"Corporate Pay/Hedge Fund Pay - Are the Differences Warranted?"

Sydney M. Williams

Thought of the Day

“Corporate Pay/Hedge Fund Pay – Are the Differences Warranted?”

April 5, 2010

Among the more fascinating business articles last week was Thursday’s Wall Street Journal’s entitled: “Occidental Chief Tops Pay List.” What made the piece particularly interesting was its juxtaposition against an article in the same day’s New York Times: “Hedge Fund Pay Roars Back.” The immediate conclusion one draws is that one would rather manage a hedge fund than be the CEO of a public firm, as the former paid about one hundred times more than the latter.

I have written in the past of the habit of boards of public companies appearing to have greater allegiance to the managements they are charged with overseeing rather than the shareholders they represent, in rewarding mediocre performance with excessive pay.

I have also written that capitalism provides unlimited opportunities for creative individuals willing to take risk on themselves, on markets, or on both. The hedge funds cited in the Times article are proof of that fact. And, while a few dozen have provided enormous rewards to those willing to accept the risk of starting such a business, there are thousands that have disappeared, disappointing both their founders and their investors.

Nevertheless, the contrast in pay, using the top five businesses in each category, is significant. The five public companies mentioned in the Journal article – Occidental Petroleum, Disney, Travelers, IBM and Johnson & Johnson, in aggregate, paid their CEOs $132.4 million; whereas the managers of the five hedge funds, in aggregate, earned $13.5 billion. Given the multiplier effect of economics, in terms of contribution to GDP, the differences are equally compelling. The five public companies employ 700,000 people and they generated $230 billion in revenues last year, numbers far different from the hedge fund industry.

Certainly the hedge fund industry makes contributions to the economy in terms of the allocation of capital, both in terms of equity investments and in terms of keeping interest rates lower than they would otherwise be, but their contribution to GDP is far less than their counter parts in the public arena.

In a capitalist society, entrepreneurs have the opportunity to either succeed extraordinarily, or to fail miserably. Managers of hedge funds are entrepreneurs. On the other hand, most managers of public corporations are hired guns. They assume little risk and potentially extract large returns, some times fore dismal performance. There are obvious exceptions such as Bill Gates and Paul Allen of Microsoft and Larry Ellison of Oracle, men who took a shot on a concept.

The publicity of the huge pay packages at hedge funds has already generated problems for the industry, besides the obvious disadvantage of having one’s wealth broadcast. The Administration has deemed carried interest to be treated as ordinary income, as opposed to a capital gain, a decision with which it is difficult to disagree. Increased regulation and a SEC requirement for greater disclosure in terms of investment positions will raise costs for the industry.

So, while hedge fund pay may seem excessive, in my mind it is not as harmful as pay for failure which has too often been the case at public companies. Boards of Directors of public companies need to take seriously their duty to represent shareholders, not management, and should be liable for mistakes.