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At the 3rd Annual Faculty Case Debate on April 3, Kellogg professors (from left) Tim Calkins, Harry Kraemer and Niko Matouschek discuss whether the government should regulate the compensation of senior executives.

Professors Tim Calkins, Harry Kraemer and Niko Matouschek

A price to pay

Kellogg professors debate the merits of regulating executive compensation

By Rachel Farrell

4/9/2009 - Many Americans, if asked, would heartily endorse the prospect of capping executive pay. In a recent Rasmussen survey, for example, 36 percent of those polled said that the government should tightly control CEO salary.

But not all professors at the Kellogg School agree. At the 3rd Annual Faculty Case Debate on April 7, three faculty members – Tim Calkins, clinical professor of marketing, Harry Kraemer, clinical professor of management and strategy, and Niko Matouschek, associate professor of management and strategy – delivered opposing arguments on the issue before an audience of more than 100 students in the Owen L. Coon Forum. The student-run debate was moderated by David Besanko, senior associate dean of strategy and planning and the Alvin J. Huss Professor of Management and Strategy.

In his opening statement, Calkins expressed his distaste over senior executives’ exorbitant compensation. “To me, it makes absolutely no sense,” he said. “It’s an embarrassment. And the [incentive] structure is wrong – it makes CEOs do everything in the short run to goose up their compensation.”

Kraemer, who said that he “phenomenally” disagreed with Calkins, argued that government intervention would not solve the problem of inflated pay. Instead, there are three “potential solutions,” he said. “First, if you are the leader of an organization, and someone gives you compensation that is out of line with what is reasonable, you shouldn’t take it. Second, it’s the responsibility of a board of directors to approve compensation increases. Third, as a shareholder, if you think the board of directors is doing the wrong thing, you have the right to vote them off.”

That’s not realistic, Calkins countered. Stakeholders cannot count on a CEO’s integrity to determine compensation. Boards are under pressure to keep their chief executives happy. And if you’re a shareholder “and you get a proxy in the mail, you might as well make a paper airplane out of it,” he said. “They never let you vote on the compensation.” Therefore, a pay cap – or some type of regulation – is necessary, he concluded.

Kraemer make clear his distrust of any form of regulation. “‘Smart intervention’ is an oxymoron – it’s like ‘jumbo shrimp,’” he said. “I don’t know what it looks like.” Moreover, he said, pay caps had unintended consequences, such as causing a talent drain from public companies to private companies.

Matouschek, who took the middle ground on the issue, pointed out that AIG paid its “No. 2 guy,” Douglas Poling, $6.4 million dollars to unwind company contracts. “So is talent really that scarce?” he said, addressing Kraemer’s argument. “Do I really need that person to unwind these contracts and do I need to pay him $6.4 million dollars? Do I really need this guy who already proved he was an idiot?”

The real issue, Matouschek said, is that some firms have become “too big to fail.” The CEOs of these firms are incentivized to take big risks, because the government will bail them out if they make bad gambles. “If it comes out heads, I win; if it comes out tails, I break even,” Matouschek said.

The Faculty Case Debate was sponsored by the Social Impact Club, a student-run organization that aims to inspire Kellogg students to use their MBA education to make a positive social impact in the nonprofit, public and private sectors. A pilot version of the debate was launched in 2006 and became a formal event in 2007.