CEO and industry pay

When I came to HBS admit weekend last spring and started asking other students what their plans were after their MBA, very few told me they planned to go into a traditional business. Most of the words flying around were Hedge Funds, Private Equity, Investment Banking, and Investment Management. A common theme to all those industries is that they all create value by moving money around smartly... taking it from one place, putting it in a better place, and getting more out of it. In this sense, they create a lot of value for people. But they don't actually create a tangible product. I left wondering why this was such an attractive sector.

After a semester of HBS, I now have a much better idea. While many people have a natural inclination for financial services, another very compelling attraction are unbelievable margins, and therefore, individual compensation. People who work in businesses that actually make things are called people who work in "industry." The financial services sector advices, invests in, and buys and sells these industry units at a significant commission on each transaction.

This left me asking why the margins are so high in financial services. In other words, why competition doesn't drive margins down to more competitive levels like they do in the rest of the world? Here is an example...

Let's compare the compensation of the CEO of General Electric and the CEO of Goldman Sachs. I will compare 2007 data since that is what I have available for both.

1. General Electric

• Net corporate income (profits) was $22.2 Billion.
  
• CEO is Jeff Immelt (Harvard Business School Alumnus)
• CEO compensation was $14.2 million

2. Goldman Sachs

• Net corporate income (profits) was $11.6 Billion
• CEO is Lloyd Blankfein (Harvard Law School Alumnus)
• CEO compensation was $70.3 million

Now, this is not at all meant to be bashing CEO compensation schedules. I believe people should get paid every penny they are worth. What I don't understand is why the CEO of General Electric makes a fifth of the CEO of Goldman Sachs, while his company's net profits are twice as much as Goldman Sachs. The fact that General Electric is that much larger shouldn't come directly into play because we are talking net profits, not total revenue. Sure GE has to spend more money on capital intensive items, but supposedly their income statement already reflects that. What we see is that the CEO of GS makes exactly 10x more in compensation per dollar of profit than the CEO of GE.

This quickly trickles down, since it's not just a the CEO level. Mr. Blankfein's VPs and Directors probably also make a similar premium over that of Mr. Immelt's leaders. From these figures, it's no wonder that financial services is first and foremost on so many people's minds when it comes to careers, and I certainly don't blame them. The main question I have is: why?

If one investment bank for example paid its executives a little bit less, and passed that savings on to their clients, wouldn't they in theory get more business in the long run? Isn't that a basic tenet of fundamental marketplace competition? Minimize your costs to optimize sales? Some may argue that then those banks wouldn't attract the top talent. But why is the argument not the same for other companies? Similarly, can somebody really argue that there aren't enough qualified people to lead Goldman Sachs making $20 million a year? Is Mr. Blankfein really worth 3x as much as the poor unqualified guy who would work for a mere $20 million a year?

I want to emphasize that I have absolutely nothing against Goldman Sachs, despite some of their bad press lately. I believe in capitalism and that one should earn what he is worth. What I don't understand are the forces at play which skews the financial industry to be so far removed from the others. Maybe I will learn that in my second semester!