HOSPITALS: How much is too much?

The only major hospital CEO to also be a blogger, Paul Levy at Beth Israel Deaconess, is wondering whether his salary of $1m is too much. My flip answer is, well of course it is, but would you turn it down?

Much of the issue is that salaries for high end positions are set “competitively.” In other words the compensation board of for-profit and non-profit institutions and wants to reward their CEO better than his peers. Like in Lake Woebeggon, every board in Boston and way beyond thinks it has the best CEO, so they deserve more than average—so the spiral increases. And the bigger the non-profit gets the bigger the salaries. Someone sent me a form last year with salaries for the top brass of Kaiser Permanente. I didn’t bother verifying it but I recall that it claimed that more than a dozen senior execs had total comp of over $1m.

I wrote a long article about this last year, called Overpaid Facility Managers?, looking at the salary of a decent sized community hospital in the SF Bay Area with some $300m in revenues—as opposed to Beth Israel Deaconess’ $1 billion. That CEO too was on close to $1m total comp.

The problem is that there are almost 2,000 hospitals of that size or larger. If all their CEOs get that amount, or even $500,000 a year, then the whole comparison inflation cycle goes on. And really how hard is it to run a $300 million business, where most of the income walks in the door because of location, referrals of agents (physicians) and government subsidies? I don’t know.

Paul compares himself to a sports star. But the sports stars make so much because they fill hours of TV cheaply which generates lots of advertising revenue. Would we watch the same teams with less good stars? I doubt it, and it’s for sure that the owners are not willing to risk finding out. Which is why the big stars who are measurably better in both statistics and winning percentage get so much more money than those not quite as good.  There are only so many Kobe Bryants, Ronaldinhos, Derek Jeters et al.

The question Paul needs to ask himself is not whether he works hard and does a good job relative to other big AMC CEOs. Of course he does. The real question is are there more than  couple of hundred people who could do his job roughly as well. In other words if the board changed out a .300 hitter for a .265 hitter, would the effect on Beth Israel Deaconess be noticeable the way it would be for the Lakers if Kobe was traded for a journeyman shooting guard.

My guess is that the cult of the CEO is well overblown. And that while Paul is by no means a big offender in creating it (and may be helping to knock it down), we are stuck in a cycle where no one dares take the risk the way the Oakland A’s do in baseball—get unrecognized young talent in, pay less for it and get just as good results. But it’s unlikely to change for some time.

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  1. Affinity Health Systems in the Fox Valley of Wisconsin and Dr. AlBitar
    Let me vent for whatever good it will do.
    I was wishing to just throw out a negative comment about Affinity Health Systems and Dr. AlBitar. They deserve to have something negative said about them in the
    public arena. My only hope is that when a person googles up the names they’ll see the other side of the story and therefore, get a better picture of the hell that they are.
    What can I say? I lost. I screamed at them and screamed at them and lost my case.
    They’ve got the power all on their side so they don’t have to bend over and correct their injustice. They can just continue on as the crooks and killers that they are
    as if no knat ever buzzed once. And no knat WILL ever be loud enough for anyone to hear because Affinity Health Systems and Dr. AlBitar are deaf and the country that these two thrive in is all mentally ill.
    It’s like being in a huge dream and not being able to move. It’s like that painting “The Silent Scream.” Yes, I lost. They won. End of story. Too bad. Who cares? My choice now is to never go into their facilities again least I be crooked at and killed at worse the next time.
    Affinity Health Systems is a lifeless money ameba that sucks on human beings. And Dr. Albitar is a get rich quick slug that found their swamp good for doing his leaching. Now tell, me, what company on earth could survive and stay in business when their goodwill is viewed like this? Only in health care, of course!
    We went in for a stress test….stupid, stupid, stupid us. We believed that it was a harmless thing to do.
    We stupidly signed all our assets away at the door under their coercive, greedy, green eyes, licking their chops the whole while of outpatient admissions. We were a little worried that there may be something wrong with the old pumper.
    They led us to the test (to the place where they’d milk us for everything we were worth), where a non-Affinity doctor performed the test. Stayed with us the whole time and told us that all was okay. What a true saint she was. She also only charged $185. A fair price, we thought, considering she was there a really
    long time.
    BUT then the OTHER bills came rolling in from Affinity Health Systems and Albitar. One company who watches the prices of medical services, named Patient Care out of Milwaukee , WI, told me that Affinity Health Systems is the second highest priced place in Wisconsin and in the nation! The price which we were gouged was 400% higher than the price four years ago at a different hospital. Affinity’s price for the stress test was a whomping $2,587.
    And, then, the invoice from their wise-ass doctor showed up at our door. A doctor that we didn’t even see. A doctor whom we didn’t know had even existed. He decided after seeing our name at the clinic that day that he’d just haul off and send us a bill, too. It was for $551 for (he said) may have been 15 minutes of work. Did he do anything? Probably not. Just a greedy bastard leaching on for no reason but to get on one of Forbe’s billionaire’s lists.
    So I lost. I wasn’t going to pay. But I have to pay, ’cause they want my grave plot, too, the only asset that I have left after ten years living with this sucking health care system breathing over my life. Affinity even owns the collection agency that gets their unpaid accounts! Oh, it is a separate entity
    so, really, it isn’t all one company, they say. Ya, right.
    They are f**king b***tards and they’re all going to hell. And no one, NO ONE does one stinking, damned thing about it. They just let the ball keep on rolling and rolling and let the greedy b**tards keeping on grabbing and grabbing.
    Affinity Health Systems and Dr. AlBitar are free enterprise at it’s finest. A true testament to America.
    I’d like to see capitol hill have a hearing on this, but it will never happen.

  2. jd,
    I think you make some great points. Performance-based comp is something that i think every board should purse with senior level execs. In companies that i work with, we often shoot for company-wide bonuses based on large, bottom-line goals, so that everyone has incentive to perform to a standard. Every employee (including the CEO) should have to meet a performance standard to take home full pay.
    I also think the reference you and Matthew have made to the Oakland A’s is an interesting one. Not sure if you have read the book Moneyball, but its fantastic and a great analog to this conversation. Unfortunately, the A’s used a body of data gathered over many years (remember how stat-driven our baseball fanatic friends are) to find pricing anomolies in the market for talent in baseball. Alas, no such body of data exists in the market for CEOs. Applying a “lets go for the untested hungry guy” strategy is appealing in a lot of ways, but i think is a little unrealistic. Were i a board member for a hospital in my own community, a hospital which presumably had a multi-million dollar budget, I would feel a great deal of pressure to hire the best candidate i could. I think saving a few hundred grand to take a risk on an un-proven candidate would be irresponsible. This is certainly NOT what the Oakland As do – they buy dollars for 10 cents because they have better information than everyone else.
    In my opinion, society is best served not by allocating capital according to arbitrary formulas, but by providing incentive for our most talented citizens to create, build and lead great organizations. If boards begin to think formulaicly (sp?), they’ll create all sorts of weird frictions and the end result will be that talented execs will migrate to other professions (we’re seeing this with physicians today). The free market for labor is a time-tested institution and one with which we should not tinker. Free markets exhibit radical swings from time to time, but they correct themselves. This will be the case with CEO comp. Ultimately, the issue to focus on is governance ie making sure that board members know what they’re doing, and have the right incentives, when they negotiate and structure a candidates comp. There must be a culture of performance at every level in the organization, and thats got to start with the board.
    Hiring a CEO is the most important decision a board will make, and it is often the most difficult as well. Past success is not always a good indicator of future performance. Political pressures weigh heavily. If a board is not disciplined and unified in its effort, more than likely a bad decision will be made.
    I have no idea if Paul Levy is worth $1mm year. He may well be worth twice that – i have no idea. If he is, BIDMC should be, in my opinion, happy to pay the price. If he’s not, then you have to look at board, not the CEO, for answers.

  3. jd,
    A few more comments on CEO (and other executive) compensation.
    Over a 35 year career in the money management business, I have met and interacted with literally hundreds of CEO’s, company presidents and CFO’s in many different industries and have developed some strong opinions about issues relating to senior corporate management.
    First, there are many issues that affect a given company’s economic and profit performance, some of which senior management can influence and some of which it can’t. Among the latter are growth (or lack of it) in GDP, level of inflation and interest rates, pricing of global commodities like oil, steel, aluminum, chemicals, paper, etc. and external shocks like the 9/11 attacks. The key areas where management can make a difference are picking and developing management talent and allocating capital. At the end of the day, what you want is what the current General Electric CEO, Jeff Immelt, calls “performance with integrity.” However, factors that management cannot control can easily swamp what it can influence, especially over the short term. For that reason alone, setting incentive compensation targets is not as easy as it sounds.
    I am reminded of a comment Warren Buffett often makes which goes something like this: If you put a management with a reputation for brilliance in charge of a business with a reputation for bad economics, it will be the business that emerges with its reputation intact.
    Difficult decisions to outsource jobs in order to reduce costs are just that – difficult. Managements don’t go home and celebrate putting employees out of work. They usually take these actions to hold onto existing business or effectively compete for new business.
    When Boards are looking for a new CEO, you have to ask, why is there a need for a new CEO? The answers include: (1) the incumbent has reached the mandatory retirement age, died, or can no longer perform the job due to failing health, or (2) the company is performing poorly and the Board feels that a new team and a new strategic direction can right the ship.
    Most of the time, the successor is an internal candidate replacing a CEO who is retiring. There is an established compensation structure that spans all the levels of management and reflects market conditions and frequent surveys that compensation consulting firms do to show managements how their pay stacks up vs their competitors. Historically, base compensation is a function of skill, education, responsibility and danger. Executives with profit and loss responsibility have incentive compensation plans on top of that which attempt to reward appropriate performance metrics.
    If the Board wants to bring in an outsider, it generally seeks an executive with a track record and the skill sets it most needs as well as a good fit with its corporate culture (or a mandate to change the culture). Such an executive often has to leave behind stock options that have not yet vested and other forms of compensation which the new company has to, in effect, make him or her whole for in order to induce the candidate to take the new position. Sometimes a division manager at a company like GE will get a chance to become CEO of a considerably smaller company. Compensation consultants provide guidance as to what the market is in that industry for executives at a given level and what it will take to attract the candidate they want. The whole system is biased to err on the side of generosity. For an outsider at the CEO level, the Board also generally feels that it has to give the new CEO and his team at least 3-5 years to turn the battleship around and show results.
    It’s not an easy issue, but it’s not the place to skimp, in my opinion regardless of what the worker bees might think.

  4. Barry,
    Thanks for the history and context. It sounds like you’ve been around the block once or twice more than I have.
    There might have been a miscommunication. I wasn’t contemplating government regulation of compensation so much as thinking from the board’s point of view. If there is so little correlation between what they vote to compensate the CEO and performance, why not (a) pay less, and/or (b) tie payment more to performance?
    One way to think about the lack of correlation is this: boards really aren’t very good at predicting good CEOs. This is especially true if by “good” we mean “above average,” since everyone wants to be above average but by definition roughly half won’t be. In that case, why not pay CEOs less to start?
    Until and unless there is data to support the conclusion that you don’t get competitive candidates with lower pay packages, it is not in the interest of the company or its stakeholders to pay more. This is where Matt’s comment about the Oakland A’s comes in. There are lots of smart, talented, experienced, hungry people who would jump at the chance to run a hospital even if it meant getting paid $500,000 instead of $1,000,000. Are there not? Is there anything more than anecdote and groupthink to the contrary? In fact, you might even tend to get a better candidate who will take the added responsibility in order to have the opportunity to make a difference without a (big) jump in pay. Their egos may be better aligned with the organization’s mission. I’m thinking entirely in terms of the board’s interest in the company here, not morality or politics.
    The second point also follows from the supposition that board’s don’t/can’t reliably predict good CEOs. Why not tie a higher percentage of compensation to performance in case (as is quite likely) the person does not live up to expectations. At least if you get a flop you pay 30% less (or 60%, etc.) for it. I also have no problem with the CEO earning more if the company exceeds its goals.
    As for the issue of an appropriate level of CEO pay relative to other employees, I think any simple metric can be easily gamed. For example, if you look at average employee income you could outsource lower-pay work so that the only employees were upper-level management.
    Also, I do think that the size of the organization matters. A $100 billion company with an average pay of $40,000 is not the same as a $1 billion company with an average pay of $40,000.
    Final note on compensation: if we’re concerned about the working poor (and I am), then the average income is not the best measure to use because high salaries skew it up quite a bit. The median income would be better, and some combination of median income, lowest representative income and total enterprise revenue would be better still. Here I am not thinking from the perspective of the company’s best interest, but from the society’s interest.

  5. jd,
    A number of years back (I forget how many), Congress passed a law that only allows a tax deduction for executive pay up to $1 million per year unless it is tied to performance. The performance component came to consist mainly of stock options and restricted stock on the theory that the only way the stock would go up is if the management grew the enterprise. Unfortunately, stocks also go up when the underlying companies grow in line with the economy or their markets and stock price earnings multiples rise due to lower interest rates and long term inflation expectations. I think capping the tax deduction on non-performance related compensation was a mistake and should be repealed.
    I think it would be reasonable for the non-performance related portion of total CEO compensation (including benefits) to be set at 40-50 times the total compensation of the average worker in that (large) company. So, if the average guy earns total comp (including health insurance, pension benefits, etc.) of $80K, then $3.2 – $4.0 million in base compensation would be reasonable for the CEO. Since senior management is in a position to create or destroy value by formulating and executing strategy (including making and integrating acquisitions, introducing new products, expanding into new geographies, etc.) whereas the average worker is not (for the most part), performance comp should be on top of base and should be zero if targets are missed badly but could be up to one or two times base if they are completely achieved. Average workers often have profit sharing plans that can pay up to 15% of pay, which I think is an upper limit set by tax law, but I don’t know that for sure. The main reason that CEO compensation increased so much starting in the 1980’s was because the stock market took off after going basically nowhere from 1966 to 1982. I know for a fact that, in the case of United HealthGroup, the Board never contemplated that the stock would do anywhere near as well as it did when it set option awards in the middle and late 1990’s. Many Boards encountered a similar experience, though United was an extreme case, especially as it related to its then CEO, William Maguire.
    For non-profits, I wouldn’t be surprised if the CEO’s base pay is closer to 20 times or even less that of the average employee. Obviously, it needs to be sufficient to attract and hold a qualified individual. Depending on the organization’s needs and objectives, targets can cover anything from revenue, to occupancy to fund raising to lowering infection rates to IT modernization to community outreach objectives. It’s the job of the Board to determine the organization’s priorities and what it wants and expects the CEO to achieve.

  6. jojo raises another point worth repeating: it isn’t just that pay is not (or not sufficiently) tied to performance. It is that the average CEO pay is too high relative to total company wages. We are creating the kind of bi-polar society that you find in Latin American countries, with a wealthy elite that exploits a vast, poorly educated working class. The middle class that expanded greatly with unions in the 1940s and 50s is slowly eroding.
    I am of the view that class war is inevitable under such circumstances. Our politics would tend more and more to oscillate between reactionary and socialist, and our vast Wal-Mart shopper working classes would be less able to compete for jobs in the global information age. The last thing we need to create in America is Venezuela.

  7. Barry,
    I like your formula for options, though I think that there is more to Matt’s point than you addressed. It isn’t just that CEO options and bonuses show no correlation with performance, but that CEO pay overall does not. Now, I haven’t seen those statistics, and I’m not sure if they apply to companies beyond the Fortune 500. Assuming it does, then we really need to ask ourselves: is pay tied to performance at all? And if not, why the hell not?
    Here is an additional suggestion: when CEOs get hired, they agree to tie their total compensation (including base salaries) to certain measurable results. The CEO is being hired to increase revenues by 20%, profits by 15% (or 30%, whatever), improve the brand image as measured by a survey, etc. If those targets are not met, compensation will decline according to a formula. If they are exceeded, compensation increases. If the board and CEO want to make it a complicated formula, fine. If they want to make it public, even better (do they have to in some cases?)
    Performance-dependent compensation should be at least 50% of total compensation.
    What say you?
    Oh, and non-profits should have more public interest metrics thrown in, not just financial ones.

  8. Most CEO’s are little more than figureheads that depend on the people under them to do the real work, all the way down the chain. Therefore, the wealth should be spread more evenly throughout the company. 400 to 1 pay ratio’s are criminal. Pay should be more reasonable and and whatever is left over should be returned to the shareholders or the customer (in the form of lower prices).

  9. Matthew,
    I agree with you on the lunacy of corporate CEO’s who create no value or even destroy value getting huge paydays to go away (or to stay). Disney’s Michael Eisner, for example, destroyed value during the last ten years of his tenure but he personally never had a bad year.
    If it were up to me, CEO’s and other senior executives who are in a position to formulate and execute strategy would get competitive salaries. Competitive means enough to attract and hold qualified people. Option awards should only pay off based on the extent to which total return to shareholders exceeds what could have been earned from investing in a broad based index fund over the same period. So, if it’s a boom period in the market and the S&P 500 returns 15% per year for five years, only returns above the index total return would be rewarded. Conversely, if the economy goes into a deep funk and the broad market only returns 5% per year or even zero, I would consider any return above the market benchmark to be value added. Sometimes luck will play a role like an oil company executive riding a spike in oil prices, but I can live with that. For most of us, the primary determinants of our life outcome are luck and effort.

  10. Barry–This is obviously true if you are right and that you NEED a .300 hitter. But the A’s have shown that you can do just as well in the market with cheaper talent. And you know that assessments of Fortune 500 CEO performance show little relation between performance and compensation. Remember HP paying Fiorina $20m to go away?

  11. I think most conversations about CEO comp have two elements: 1) jealosy; and 2) the belief that no on really “needs” that much money. The real issue should be accoutability and results, just as it should be with every position (including physicians).

  12. Matthew,
    When Paul Levy took the job to become CEO of BIDMC in January, 2002, it was losing $70 million per year. Now it’s profitable, thanks in large measure, to his leadership and that of the Chief Information Officer. For some insight into their approach to IT, read this article.
    I think he is well worth his compensation and said so on his blog. The former CEO of General Electric, Jack Welch, has commented in the past that having the right person in a key spot in an organization can make a huge difference in how the organization performs. It appears that Mr. Levy is the right person for BIDMC. The CEO’s compensation is not the place to skimp in trying to save money. Even if all of the hospital’s revenue were coming from taxpayers, I think we would be better off paying $1 million for a solid leader than $300,000-$500,000 for an amiable, ineffectual bureaucrat.
    Taking your figure of 2,000 hospitals with revenue of $300 million or more, even if every CEO were paid $1 million, that’s $2 billion or 0.1% of our $2 trillion in healthcare costs. Cut the figure in half, and we save 0.05% of healthcare costs. I’ll take the 300 hitter for $1 million over the el cheapo 265 hitter for $500,000 any day.