By James Kwak
Two people forwarded me Johann Hari’s Huffington Post article about management consultants, provocatively titled “The Great Management Consultancy Scam — and How it Could Be Coming for Your Job.” It seems that someone is once again bashing management consultants as witch doctors and scam artists, and I, improbably, must come to their defense. “Improbably” because I am generally critical of management consulting, and I have spent many hours with former McKinsey colleagues talking about how little we knew back when we were consultants. I am frequently asked by other students whether they should become consultants, and my general answer is, in a nutshell, “It’s a lousy job, and not nearly as exciting as the recruiting pitch makes it out to be, but it’s a good thing for your resume if you actually want to be in the business world.” (If you know me and are actually considering becoming a consultant, feel free to call me.)
Hari’s article is largely based on books by former consultants, primarily David Craig’s “brave” memoir (written five years ago; David Craig is a pseudonym). Here’s a quote from Craig: “We were proud of the way we used to make things up as we went along. . . . It’s like robbing a bank but legal. We could take somebody straight off the street, teach them a few simple tricks in a couple of hours and easily charge them out to our clients for more than £7000 per week.” According to Craig (according to Hari), all of management consulting boils down to recommending that the client lay off thirty percent of its staff, after one week of observation and analysis.


The More You Pay, the Less You Get
By James Kwak
Schumpeter at The Economist pointed me to a paper by Richard Cazier and John McInnis on one of my favorite topics: CEO hiring. Cazier and McInnis first confirm, not surprisingly, that pay for new, externally-hired CEOs is positively related to the past performance of their previous firms. In particular, they measure EXCESS_COMP as the difference between actual first-year compensation and the compensation that you would predict just based on the characteristics of the hiring firm; EXCESS_COMP turns out to be positively associated with the CEOs’ prior firms’ stock returns. That makes sense, since you would think that people from successful companies would be able to command a higher price than people from less successful companies, and it isn’t obviously controversial, since you would think they would deserve it.
But what do the new firms get for this pay premium? It turns out that their future performance, measured in terms of return on assets and operating return on assets, is negatively associated with excess compensation based on prior performance.* In other words, people from successful companies don’t deserve the pay premium because the higher the premium they are able to command, the less well they are likely to do.
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Tagged business, CEO compensation