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. 
 

6:08 PM

Are the Health Plans of the Very Rich Different from Yours and Mine?

Yesterday, the New York Times published an intriguing story about "Cadillac" (that is, expensive) health insurance plans,

Goldman Sachs is one of the nation’s richest banks, and hundreds of top Goldman employees have a health care package to match — one of the 'gold-plated Cadillac' plans cited by those involved in the health care debate in Washington.

Goldman’s 400 or so managing directors and its top executive officers participate in the bank’s executive medical and dental program as part of their benefits, according to documents filed with the Securities and Exchange Commission. The program generally costs the bank $40,543 in premiums annually for each participant’s family.

Those taking part in the plan include the company’s chief executive, Lloyd C. Blankfein, and four other top officers, as well as managing directors, whose base salary is $600,000.

Goldman’s medical coverage entered the health care discussion on Sunday when David Axelrod, senior adviser to President Obama, cited the Goldman program as an example of the expensive benefits the administration might consider taxing to help pay for its health care program.

'The president actually was asked this the other day by Jim Lehrer, and what he said was that this was an intriguing idea to put an excise tax on high-end health care policies like the ones that the executives at Goldman Sachs have, the $40,000 policies,' Mr. Axelrod said.

A proposal by Senator John F. Kerry, Democrat of Massachusetts, would impose an excise tax on the insurers that issue policies like Goldman’s, with the expectation that the insurers would pass along most, if not all, of the cost to employers who buy the plans.

Leaders of the Senate Finance Committee, which is working on bipartisan version of the health care legislation in Congress, had long expressed interest in taxing some employer-provided benefits — a move many budget experts say would help slow the steep rise in health costs.

Negotiators have not yet determined the value of the plans that would set off a tax on the insurance companies; the numbers under discussion range from $20,000 to $40,000 annually, a senior administration official said.

The lower end of that range would increase the amount of money the tax would raise but would also hit some middle-class workers, whose unions in some cases negotiated robust health benefits in lieu of pay increases. Typical employer-provided plans cost $13,000 to $20,000 per family, depending on the location and the age of the plan participants.

A health care package costing $40,000 or more a year would generally have no co-payments or deductibles, according to Paul Fronstin, an analyst at the Employee Benefit Research Institute, a Washington nonprofit that studies benefits. It would also have no limits on doctors or procedures, no restrictions on pre-existing conditions and no requirements for referrals.

Few people have such policies, Mr. Fronstin said. 'It would only be top executives who run big businesses, mainly people in the C suite,' said Mr. Fronstin, referring to companies’ chief officers.

It was not clear from this article how many top corporate executives have such plans, and whether leaders of other kinds of organizations, like large not-for-profits, also have them.

My main concern about such plans is not how much they contribute to top corporate leaders' compensation packages. Such packages are generally already so outrageously huge that providing $40,000 rather than $13,000 worth of health insurance is a trivial increase. My concern is not that plan recipients' demands for health care will collectively increase health care costs, because they include only a tiny portion of the population.

My main concern, instead, is how much these plans further insulate already cocooned top executives from the vicissitudes of daily life, particularly related to coping with our current dysfunctional health care system. What benefits executive health care plans provide is not clear, but presumably they insulate executives from having to deal with the managed care/ health insurance bureaucracy which frustrates patients seeking particular services, but not necessarily the most expensive, or least beneficial services. Such executives might thus not have gut level appreciation of how dysfunctional the health care system has become for even insured patients. Since top executives often are disproportionately influential members of the "superclass," their disconnection from the realities of dysfunctional health care is likely to translate into little real support by the powers that be for meaningful health care reform. There support may be further retarded by the influence of their fellow superclass members whose personal fortunes depend on the status quo in health care.

Real improvement of health care may depend on finding leaders who have better understanding of the plight of real people.

1:50 PM

More Gravity Defying Compensation for Not-for-Profit Health Care Leaders

Two recent articles featured more about gravity-defying compensation given to the leaders of not-for-profit health care organizations. We had recently posted about how the CEO of one not-for-profit health care insurer rose while the organization's revenue and enrollment fell. Similarly, from the Detroit News,

Blue Cross Blue Shield of Michigan -- the state's largest insurer -- gave pay hikes to six top-level executives in 2008 and doled out generous retirement packages for four former senior vice presidents, despite the nonprofit organization's loss of $144 million last year.

The organization's deteriorating financial health, a justification for Blue Cross officials wanting to raise rates on its line of individual insurance policies, had prompted widespread job cuts at the Detroit-based insurer.

In January, Blue Cross said it needed to eliminate about a 1,000 positions.

Despite those cuts, CEO Daniel Loepp received a compensation package of base salary, bonuses and other compensation totaling $1.8 million in 2008, up from $1.7 million in 2007.

The CEO's bonus last year was $727,575, up from $696,777 in 2007, according to documents filed last week with the Michigan Office of Financial and Insurance Regulation.

Blue Cross spokesman Andrew Hetzel said the 2007 to 2008 increase was to help bring Loepp's total compensation in line with CEOs at other comparable-size Blue Cross organizations nationwide.

The retirement packages -- ranging from $3.1 million to $994,132 depending on the executive -- were for four senior vice presidents who'd each been with the organization an average of nearly two decades, Hetzel said.

Hetzel added that all the senior level executives are taking pay cuts this year -- including a 5 percent reduction in their base salary.

And the compensation packages for 2008 were set by the Blue Cross board at the end of 2007, Hetzel added, well before the organization saw need to cut its work force.

Note how the pay of the top leaders of many health care organizations seems to defy gravity, going up faster than inflation, going up even when the organizations lose money, going up even when the organizations have to lay off workers. There is always an excuse. But in this case, once the miserable results of 2008 became clear, why could the board not re-assess the CEO's pay? Finally, note that even if there is a decrease in 2009, it is a decrease only compared to the elevated 2008 level.

Locally, the Boston Phoenix assessed the pay of the CEOs and other top leaders of all the states not-for-profit hospitals. Some of its main findings were -

The compensation of the CEO of the state's biggest hospital system is higher than any other New England hospital CEO:

Receiving almost $3 million in annual salary and benefits in each of the last two years, Lifespan CEO George Vecchione is the highest-paid health-care executive in New England. Vecchione collects almost $1 million more each year than the CEO at the region’s largest health care network, Partners HealthCare System in Boston, although Lifespan is much smaller than Partners, and New England’s second largest network, Caritas Christi Health Care, also in Boston. In 2007, only Lahey Clinic CEO David Barrett approached Vecchione’s compensation, thanks to a one-time supplemental retirement benefit of $1.5 million; even with that payment, Barrett received $300,000 less than the Lifespan leader.

The compensation of many RI hospital CEOs, and of other RI hospital leaders is high compared with peers in other states, and has risen much faster than inflation:

Modern Healthcare's executive compensation survey suggests that Vecchione is not the only Rhode Island health-care CEO who is paid well above the national median. When benefits, expenses, and long-term incentive plan payments are subtracted from Care New England CEO John Hynes's compensation package, the remaining $911,562 is well above the $570,000 median base pay and bonus paid to the 60 CEOs of small hospital networks surveyed in 2007.

Once benefits, long-term incentive pay, and terminated life insurance payments are subtracted, Women & Infants Hospital CEO Constance Howes received $481,625 in 2007, and Kent County Memorial Hospital's Mark Crevier collected $551,799. Meanwhile, salary and bonuses for Rhode Island Hospital's Amaral ($693,477) and Miriam's Hittner ($572,132), were more than $100,000 above the national median.

Several other Lifespan administrators received more than $500,000 in compensation in 2007: general counsel Kenneth Arnold ($623,902); treasurer Mary Wakefield ($672,057); chief physician Arthur Klein ($935,291); senior vice president for shared services Frederick Macri ($569,777); and Lifespan Physician Service Organization CEO Joel Kaufman ($542,162). No other Rhode Island hospital executives listed on the tax returns received more than $500,000.

Salaries at the smaller community hospitals present a mixed picture. Modern Healthcare's 2007 median compensation at independent hospitals with revenues under $200 million is $350,500. The CEOs of Westerly and South County hospitals and Roger Williams Medical Center were well below the median, while St. Joseph's John Keimig was slightly above. The 2007 salary and bonuses, however, for Memorial Hospital's Francis Dietz ($572,000), Landmark Medical Center's Gary Gaube ($673,164), and Rehabilitation Hospital of Rhode Island's Richard Charest (440,593) were considerably above the median.

Not only are compensation packages high, they have increased at incredible rates for some executives. Two Care New England executives watched their pay more than double over the last seven years, in part due to long-term incentive plan payments in 2007.

Butler Hospital CEO Patricia Recupero's compensation grew 117 percent, while Hynes' pay increased 107 percent. In addition, Landmark Medical Center CEO Gaube's compensation increased 107 percent as his hospital slid into financial insolvency. The compensation for three other CEOs, Memorial Hospital's Dietz, Emma Pendelton Bradley Hospital's Daniel Wall, and Lifespan's Vecchione, increased between 90 and 99 percent over the last seven years.

Three CEOs of Lifespan hospitals received lesser raises since 2000: Amaral (65 percent), Hittner (62 percent) and Newport Hospital's Arthur Sampson (55 percent). St Joseph Health Service CEO Keimig, who, like Amaral and Gaube, has resigned, received a 72 percent pay increase over seven years.

CEO compensation has risen quickly even at institutions whose finances are failing:

Increases in compensation for Gaube and Charest are among the most notable. In a December 2008 report, the state Department of Health labeled Landmark Rhode Island's financially weakest hospital. Landmark ran a small profit in 2004, but starting in 2005, the Woonsocket hospital slid into insolvency.

In June 2008, the Rhode Island Superior Court appointed a special master to run the troubled institution. Landmark also owns 50 percent of the Rehabilitation Hospital of Rhode Island, where Charest served as president, as well as second in command to Gaube at Landmark.

While the hospital ran in the red, however, Gaube and Charest continued to receive raises. A review of the hospital's tax returns indicates that Gaube's compensation increased 37 percent, or almost $200,000, from 2005 to 2007. Over the same two-year period, Charest's pay increased 32 percent, or more than $100,000.

The article does provide some insight into the thinking of those in charge of awarding these bloated pay packages. For example, regarding the pay received by the Care New England CEO:

'John Hynes earns every penny,' says Care New England board chairman Jonathan Farnum, adding, that few people have the skill set to handle the job. He describes Hynes and Vecchione as workaholics who are always on call and constantly handling crises. 'The people are well-served,' Farnum says. 'I don't think they're [the CEOs] driven to maximize their own personal salaries.'

What a peculiar argument to make in a health care context. Lots of people in health care work long hours and are on call frequently, and unlike a hospital CEO, may have to handle life and death decisions in the wee hours of the morning. And most of them make far less than Hynes, who was still not the highest paid leader in the Phoenix article. What really seems to be the rationale, in my humble opinion, is the belief that the work of executives is somehow much harder and more deserving than the work of anyone else, including physicians.

Those who set executive pay were unmoved by the arguments that medicine and health care are callings, and that not-for-profit should not pay their executives comparably to the richest for-profit corporations:

With 10,000 employees and $1 billion in revenue, Lifespan is more like a for-profit health-care institution, [Lifespan board chairman Alfred] Verrecchia says, adding, 'We wouldn't be paying any different if we were for-profit or not-for-profit.'

Verrecchia also disputes the idea that high CEO salaries may discourage donations to the hospital. 'We're not receiving funds to manage day-to-day operating procedures at the hospitals,' he says. Fundraising pays for specific programs, he explains, like a new emergency or operating room.

In response, let me just quote more of the Phoenix article:

'They may be able to persuade donors of that,' counters Alan Sager, a Boston University professor of health policy and management, 'but money is fungible. Money can be moved.' Sager adds, 'If the CEO gets $2.9 million, that's money the hospital can't use to underwrite care for uninsured or underinsured people.'

Sager notes that 30 nurses could be hired with Vecchione's salary. 'Does this person do as much good in the world as 30 nurses?' he asks. 'I find that hard to believe.'

The follow up to that may make the most important point of all:

As president and CEO at Pawtucket-based toymaker Hasbro, Verrecchia was paid $8.4 million in 2006, and $16.5 million in 2007, according to Security and Exchange Commission documents. This is another part of the problem, says Sager: The corporate lawyers and executives who sit on hospital boards form 'a club' with the hospital executives, in which six- and seven-figure salaries are normal. The result, he says, is a 'financially combustible combination' for nonprofit hospitals.

That really seems to be the bottom line. As hospitals become more like big businesses, their leaders identify more with the power elite, or the "superclass," than with their staff, much less their patients. Their sense of entitlement grows, and their understanding of the problems of ordinary people wanes. Whether their devotion to the healing (and sometimes academic) missions of their organizations can survive under these circumstances is open to question.

(Note, for full disclosure: I am a part-time voluntary teaching attending at one of the Lifespan hospitals, if my position survives this posting.)

10:51 AM