Health Care Hired Managers Not Playing by the Same Rules - the Example of Lancaster General Health

That all people in the US do not play by the same rules, and that more specifically the richest people do not play by the same rules as the somewhat or a lot less rich, became a topic of discussion after the 2008 global financial collapse/ great recession.  A powerful discussion of this theme appeared in Predator Nation, the book by Charles Ferguson that followed his award winning documentary, Inside Job:

Ponder the toxic effects of too much wealth, too much power, the new culture of American investment banking, and a life conducted within the cocoon of America's new oligarchy. [p 112]

He focused on the culture of finance, but as we have seen, this culture has overlapped the culture of health care.  Thus we have shown multiple examples of those who have become rich due to their positions in health care, almost always positions as high-ranking hired managers of health care organizations.  They get paid according to different rules than apply to other hired employees, and live by different rules than their less-favored fellow employees, again by virtue of their positions.

Some of these examples were of CEOs of huge, for-profit health care corporations,  However, we have increasingly seen hired managers of moderate size non-profit organizations who also appear to play by different rules than their fellow employees.

The Executives of Lancaster General Health

The latest example appeared through reporting found in LancasterOnline, the web presence of several newspapers in Lancaster, Pennsylvania, about a regional community health care system, Lancaster General Health.  The system includes one major hospital, Lancaster General, an obstetrics hospital, and a variety of satellites and out-patient facilities.    

The system was facing challenges in 2010:

In 2010, times were getting tougher for Lancaster General Health.

The mammoth [sic] health care system would notch record revenues of nearly $1 billion that year. But its annual surplus fell for the fourth straight year. Though destitute by no means, galloping expenses and uncertainty in the marketplace were hammering LGH's business model, prompting changes. Two units were closed, some positions were eliminated, and 170 employees were reassigned.

However, despite these difficulties,

Two executives — CEO Tom Beeman, who was on military leave part of the year, and Executive Vice President Jan Bergen, who helped fill in for Beeman in his absence — earned more than $1 million in total compensation; another six got at least $500,000.

And those top 21 executives collectively received more than $2 million in bonuses and incentives.

That lavish total compensation included "perks" that were likely not furnished to lesser employees, for example

The IRS form lists few explicit perks, save one: LGH paid $1,044 in social club dues for Beeman in 2010.

Said Regina Mingle, LGH's executive vice president of human resources: 'In this community, if you need to do business, you do it at the Hamilton Club or Lancaster Country Club. We decided ... we would pay those fees.'

It seems doubtful, however, that any other employees who felt that they did "business" at country clubs or similar establishments were entitled to subsidized dues.

This relatively lavish pay was part of a pattern.  Executive compensation had been increasing out of proportion to any obvious benchmark for a while.

 In fiscal year 2005-06, CEO Tom Beeman earned a comparatively modest total compensation of $646,094. By 2010, that had more than doubled, to $1.35 million. That figure included a base compensation of $606,728, along with $345,000 in bonuses and incentives and $279,511 in retirement and other deferred compensation.

Bergen, who along with Executive Vice President Marion A. McGowan took on some of Beeman's duties when he left in October 2010 for a nine-month military leave of absence, saw her compensation rise from $332,823 in 2005-06 to a total of $1.1 million in 2010. The latter figure included $425,967 in base pay, $177,752 in bonuses and incentives, $111,383 in retirement and other deferred compensation, and $320,208 in what the IRS calls 'other reportable compensation' such as employee contributions to 401(k) or 403(b) retirement plans.

The third highest-paid LGH executive in 2010 was McGowan, whose compensation package totaled $772,978, including $456,789 in base pay and $192,226 in bonuses and incentives. Fourth on the list was 

Dr. Lee M. Duke II, senior vice president and chief physician executive, whose compensation totaled $746,830, including $405,083 in base pay and $140,377 in bonuses and incentives.

Fifth was Chief Financial Officer F. Joseph Byorick Sr., whose total compensation of $652,667 included $397,160 in base pay and $140,500 in bonuses and incentives.

So note that CEO Beeman's compensation was for less than one full year's worth of work.  His annualized rate would have been even more.

A companion article noted that part of CEO Beeman's bonus for 2010 was justified by his efforts to keep in touch with the institution while he was physically not present, and was, in fact off-site for an extended period fulfilling a military reserve commitment

 In October 2010, Lancaster General Health had a problem.

Its CEO, Tom Beeman, was shipping out for a military tour of duty, to serve as deputy director of the National Intrepid Center of Excellence in Bethesda, Md. Two other administrators —  Executive Vice Presidents Jan Bergen and Marion W. McGowan — would step into Beeman's shoes while he was away.

Yet Beeman stayed involved. 'We had regular Skype [video-conferencing] calls,' said Alex Henderson, chairman of the LGH Board of Trustees.

That, LGH officials believed, merited a bonus. So Beeman got nearly $90,000 for his efforts in absentia.

Note that this verified that Beeman got more than $1 million in compensation despite not having worked a whole year, since it was necessary for two other executives to take over his work.

Furthermore, while US law does mandate employers to re-hire employees who take leaves to fulfill military reserve commitments (look here),  I suspect that very few employers pay employees anything while they are away (although reservists are certainly paid by the government for their reserve duty).  However, Beeman got a bonus merely for keeping in touch while he was away doing another job.  I further suspect it is extremely unusual to pay an employee a bonus for trying to keep in touch during his or her military service.

So the reporting on compensation given to top hired managers at Lancaster General emphasized that executive pay is set using very different rules than are used to set the pay of other employees.

The Talking Points Reappear as Justifications for Exceptional Compensation of Hired Managers

Furthermore, the justifications made for the Lancaster General top executives' large compensation packages echoed talking points used to support such largess for top hired managers in other health care settings, but did not explain why hired managers merit exceptional treatment.   We first listed the talking points here, and then provided additional examples of their use here, and here.   The talking points are:
-  we pay what everyone else pays
-  CEOs work hard and are brilliant, and so deserve high pay
-  high pay is needed to attract and retain competent, if not brilliant people.

None of the examples of these talking points we have seen so far explain why these apply to CEOs and other top hired managers, but not to other kinds of employees.  .

We Pay What Everyone Else Pays

A third article in the LancasterOnline series noted that executive compensation was based on information on what everyone else pays,

nonprofits must hire consultants to study how similarly sized nonprofits pay their executives.

LGH's consultant is a firm called Mercer, headquartered in New York City with an office in Philadelphia. Charlie Scott, of Mercer, has in recent years helped LGH determine what to pay its highest-compensated executives.

 'Our role is to be [an] independent source of market norms,' said Scott, determining 'levels of compensation available in the market for executive positions, as well as how compensation is paid.

This is an interesting variant of this talking point, because it essentially blames the reasoning on the Internal Revenue Service.  The article did not explain how Mercer determined the extent of the appropriate market, nor how it obtained a representative sample of data about that market.

CEOs Work Hard and Are Brilliant, and So Deserve High Pay

High Pay is Needed to Attract and Retain Competent, if not Brilliant People

These justifications are often combined.  In the case of Lancaster General, the examples included

At LGH, officials say the generous compensation is necessary to attract and retain the top talent. Said Lancaster attorney Alex Henderson III, chairman of the Lancaster General Health board of trustees and its compensation committee, which decides what to pay top execs: 'Demand for top-notch hospital executives has grown, and we have to respond to that.'

'We're not looking to be average.'

I seriously doubt that the hospital system is committed to "generous" pay to get "top talent" for all of its job openings.  Again, I doubt the generosity includes full pay for leaves taken for military service, or, for that matter country club dues.

Another version was offered by the chair of the system's board of trustees:

 Trustee Henderson said that as LGH's goal isn't to maximize revenue but save lives, executives can be doing a fantastic job — worthy of six-figure bonus and incentive pay — even when the system's financial performance slips.

Consider an executive who devises a way to shorten stays for patients, Henderson said: 'That's great for the patients, for insurance companies, for nurses who don't have to take care of people who don't need to be here' — but it's bad for LGH's bottom line.

Left out of the first part of the statement was how one could attribute lives saved to the work of a hired manager, especially, as in the case of CEO Beeman, a manager with no direct experience caring for patients.  Mr Beeman's official hospital bio listed this educational background,

Prior to joining Lancaster General Health, he served at Saint Thomas Health Services as its President and Chief Executive Officer, and the Senior Vice President for Hospital Operations and Executive Director of the Hospital of the University of Pennsylvania.

It did not include any former positions that would have involved direct patient care. 

Health care actually does not save lives that often, but hopefully does often ameliorate disease and injury, reduce suffering and improve function.  However, the people who actually directly accomplish this are health care professionals, nurses, doctors, therapists, etc, not managers who sit in offices.  

I will merely note that Mr Henderson's second example apparently was theoretical.  There was no example given of an executive who actually did shorten length of stay.  

In a third article in the LancasterOnline series, the compensation consultant employed by Lancaster General Health reiterated the argument that one must pay top dollar for scarce managerial talent:

[Mercer consultant Charlie] Scott said that the law of supply and demand that applies 'to any type of talent pool applies to health care executives. There's normally a lack of supply of what's considered blue-chip talent ... [and] the increasing complexity of the health care industry requires an increasing level of talent and capability.'

Note that no one who defended the compensation given to CEO Beeman or other top managers provided evidence that they are "top" or "blue chip" talent, or that they, rather than the health care professionals who work at or for the system save lives.

Summary

In our last US election campaign season, a few candidates pledged to level the playing field so that rich and poor would play by the same rules.  Other candidates scoffed at the importance of the problem, or called its invocation class warfare.  Meanwhile, in health care, we just accumulate more examples that different people play by different rules.

So we have yet another particular example of how top hired managers, particularly CEOs, of even modestly sized, non-profit health care organizations get to play by different rules than those affecting other employees, and other people who work in health care.  As in previous cases, the justifications provided for these different rules were basically a repeat of poorly conceived arguments that have been cited often by defenders of executive exceptionalism. 

The "we pay what everyone else pays" is basically an appeal to common practice fallacy.  Why we have to do so is never stated.  In any case, the argument did not include why the limited selection of comparator hospitals and executives used is a representative sample of "everyone."  Furthermore, as we noted here, what evidence there is suggests that skills required to run one organization do not necessarily transfer to another, suggesting the comparison to "everyone" makes no sense.

As is usual, the "CEOs are brilliant" argument is basically an appeal to authority fallacy, and provided no evidence that the particular CEO is brilliant.  In fact, it seems that everyone who has used this talking point before claims his or her CEO is brilliant. (Look here for example.) Obviously, all CEOs cannot be above average. 

Finally, as noted here, there is no evidence that without high pay worthy leaders could not be hired or retained.

Unfortunately, the otherwise excellent articles on Lancaster General did not challenge any of the defenders of executive exceptionalism to better justify their assertions.  Nor were they asked to consider its adverse effects. 

As we have frequently said, current policies about paying hired health care managers leave the managers unaccountable for the effects of their actions on patients' and the public's health, and worse, fail to deter and may even encourage ignorance of the health care mission, frankly mission-hostile behavior, self-interest, conflicts of interest, and outright corruption.  Meanwhile, paying nearly all top managers as if they were brilliant, while setting much harsher standards for the employees who actually take care of patients, including health professionals, demoralizes those on whom patients actually depend for care.

As we have said endlessly,....   Health care organizations need leaders that uphold the core values of health care, and focus on and are accountable for the mission, not on secondary responsibilities that conflict with these values and their mission, and not on self-enrichment. Leaders ought to be rewarded reasonably, but not lavishly, for doing what ultimately improves patient care, or when applicable, good education and good research. On the other hand, those who authorize, direct and implement bad behavior ought to suffer negative consequences sufficient to deter future bad behavior.

If we do not fix the severe problems affecting the leadership and governance of health care, and do not increase accountability, integrity and transparency of health care leadership and governance, we will be as much to blame as the leaders when the system collapses.

More Reasons to Doubt How CEOs are Chosen and Paid

Health Care Renewal is about problems with the leadership and governance of health care organizations.  Since the global financial collapse/ great recession began in 2008, it became evident that the problems we saw affecting health care leadership were similar to problems affecting other large organizations, notably financial firms.  Recently, I spotted a series of articles that raise more questions about how business leaders, and by extension, leaders of health care organizations are chosen and paid.

Doubts about Generic Managers

We have often questioned the wisdom of having health care organizations lead by people with little if any direct health care experience, little knowledge of health care on the ground, and little commitment to health care's core values.  We have called such leaders generic managers.

A New York Times article by Gretchen Morgenson from September, 2012, cited new academic work that questioned the abilities of generic managers.  The source article was Elson CM, Ferrere CK.  Executive superstars, peer groups, and overcompensation - cause, effect and solution.  Ms Morgenson summarized,

Mr. Elson and Mr. Ferrere conclude, contrary to the prevailing line, that chief executives can’t readily transfer their skills from one company to another.

Furthermore, Ms Morgenson interviewed Mr Elson, who said,

But we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often, but when they do, they’re flops.

Also,

But there is little evidence, according to Mr. Elson and Mr. Ferrere, that a hot market exists for interchangeable chief executives. First, they note numerous academic studies indicating that C.E.O.’s selected from within a company perform better than outsiders, especially in the creation of long-term shareholder value.

'There is no conclusive empirical evidence that outside succession leads to more favorable corporate performance, or even that good performance at one company can accurately predict success at another,' the authors conclude. 'In short, executive skills cannot pass the most basic test of generality: transferability.'

To be sure, this flies in the face of the widely held view that skilled managers have become generalists and are therefore far more interchangeable than in previous years. Proponents of this thesis argue that top managers today can accumulate a broad knowledge of economics, finance and management science, giving them the ability to manage any type of company effectively. Technological advancements also give chief executives access to untold amounts of data about a particular company that in previous times would have taken years to amass and synthesize, this view holds.

But the data on actual C.E.O. moves raises questions about just how portable C.E.O. skills really are. The Delaware paper cites several studies indicating that relatively few chief executives land new top jobs elsewhere. One study, a 2011 analysis of roughly 1,800 C.E.O. successions from 1993 to 2005, found that less than 2 percent had been public-company chief executives before their new jobs.

This data and these observations seem to broadly apply to business executives, but there is no reason to think they do not apply to executives of health care corporations.  Furthermore, given that on its face, health care is less like making automobiles than, say, the restaurant business is, there is no reason to think doubts this raises about the abilities of generic managers should not be even bigger in health care, and should apply not just to for-profit, but to not for profit corporations.  Yet the trend in health care seems to increasingly favor generic managers of not just for-profit health care corporations, but also hospitals and hospital systems, non-profit health insurers and managed care organizations, health care charities, disease advocacy groups, and even medical associations, medical schools, and their parent universities.  

Doubts about Executive Compensation

Peer-Group Benchmarking

We have often posted about amazingly generous compensation given to top leaders of health care organizations.  Health care corporate CEOs can make tens of millions of dollars, occasionally even more.  While CEOs of not for profit health care organizations make less, they still now can makes millions of dollars.  Ms Morgenson called the usual justification for these huge amounts of compensation the "pay-'em-or-lose-'em" myth.

Corporations are forever defending big executive paydays. If we don’t pay up, the argument goes, our sharpest minds will jump to our rivals.

This notion, or myth, depends on the argument that generic managers are the best managers, which appears to be largely unsubstantiated, as we noted above.

 In other words, the argument that C.E.O.’s will leave if they aren’t compensated well, perhaps even lavishly, is bogus. Using the peer-group benchmark only pushes pay up and up. 

Furthermore,

Importantly, the study disputes the notion that executive pay today is a result of an efficient bidding process for finding and retaining a scarce and valuable commodity: managerial talent. 'In essence, this process creates a model of a competitive market for executives where it otherwise does not exist,' the authors wrote. 'Through the operation of a market, it is argued, wages are bid up to an executive’s outside opportunities.'

Instead, as noted above, since the skills needed to run one sort of company or organization may not readily transfer to other companies and organizations, even seemingly similar ones, such a market does not exist. 
 
 Incentives Based on Short-Term Financial Results

We have also previously discussed (look here) how contemporary economic dogma suggest that the only measure of success of a for-profit corporation is "shareholder value," which has come to mean the stock price over the short term.  There is reason to think that this focus on short-term economic performance has also become the major measure of success of health care organizations.  Another word for this phenomenon is "financialization."  

An op-ed in the UK Independent questions this focus because of its economic effects.  Anthony Hilton wrote about the views of Andrew Smithers,

His starting point was that the economy was floundering because of inadequate demand. Personal spending is flat for obvious reasons but the real culprit is the companies who are hoarding cash and refusing to invest.

Others have noticed the cash hoarding but explain it away by saying we live in uncertain times and companies will start investing again once they become more confident about the economic outlook. Smithers disagrees fundamentally with this. He says companies are not investing because executives are bonused to deliver short-term profits. Costly spending on investment projects is therefore anathema to them. Investment may deliver long-term prosperity but by that time they will have left the company. It also depresses short-term profits while they are still there.

We have in the last two decades, under the mantra of shareholder value and aligning the interests of management with shareholders, created a new breed of management incentivised to believe that what is good for them is good for the business. They dislike investment because it reduces their bonuses .

They don't invest surplus cash. They hoard it or they use it to buy back their own company's shares.

When the majority of the managements in publicly quoted companies start behaving this way, as they now do, we have a serious problem. They are sitting on cash which is the equivalent of six per cent of GDP. This deadweight of unused resources prevents lift-off and threatens to leave the economy forever trapped in the mire.

Smithers says this behaviour by management is a structural change — meaning it is something which won't go away. It makes this down- turn different from all that have gone before.

There is no reason to think that health care corporations are not hoarding money in the sense described above.  If so, they may be failing to invest in drugs or devices that would have helped patients in the future.

Because of the limited reporting required of large health care non-profit organizations in the US, it may be very hard to tell if they are similarly hoarding money, but if they are, the effects again might be to fail to provide patients long-term benefits they might otherwise have enjoyed.

The Ultimately Self-Destructive Outcome

Meanwhile, writing in the New York Times, Chrystia Freeland, the author of Plutocrats: the Rise of the New Global Super-Rich and the Fall of Everyone Else, explained why picking the wrong leaders  and paying them too much may be bad for everyone.  We have noted that an increasing fraction of the wealthiest one percent of the US are current and former corporate executives.  Ms Freeland wrote how domination by an increasingly wealthy and powerful elite usually dooms the countries they dominate.

what separates successful states from failed ones is whether their governing institutions are inclusive or extractive. Extractive states are controlled by ruling elites whose objective is to extract as much wealth as they can from the rest of society.

So

it is the danger America faces today, as the 1 percent pulls away from everyone else and pursues an economic, political and social agenda that will increase that gap even further — ultimately destroying the open system that made America rich and allowed its 1 percent to thrive in the first place.  

Furthermore,

It is no accident that in America today the gap between the very rich and everyone else is wider than at any time since the Gilded Age. Now, as then, the titans are seeking an even greater political voice to match their economic power. Now, as then, the inevitable danger is that they will confuse their own self-interest with the common good. The irony of the political rise of the plutocrats is that, like Venice’s oligarchs, they threaten the system that created them.

So it is not merely that overcompensating generic executives has likely been one of the major reasons our health care is so expensive, inaccessible, and mediocre.  The larger problem of overpaying under skilled executives threatens to destroy our whole society.  How cheerful

Summary

The way forward seems clear.  It is just blocked by the interests of the rich and powerful elite which our current foolish policies have created.

In a health care context, leaders of organizations should only be those with clear knowledge of, experience in, and commitment to the values of health care.  Their compensation should be reasonable, and based on their ability to uphold these values first, with financial goals clearly second, and short-term financial goals probably not at all.  Pay should not be bench-marked to compensation of leaders of other organizations, especially not of vastly different kinds of organizations.

Whether there is any chance of such changes happening while corporate boards of directors, and non-profit boards of trustees are dominated by executives of other organizations is doubtful.  Thus we also need to change the governance of for-profit health care corporations to clearly reflect the long-term interests of the stockholders, who will only prosper if in the long run their companies provide products and services that help patients at a fair price and with minimal risks.   Thus we further need to need to change the governance of health care non-profits to reflect the needs of patients, their communities and other key constituencies.  That should keep us all busy for a while. 
 

A Camel Through the Eye of a Needle - at Non-Profit Health Insurers

It is time to drag out that well-worn phrase,...  sometimes you just cannot make this stuff up. 

Recently, the New York Post reported about executive compensation at some non-profit health maintenance organizations/ health insurance companies in New York.  To wit,

FidelisCare

At one Catholic-run health insurer for the needy, charity starts in the executive suite.

Mark Lane, the CEO of the Fidelis Care/New York State Catholic Health Plan, receives a $1.1 million salary plus another $864,000 in retirement pension and other benefits, The Post has learned.


His total compensation comes to nearly $2 million.

Fidelis is a tax-exempt, not-for-profit HMO serving 750,000 patients throughout the city and state who mostly qualify for Medicaid, the public insurance program for the needy. That means nearly all of Fidelis’ revenues come from taxpayers.

Meanwhile Fidelis’ executive vice president and chief operating officer, the Rev. Patrick Frawley, an ordained Catholic priest, is paid $587,249.


Frawley received more than $900,000 in other retirement and deferred benefits — raising his total compensation to $1.54 million, according to IRS filings.

That’s a lot of pennies from heaven.

'It’s shocking to me,' said a source familiar with Catholic health charities.

Amazingly, the justification that was trotted out in this case was just of the "our CEO is brilliant" variety, but in this case, provided by a Bishop:

Fidelis defended the salaries of its top officers, who oversee a $3 billion operation.

Bishop Joseph Sullivan, a member of Fidelis’ board of trustees who formerly served as chairman, called the compensation 'generous but fair.'


He said the goal is for salaries to be at the '75th percentile' of rivals.


“Our ability to continue to grow is based on the quality of leadership. You get what you pay for. Lane and Father Frawley are worth every penny,” Sullivan said.

Fidelis also issued a statement explaining that Frawley, after serving in pastoral roles for 25 years, was granted release from his priestly assignment to pursue a career in health care.

So much for a vow of poverty, even at a non-profit providing health care mainly to the poor.

EmblemHealth

On the other hand, executives of secular, but still non-profit health insurers do even better,

Anthony Watson, CEO of EmblemHealth, gets a compensation package of $8.5 million — about half in salary and bonuses and the rest in retirement and deferred benefits, according to IRS filings.

Two other EmblemHealth executives also snagged multimillion-dollar compensation packages.

Summary

We have noted before how the "peer benchmarking process," setting executive (but not necessarily other) compensation based on a comparison with compensation at other, often highly selected organizations, coupled with the "Lake Wobegone Effect," the belief that one's own executives are always above average, will lead to inexorable rises in executive pay, regardless of performance, or whatever else is going on in the world. The Bishop's assertion that Fidelis' executive compensation should be at the seventy-fifth percentile, because of the "quality of leadership," not further described, is a perfect example of these phenomena.

It is striking to see these phenomena at a non-profit organization whose mission is:

to ensure that every resident, regardless of income, age, religion, gender, or ethnic background, has access to quality health care, provided with dignity and respect.

So, ad infinitum, I repeat.... health care organizations need leaders that uphold the core values of health care, and focus on and are accountable for the mission, not on secondary responsibilities that conflict with these values and their mission, and not on self-enrichment. Leaders ought to be rewarded reasonably, but not lavishly, for doing what ultimately improves patient care, or when applicable, good education and good research. On the other hand, those who authorize, direct and implement bad behavior ought to suffer negative consequences sufficient to deter future bad behavior.

If we do not fix the severe problems affecting the leadership and governance of health care, and do not increase accountability, integrity and transparency of health care leadership and governance, we will be as much to blame as the leaders when the system collapses.

"Peer Benchmarking," the "Lake Wobegone Effect," and Outsize Executive Compensation: the Amgen Example

We recently discussed why health care's 99 percent may have reason to be upset with the one percent, the elite that run health care organizations. Once cross-posted on the KevinMD blog, it caused an eruption of controversy. This included some anonymous commentators who insisted that top leaders' made contributions to health care that were so heroic that their compensation was insufficient.

So conveniently an article this month in the Washington Post dissected the mechanisms that let pay of top health care leaders inexorably rise whatever their and their organizations' performance. 

The Amgen CEOs Compensation

It used as an example the compensation given to Kevin W Sharer, the CEO of Amgen, the biotechnology and pharmaceutical company.

Sharer, a 63-year-old former Navy engineer, was already earning lots of money — about $15 million in the previous year, plus such perks as two corporate jets.

The board decided to give Sharer more. It boosted his compensation to $21 million annually, a 37 percent increase, according to the company reports.

This outsize compensation has allowed Mr Sharer to live large.

He owns at least three homes, according to property records: a $2 million home in Los Angeles, a $6 million spread in Vail, Colo., and a $5 million place on Nantucket.

The Company's Less Than Stellar Performance

This huge raise on top of an already huge compensation package, however, seemed completely unrelated to the performance of the company Mr Sharer lead.

Shareholders at the company, one of the nation’s largest biotech firms, had lost 3 percent on their investment in 2010 and 7 percent over the past five years. The company had been forced to close or shrink plants, trimming the workforce from 20,100 to 17,400.

In addition,

by 2006, the growth that once distinguished Amgen had begun to taper off.

In 2008, Forbes magazine named ... [Sharer] among among the country’s most overpaid bosses because the company’s returns had dipped 4 percent annually over six years while he’d earned an average of $12.3 million.

The lack of enthusiasm was even more noticeable among the people who know most about Amgen — insiders. Companies are required to report when their officials sell stock. Since 2002, the ratio of share sales to purchases has been 12 to 1, according to Bloomberg data reviewed last fall by Christopher.

"Peer Benchmarking"

The Post article then analyzed the process used to set CEO pay at Amgen, and at many other corporations and organizations, and how it lead to such extreme results.

This is how it’s done in corporate America. At Amgen and at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.

The idea behind setting executive pay this way, known as 'peer benchmarking,' is to keep talented bosses from leaving.

We have discussed examples of peer benchmarking before, most recently here. Yet I believe the Post article has the clearest explanation to date of how this works and what its results are. Note that:

It wasn’t until recently, however, that its pervasiveness and impact on executive pay became clear. Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Peer benchmarking has two components. First the pay of peers are assessed, that is, benchmarked:

Amgen selected 11 companies in the biotech/pharmaceutical field, which seems natural enough.

However, how the peers are chosen is important (just as how the comparator treatment is chosen in a clinical trial of a drug is important.) In this case,

But most of the companies on the list are far larger than Amgen. Amgen’s revenue in 2010 was $15 billion; the median revenue of its peer companies was $40 billion, according to Equilar.

The practice of choosing peers that boost pay is common. Studies by Faulkender, Bizjak and ISS Corporate Services have shown that when choosing 'peers' for pay-setting purposes, companies tend to choose larger firms or firms with more highly paid chief executives.

Then an assessment is made, almost always by the organizations board of directors or trustees, of how the CEO compares to these supposed peers:

Maybe even more significantly, however, the Amgen compensation committee also decided that Sharer, despite being at a smaller company, should earn stock compensation at the 75th percentile of peers.

This is critical because stock compensation tends to be the largest component of executive pay.

What is missing in the Post article is any rationale for the assessment that Sharer was doing so much better than the median CEO of these questionably comparable companies. The information presented in the article suggested instead that the company was doing badly, with decreasing revenue, decreasing share prices, and declining employment.

Cronyism on the Boards

Serving on the board of directors of a for-profit corporation requires board members to "demonstrate unyielding loyalty to the company's shareholders" [Per Monks RAG, Minow N. Corporate Governance, 3rd edition. Malden, MA: Blackwell Publishing, 2004. P.200.] (Boards of trustees of non-profit organizations have duties of loyalty, "a board member must give undivided allegiance when making decisions affecting the organization" and duty of obedience, "board members [must] ... be faithful to the organization's mission. They are not permitted to act in a way that is inconsistent with the central goals of the organization," per BoardSource.)

Rather than representing the interests of stockholders, however, many boards seem to put the interests of the CEO and top management first:

The practice has persisted because corporate board members, many of whom have personal or business relationships with the chief executive, have been unwilling to abandon the practice.

At Amgen, for example, four of the six members of the board compensation committee had personal or business connections to Sharer before joining the board. In fact, he nominated at least two of the six to the board, according to a company source and reports.

These kinds of ties — between chief executives and the boards that oversee them — permeate corporate America. On a typical board, the chief executive considers about about 33 percent of the board of directors as “friends” rather than as mere “acquaintances,”according to a survey of chief executives at about 350 S&P 1500 corporations conducted over 15 years by University of Michigan business professor James Westphal.

More tellingly, the chief executive is likely to find even more friends on the compensation committees of corporate boards — almost 50 percent.

The Obvious Problems with Peer Benchmarking

But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the 'Lake Wobegon' effect.

It wasn’t until recently, however, that its pervasiveness and impact on executive pay became clear. Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Since then, researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.

Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her 'peers' earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.

'Peer benchmarking has a significant influence on CEO pay,' Bizjak said. 'Basically, you can’t have every CEO paid above average without pay ratcheting upward over time.'

The gap between what workers and top executives make helps explain why income inequality in the United States is reaching levels unseen since the Great Depression.

Since the 1970s, median pay for executives at the nation’s largest companies has more than quadrupled, even after adjusting for inflation, according to researchers. Over the same period, pay for a typical non-supervisory worker has dropped more than 10 percent, according to Bureau of Labor statistics.

Critical to executive pay levels is peer benchmarking.

Even before the extent of the practice was known, it drew criticism from prominent business figures. After the Enron scandals, a blue-ribbon committee led by Peter G. Peterson, then chairman of the Federal Reserve Bank of New York, and John Snow, former chairman of the Business Roundtable, called for setting executive pay 'unconstrained by median compensation statistics.' Legendary investor Warren Buffett, in one of his famously plain-spoken letters to investors, likewise derided the method.

'Outlandish ‘goodies’ are showered upon CEOs simply because of a corporate version of the argument we all used when children: ‘But, Mom, all the other kids have one,’' he wrote.

Similarly, former Federal Reserve chairman Paul Volcker called it the 'Lake Wobegon syndrome' in congressional testimony in 2008, referring to Garrison Keillor’s fictional town where 'all the children are above average.'

Summary

Peer benchmarking, as it currently is implemented, is an irrational system that has nothing to do with the free market. It shows how perverse the incentives given to top health care leaders have become. It shows how top hired executives of health care organizations are no longer are accountable to anyone. The boards that are supposed to exercise stewardship over them have become their cheerleaders, possibly because they are populated by cronies, and current and former hired executives of other organizations who are more interested in preserving the wealth and power of hired executives than representing shareholders, or upholding organizations' missions.

The problems caused by such perverse incentives include:

- Paying the leaders so well (and supporting the public relations staff who sing their praises) costs money that could better be used to improve patients' and the public's health.

- Providing such perverse incentives, which seem entirely unrelated to the organizations' primary missions, is likely to distract leaders from the organizations' abilities to support these missions.

- It is likely that employees of such organizations who actually try to uphold the mission will be demoralized by the realization that their leaders' enrichment comes first, further damaging the organizations' ability to uphold the mission.

- Finally, it is possible that such perverse incentives attract leaders who are particularly unsuited to the task of upholding the mission.

So, ad infinitum, I repeat.... health care organizations need leaders that uphold the core values of health care, and focus on and are accountable for the mission, not on secondary responsibilities that conflict with these values and their mission, and not on self-enrichment. Leaders ought to be rewarded reasonably, but not lavishly, for doing what ultimately improves patient care, or when applicable, good education and good research. On the other hand, those who authorize, direct and implement bad behavior ought to suffer negative consequences sufficient to deter future bad behavior.

If we do not fix the severe problems affecting the leadership and governance of health care, and do not increase accountability, integrity and transparency of health care leadership and governance, we will be as much to blame as the leaders when the system collapses.