or about $1.25 billion per year! I doubt that very many CEOs are paid his much. Beauchesne’s article contained enough statistics that I was able to ...

During the tech boom, employee incentive stock options were widely used by companies to provide extra income to employees. Management justified stock options by saying that they aligned the interests of employees and shareholders. Aligning the interests of a company’s owners and employees is very important to the survival of the company as I explained in this post about alignment of interests . On the surface, it would seem that stock options can do the job. After all, if the company’s stock price goes up, it benefits both the shareholders and the employees holding options. Unfortunately, closer examination will show that stock options do a very poor job of aligning interests. To begin with, most employees do not have enough influence within a company to affect the stock price perceptibly. From middle management down to the workers, stock options are just lottery tickets whose payoff is unrelated to the employee’s performance. Stock options do almost nothing as an incentive f...

In yesterday’s post , I showed that the interests of homeowners and the real estate agents who work for them are poorly-aligned. The concept of alignment of interests is an important one for understanding why people do the things they do. It can also be useful for predicting how others will surprise you or disappoint you, or maybe try to take advantage of you financially. I used to play on a softball team that was sponsored by a sports restaurant/bar. We were young and took our commitment to our sponsor seriously. We would sometimes show up after a game with more than 20 people including players, friends, and family. We were developing a great relationship with this sports bar, or so I thought. After the third or fourth time we arrived at this sports bar on a Monday or Wednesday around 9:30 pm, it became clear that they weren’t very happy to see us. They would tell us we couldn’t sit in one section or another, and would try to hustle us out quickly. We weren’t rowdy, and the...

The fundamental problem with incentives for real estate agents is that the extra commission on a higher price is too small to be worth the extra effort.  Agents have little incentive to work hard to sell a house for the highest price possible.  The interests of the agent and homeowner are poorly aligned. Let’s look at an example. Suppose that a fair price for Hanna’s house is $375,000, and that her current mortgage principal is $275,000. After she pays off her mortgage and pays the real estate fees, legal costs, and other costs, she’ll have about $75,000 left over. If the sale price is $25,000 higher or lower, it would make a big difference in how much money Hanna gets. Let’s say that Rick, the real estate agent, gets to keep 2% of the sale price of the house for himself. Of course, the full cost to Hanna is much higher than this, but Rick only gets a fraction of what Hanna pays. This works out to $7500 for Rick. If the sale price is different by $25,000, it only mak...