Jayashantha Jayawardhana addresses the hefty cost of overcompensating talent

In 1980, Roberto Goizueta – a Cuban émigré who had relocated to the US as a teenager – was appointed CEO of Coca-Cola, a company that didn’t own natural resources and had little in terms of physical capital.

Goizueta died a billionaire in 1997 at the age of 65. While he wasn’t the first immigrant to become a billionaire in America, Goizueta’s case is noteworthy because he made his fortune as Coke’s CEO while his counterparts built their fortunes by founding companies and eventually listing them.

His rise to the top job at Coca-Cola marked the talent economy’s coming of age, the beginning of an epochal shift that would extend to the 21st century.

By 1980, Coke was deservedly among the most valuable companies in the world for its iconic brand, and the talent that built and kept it going. Goizueta epitomised that talent and investors rewarded Coca-Cola on an unprecedented scale.

About a century ago, natural resources were the most prized assets. Standard Oil needed hydrocarbons, U.S. Steel wanted iron ore and coal, and A&P required real estate.

As Roger Martin writes in his illuminating Harvard Business Review (HBR) article titled ‘The Rise (and Likely Fall) of the Talent Economy,’ “as the 20th century progressed, America’s leading companies grew large and prosperous by spending increasing amounts of capital to acquire and exploit oil, mineral deposits, forests, water and land. As recently as 50 years ago, 72 percent of the top 50 US companies by market capitalisation still owed their positions to the control and exploitation of natural resources.”

These companies required plenty of labour as they continued to expand their operations – but these were largely routine intensive and fungible jobs. In the economic pecking order, natural resources came first, providers of capital were second and suppliers of labour took third place.

The 1960s witnessed the first waves of a sea change in the economic landscape with the extraordinary flowering of creative work that called for significant independent judgement and decision making. Though creative positions accounted for 16 percent of all jobs in 1960, they had grown by only three percentage points over the previous 50 years. However, that proportion doubled over the next 50 years to reach 33 percent by 2010.

At the time, IBM, Eastman Kodak, Procter & Gamble and Radio Corporation of America (RCA) exemplified this relatively new breed of corporations as they were all based on talent. According to the Financial Times Global 500 rankings, by the end of the third quarter of this year, Apple, Amazon, Microsoft and Alphabet Inc. remain the four largest companies in the world (investment companies excluded) as measured by their market capitalisation.

Even with some differences in their respective business models, they’re all talent driven businesses. In his HBR article, Martin observes: “Over the past 50 years, the US economy has shifted decisively from financing the exploitation of natural resources to making the most of human talent.”

While talent is the key driver of competitive advantage for businesses operating in sectors such as IT, finance and healthcare, it’s also evident that it plays an increasingly important role in other domains too.

In 2017, companies like Broadcom, First Data and CBS reportedly paid their CEOs millions of dollars in salaries, bonuses, perks, stocks and options. These astronomical compensation packages are only part of the problem with the talent economy because they pale in comparison to what the five top earning hedge fund managers took home in 2016.

According to an annual list released by Institutional Investor’s Alpha magazine, Renaissance Technologies’ James Simons topped the list with earnings of US$ 1.6 billion. He was closely followed by Ray Dalio of Bridgewater Associates with earnings amounting to 1.4 billion dollars. There are several more like Simons and Dalio who rake in millions of dollars annually.

The problem with the talent economy is that it’s becoming increasingly clear talent is overcompensated at the expense of shareholders and the economy in general. In other words, closing dream deals or incessantly trading equities and derivatives doesn’t create any economic value.

One trader’s loss is another’s gain. In fact, high frequency trading engenders high volatility in the markets, which while benefitting a few, hurts most investors. Also, it’s no secret that a number of CEOs who receive stock based compensation seek to benefit from market volatility in the equity markets rather than help their business achieve real growth.

Seasoned investors, institutions and governments need to institute corrective action to curb this egregious behaviour in the best interests of those who create real economic value.