Monday, June 01, 2009

Risk-Reward Scenarios

I'm not a good enough golfer to always appreciate many of the subtleties of course design, but I've played a few that have taught me that one key element is the balance between risk and reward. At the 18th at Indian Valley, if you can pull off a long fade, you can be 180-190 yards from the green, a difficult but doable distance. Eagle is a possibility. If you can hit a high drive 250 yards, all carry, you can have a wedge in your hand and greatly increase that possibility. However, failing at the first brings out of bounds into play (a stroke-and-distance penalty), failing at the second guarantees it.

Unfortunately, it doesn't seem to work that way in the corporate world, where risk and reward often seem to be only loosely related.

This thought is brought to me by the peril faced by the town of Cissna Park, Illinois because GM will not renew its contract with the local Chevy dealer due to bankruptcy. (If you'd said that sentence to my father 20 years ago and told him it would be due to the bankruptcy of General Motors, not the dealer...well, let's just say I now truly understand when people say they are glad someone didn't live to see something because it would have killed him. The headline "GM Bankrupt" would probably not have literally killed my father, but it would have shaken him deeply. Deeply enough that I'm grateful seeing such news was something Dad never had to experience.)

The blame for the failure of the American car industry is wide.

I suppose one could say people who even bought a Malibu (or a Neon) just because it was American-made, though they knew deep inside it was of inferior quality to a Camry or a Civic, must shoulder a little of the blame. After all, their purchases sent the wrong message to upper management. It's not that Detroit made (or that Cissna Park sold) such bad cars, it's that Japanese and European companies sold cars that were so much better. Buying less-good cars just encouraged GM and Chrysler to keep making less-good cars.

You could blame workers, I suppose. I'm sure they made mistakes. But when one remembers that American workers build Hondas and Toyotas, too, it's hard to say this is a problem with American workers.

I suppose you could blame the dealer for his fate. We've known for a long time that oil is running out. Why didn't he chuck the business his grandfather had started and sign on with Honda when they came on the scene? I remember those early Accords and Civics -- they were better than anything Detroit was producing. So why didn't the folks at Rust (irony alert) Chevrolet see the writing on the wall? Don't they share some small bit of responsibility for their fate?

Perhaps. But perhaps some people are paying too high a price for failure, given their level of responsibility for said failure.

And I think it's fair to say less responsibility for the demise of Rust Chevrolet lies with the Rust family (which has been affiliated with Chevrolet for 94 years!) than with the top management of GM.

They're the ones, after all, who guided the company to its current state, a task for which they were well rewarded. The GM CEO, Rick Waggoner pulled down $15.7 million in compensation in 2007.

But what risk does he face to justify such a rich reward -- especially when compared to that received by workers? (Even well-paid union workers.)

The board entrusted Waggoner (and all his predecessors) with making the right decisions to ensure the continued health and profitability of General Motors. They failed. But Waggoner and other GM execs -- even if they lose their jobs -- will not face the sort of deprivation that could face the families of those who work not just for Rust Chevrolet, but for the workers who won't be hired to do street repair because the town can't afford it because Rust Chevrolet represented 20% of their tax revenue might.

I'm not saying top-level execs don't deserve higher compensation -- they do. But they do because what they do is of such importance. If they set the wrong course...well, we see what happens. Unfortunately, it is the company and its employees who carry the burden of this risk. Doesn't it make sense that if CEOs feel they deserve compensation that is so out of balance with that of line workers, that they also ought to assume more risk? He's been paid a salary that is ample enough to provide the sort of cushion that can keep him cozy for the rest of his life. A far cozier cushion than the vast majority of GM employees will be able to rest upon.

I'm not sure what the additional risk CEOs ought to face when they lead their companies to financial ruin (having to live on nothing but an assembly-line workers pension?), but it seems to me the ratio between it and the reward CEOs get for their efforts is enormously out of balance. Either they have to face more daunting consequences of failure, or their salaries get pulled back to more human dimensions.

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