Why your boss is overpaid

My friend has a huge problem with her boss.

She claims that she works like a dog while he sits all day and purrs like a fat contented cat behind his rosewood altar, drinks herbal tea and swivels aimlessly in his leather chair. His daily ritual is to rearrange the post-its on his computer and send mails to the lesser-paid mortals asking for updates or demanding that they justify their existence. And when the cat is in a particularly foul mood, whoever comes into his line of fire gets skewered. 

She has figured out his apathy: His mind is either on permanent vacation, or worse still, has already retired but the company just refuses to let his body follow suit, for a reason she cannot fathom.

Her biggest grouse is that while she and her colleagues work their backs off to add to the bottom line, he is at the receiving end of a bloated salary and inflated bonus.

Before I continue, let me set the record straight. This post is NOT about my bosses, who, incidentally, all read this blog hence my urgency to clear the air. All my bosses (that's right, I have more than one) sit at work stations identical to the rest, no plush leather seats or polished wooden desks - be it mahogany or teak or rosewood. None of them use post-its or, to my knowledge, drink herbal tea.

Back to my friend. While I do (silently) admit to the possibility of exaggeration on her part, the point is hard to miss. Are our bosses really overpaid?

Years ago, economist Tim Harford tackled this issue in his book The Logic of Life and presented a downsized version in Forbes titled Why Your Boss is Overpaid. According to him, there is a logic to bosses making obscene sums of money while the downtrodden cubicle slaves toil. The ugly truth is that your boss is probably overpaid because of you. He isn't being paid for the work he does but, rather, to inspire you. So you work your socks off in your underpaid job in the hope that one day you will become an overpaid fat cat yourself.

Economists (bless that breed of individuals!) have a name for this: Tournament Theory.

According to Tournament Theory, workers are frequently ranked relative to each other and promoted not for being good at their jobs but being better than their rivals. For instance, Andy Murray was paid $1.9 million for winning the US Open. He was not paid to work hard. He was not paid to play objectively brilliant tennis. He was paid to beat his opponent - Novak Djokovic. And not in his backyard or anywhere else, specifically at Flushing Meadows. Harford goes into great detail about “tournament theory” and “promotion tournaments” in the office space, which I don't have the patience to delve into.  

This very month when the Occupy Wall Street movement completed a year, The Economist tackled the issue of overpaid bosses. With Steven Kaplan’s help, The Economist challenges three propositions:

• CEO pay just keeps on going up
• CEO pay is not tied to performance
• The Boards are not doing their job of holding fat cats’ paws to the fire

Kaplan questions the notion that CEO pay always goes up and argues that CEOs are paid for improving the performance of their company’s stock and provides data to back his claim. But according to a much earlier article in The New Yorker, overpaid CEOs are not just expensive, they are even destructive. And, you guessed right, they have data to back their claim too. 

The New Yorker ends with the conclusion that in the long run companies that do not balance pay with performance will suffer on the stock market. The Economist concludes by saying that CEO pay packets are determined by demand and supply. 

So basically, scarce good talent is heavily in demand but the supply is drastically limited. Hence the steep premium. Companies pay what it takes to woo the best bosses and show them the door if they falter. Whether the boss delivers due to his business acumen or intelligence or because he possesses the ability to attract great talent and drive them like slaves is another issue altogether and meaningless to some extent, at least to the Board. The results are what they look at.  

Back to my friend. She has rubbished all of the above. But the thought of sitting behind that rosewood desk in soft leather has got her pulse racing. 

How to win by not losing

Amidst all the huffing and puffing over the nude photos of the young royals, the Brits have a new hero: Andy Murray.

They mourned when Roger Federer’s brilliance drove him to tears at Wimbledon. As Simon Kuper of Financial Times commented of Britons obsessing over their decline: “Once Wimbledon was where posh British dilettantes effortlessly dismissed upstart Johnny Foreigners. Postwar, it became a home of British defeat.” 

Then came the emphatic victory which got them the Olympic Gold, with none other than Federer at the receiving end. But the clincher was a Brit winning a Grand Slam after 76 years. Murray finally regained some of Britain’s lost glory (which the queen should certainly be grateful for).

Of course, Murray almost jeopardized his moment of victorious glee at the US Open when he could be seen saying “I don’t have it, I don’t have it”. 
The “it” being a watch.

No, it was not a million dollar watch. 

Neither was there any sentimental mush associated with it. 

It was the 7-figure sponsorship deal with Rado that caused him to get into a tizzy. He needed to prominently display it if he did not want to tick off his sponsor and keep the bucks flowing. Fortunately, his girlfriend came to the rescue. Check out his Rado D-Star Automatic Chronograph which can be seen in these photos from The Telegraph. 

After basking in his well-deserved applause, even his normally silent coach could not contain his delight. Tennis legend Ivan Lendl, shared an  interesting insight in The Guardian. 

“A loss is a loss; and a loss is not a loss. You learn from certain losses and become depressed from other ones. When you have losses, when you put it all out there and go hard, you can be proud of yourself. And you can learn from it, and that is really important.”

Lendl's reference to losses reminded me of a book written ages ago by Dr Simon Ramo - Extraordinary Tennis for the Ordinary Tennis Player. According to him, there are two ways to play the game of tennis.

The winner's game played by pros/experts: Those who qualify are actually a remarkably small club though there are plenty of delusionary folk who are of the opinion that they fit right in here.

The loser's game played by mediocre/ordinary players: This is more the norm than the exception and most tennis-playing mortals would feel right at home here.

If you are an ordinary player, then Ramo (who graciously admits he is one) suggests that it is ridiculous to try to play with the same strategy of a professional. Come to terms with the fact that the brilliant shots, consistent-powerful-punishing backhands, long and exciting rallies, and mind-blowing crosscourt service returns are miraculous, extremely few and very far between. 

Ordinary tennis is almost entirely different. The ordinary player seldom beats his opponent, he is too busy beating himself. The ball is fairly often hit into the net or out of bounds and double faults at service are not uncommon. The victor in this game of tennis eventually gets a higher score because his opponent is losing more points. 

A summation: Professionals win points. Amateurs lose points. 

In expert tennis, the ultimate outcome is determined by the actions of the winner. The winner is able to force an error by his opponent or drive the ball just out of reach. These players seldom make mistakes. 

The mediocre player is not good enough to overcome the many inherent adversities of the game. His efforts to win more points will only increase his error rate. The strategy for winning in a loser's game is to lose less by not making too many mistakes. Avoid trying too hard. By keeping the ball in play, give the opponent as many opportunities as possible to make mistakes and blunder his way to defeat. 

In brief, by losing less become the victor.

Charles Ellis takes this very principle one step further and applies it to investing in his book 
Winning The Loser's Game and in an article published in The Financial Analysts Journal titled The Loser's Game. 

In order to outperform a diversified market-weighted portfolio, an asset manager must capitalize on the mistakes of other professionals. Ellis states that one may have a lucky outcome once in a while, but the only way an investor can beat the market is to exploit other investor’s mistakes. He suggests simplifying the professional investment management process by doing a few things unusually well, making fewer and better investment decisions and bringing down turnover. 
Concentrating on your defences is another. In a Winner's Game, 90% of all research effort is geared towards buy decisions. In a Loser's Game, the focus should be on sell decisions. Because its too hard to outperform the other fellow in buying. Also, almost all of the really big trouble that you're going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the Loser's Game.

For regular investors like you and me who are determined to try and win the Loser's Game, he offers some help:  

1) Save & Invest. Don't speculate. 

2) Invest with a long-term goal in mind and stick to it. Don't churn too much. Review your investments annually. Don't procrastinate.  

3) Most tax shelters make poor investments so don't invest in something primarily to save tax. There are exceptions, so plan carefully. 

4) Don't invest in new or interesting investments. They are too often designed to be sold to investors, not to be owned by investors. 

5) Don't invest in bonds just because you have heard that bonds are conservative or safe. Their prices also fluctuate and are a poor defense against inflation. 

6) Don't trust your emotions. When you feel euphoric, you are probably in for a bruising. When you feel down, remember that it is darkest just before dawn and take no action. Activity in investing is almost always in surplus. 

So in the investing game, don't worry too much about generating alpha. Just focus on not shooting yourself in the foot. Chances are that you will emerge one lucky loser.