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March 19, 2009

Outraged by Executive Compensation? Put Entrepreneurs In Charge.

Every time there’s an economic downturn, the spotlight shines on the super-rich and their out-of-touch lifestyles.  The iconic moment of the 1991/1992 recession was then President George Bush looking bewildered at the supermarket checkout line during the 1992 “It’s the Economy, Stupid” presidential campaign.  In 2001/2002, it was Tyco’s CEO Dennis Koszlowski spending $1 million of shareholder money on his wife’s 40th birthday party (mine is coming up this summer, by the way, and I don’t think it will cost my LPs very much at all, really).

But this latest financial crisis has seen an unparalleled amount of grotesque behavior.  First, we learn that auto industry executives flew into Washington DC to ask for taxpayer bailout money on corporate jets.  Then, it’s discovered that Merrill Lynch CEO John Thain spends $1.2 of his shareholder’s money redecorating his office (Michelle Obama’s redecoration efforts, using the same designer, is apparently only $100,000 for the entire White House!).  And most recently, we learn that AIG executives plan a junket with their bailout money and then seek to pay out bonuses to the tune of $165 million – and if Congress doesn’t intervene, we taxpayers are going to end up getting stuck with the bill.

Why is it that so many Fortune 500 CEOs simply don’t get that they are simply agents of their shareholders, not Masters of the Universe that deserve to be put on a pedestal?  Harvard Business School professor Michael Jensen has written about this time and time again in his seminal work on Agency Theory and human nature – the shareholder is the boss.  The CEO is merely a well-paid agent.  Can anyone imagine this behavior if the money they were throwing around was actually their money, as opposed to some collective of nameless, faceless shareholders?  And yet time and time again, corporate boards with their cozy inter-relationships don’t seem to get it.

I have a simple solution.  Have every Fortune 500 compensation committee run by a start-up CEO.

Perhaps the most successful venture capitalist in history, Sequoia’s Mike Mortiz (backer of Google, Yahoo, Paypal, to name a few reasonable wins), said in a recent interview that one of the ways he decides whether to invest in an entrepreneur is how much they plan on paying themselves.  Moritz views high salaries with immense suspicion.  If the founder takes a modest salary (in start-up land, that’s typically $100-200k per year – well below even President Obama’s $500k cap), he knows they believe in the future value of their business.  We at Flybridge Capital Partners are currently looking at a new deal with DFJ and one of the general partners there reported that her best CEOs are proactively, voluntarily dropping their annual salaries to $75-100k in this environment.  Last month, one of my CEOs informed me that he has decided to forgo his 2008 bonus, which he earned by beating plan (how many Fortune 500 companies beat their plans this year?).

Why this seemingly irrational behavior from entrepreneurs?  Remember, entrepreneurs aren’t saints or selfless do-gooders.  They typically work 80-100 hours per week for two reasons.  First, they are PASSIONATE about their venture for the sake of the business and its impact on the world more than the money (“Ask me about my business and you can’t shut me up,” confessed my friend Scott Savitz, CEO/founder of Shoebuy.com, the other day).  Reid Hoffman, CEO/founder of LinkedIn and an early executive at PayPal, told me last week that his whole motivation in life has been to create products or services that impact millions and millions of people.  Second, when it comes to the formula for making money, they care only about the value of their equity – current cash is to pay the bills (in some cases, not even that).  They want every possible dollar to go towards building shareholder value.  They want to prove to their investors and employees that the risk they took in investing in them and joining their cause will pay off.

Why don’t Fortune 500 CEOs feel the same way?  Why is it that they don’t view their role in life to prove to the shareholder that buys their stock in the public market that they took a worthy risk and they’ll be darned sure it pays off?  Instead, they think it’s culturally acceptable to take outsized pay packages and perks that no educated, rational shareholder would ever approve if given the chance.

The behavior is in such stark contrast to what’s going on in the small business, job-creating end of the economy, it’s absurd.  The public is understandably outraged.  I am too.  That’s why I’d fire all the compensation committee heads and turn the reigns over the start-up CEOs.  After forgoing a $50k annual bonus, can you imagine my portfolio CEO’s reaction if he were the chairman of the compensation committee on the board of Merrill Lynch and learned that John Thain spent $1,400 on a wastebasket?  But do me a favor – if this actually gets implemented – please don’t choose any of Flybridge Capital’s portfolio CEOs.  They’re too busy working 80-100 hours a week trying to build equity value for our investors that we VCs are accountable to:  our own shareholders/limited partners!

FYI:  you can follow me on Twitter at www.twitter.com/bussgang.


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Thanks for the article.

Just out of curiousity, what might your compensation structure look like?


Hi Jeff


But I do have to echo comment from Daren - does the VC business conmform to this?

Are the best VCs the ones who take the smallest management fees?

Have many (any?) VCs taken compensation cuts owing not only to the financial meltdown, but also to the fact that virtually no VC funds have provided any meaningful returns to LPs (ergo, lowering comp would allow more capital to go to work generating returns)?

I think the VC industry -- like all the other examples you cite -- needs to make a lot less on the guranteed front end (management fees) but should be eligible for a lot more on the back end (carried interest). this will cull out the dead wood partners, and put more capital to work in the portfolio (at no greater cost) and will totlly align everyones interests much more -- GPs, LPs, entrepreneurs

Wisdom in the post, and the comments.

It's appropriate for a CEO to take a pay cut before asking anyone else on his/her team to do the same, but the same principle applies one level up.

Most of the enrepreneurs in the Middle East now-a-days are so overwhelmingly influenced by the Wall Street practices that they can kill anyone preaching agency theory to them. I daily see such practices and despair. What is worse, some of the PE / VC guys turn a blind eye in the name of cultural issues - they say they can't offend the executives and even go all out to maintain good relations with the CEO even if the CEO is running the company into the ground; forget about earning bonuses on merit!

great article. We are looking for funding. www.eCreativeads.com

This sounds good, but I think CEOs at huge corporations tend to be political animals, while entrepreneurs don't waste a lot of time planning backstabbings (or the cynical would say "actually doing work"). Some would take it for the money and opportunity, I'm not sure many would enjoy it.


Looking forward to your response, when you have a moment.


Thanks for all the great comments!

On VC comp - I've written about this at: http://bostonvcblog.typepad.com/vc/2005/05/venture_capital.html. In the old days, some VCs got paid on a budget basis. When fund sizes were small, the only way to get rich was on the carry. Now, with big funds, VCs can get rich on management fees. There has been very, very little carry being distributed since 2001, particularly to the "young guys/gals" (i.e., not the firm's most senior GPs but typically the ones that do the deals).

As the President of a four person, 100% boot strapped, transaction based recruiting firm (contingency), I can fully appreciate compensation being a function of current day sales.

A tight economy delivers improved cost-containment techniques, and forces us to get closer to our core customers.

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