The Third Pillar: How Markets and the State Leave the Community Behind

by Raghuram G. Rajan

Coupled with the finding that CEOs earned so little of the value they created for shareholders, Friedman’s arguments opened the way for boards to pay management enormous amounts of stock-based compensation. The rationale was that this would align management incentives with shareholders. In practice, this raised a number of concerns. There is no clear guidance on how much is enough. Usually, in a competitive market, a worker is paid on the basis of the value he adds. However, if a new CEO enhances the company’s share price by $10 billion more than would normally be expected, does she deserve to be paid the entire $10 billion? How much growth is because of the unique assets and workers the firm possesses, which the CEO only pointed in the right direction as opportunities came along? With no real guidance, corporate boards could engage in a compensation race, which they often did by asking their compensation committees to make sure their CEO was paid more than the industry average. As many did this, the industry average escalated. High CEO pay sent a strong signal to employees, and to society more generally, that money was the central measure of worth. To the extent that money could only be made by doing the right thing by society, Friedman’s dictum was beneficial. There were many other ways of making money, though. Most immediately, if corporate management could ‘manage’ their boards and their compensation committees, payouts could be enormous, and totally unrelated to long-...

Friedman's arguments were taken advantage of as well