CEO Pay

David Wessel of the Wall Street Journal discusses a paper on the controversial topic of whether recent increases in CEO pay have been excessive. A post from May, "Are CEOs Overpaid?" is listed in the sidebar of the article as "More Critiques of This Paper":

With CEO Pay, Size Does Matter, by David Wessel, Commentary, WSJ: ...[W]hy do the 500 largest U.S. companies pay CEOs six times as much as in 1980, adjusted for inflation? ... Theories abound. Cozy, corrupt or incompetent boards are letting CEOs rip off shareholders. Today's CEOs won't work hard without lucrative incentives. A CEO's job is riskier or harder than it used to be.

Xavier Gabaix ... and Augustin Landier ... offer a strikingly different take... It's the competitive market... [T]he Gabaix-Landier argument has created such a buzz among academics since the pair began circulating a paper six months ago that it seems worth considering this alternative to the cynical view -- that CEOs are crooks -- for which the scandal over backdating of options provides support. ...

[H]ow much did U.S. companies grow in the past 25 years as CEO pay rose sixfold? Measured by stock-market capitalization, the value of all their shares, the companies grew sixfold, the pair discovered. "If all companies increase in size," Mr. Landier says, "the amount people are willing to pay for the same talent goes up."...

CEOs aren't better than they were a quarter century ago, and there isn't much difference among them. But being a little bit better CEO than your competitor is worth a lot of money, just as it is to superstars in opera or baseball.

If the No. 1 CEO -- the best -- was replaced by No. 250, how much difference would that make to the No. 1 company's market cap? It would fall ... nearly $58 million. "Very small talent differences translate into considerable compensation difference as they are magnified by firm size," they argue.

If Messrs. Gabaix and Landier are right, tweaking corporate-governance rules won't restrain CEO pay. ... Outrageous exceptions, he says, shouldn't drive policy. ...

[I]f they are right, then CEO pay hasn't much to do with motivating CEOs to work harder, and there is little economic harm to be done by taxing them more heavily. ...

The[y] ... haven't explained everything. The market cap of U.S. companies rose mightily from the 1940s through the 1970s, yet CEO compensation didn't soar much faster than the typical worker's pay.

What changed? Frank Levy, an MIT economist, has a hunch: "Coming out of World War II, and the Great Depression before that, a lot of people were very afraid of extensive labor unrest. The whole framework of collective bargaining, a decent minimum wage, high marginal tax rates, etc., were all designed to head that off."

For a while, fear topped greed. But fear of unions and of government restraints on the market forces Messrs. Gabaix and Landier describe faded around 1980. Greed took over.

Comments

[Alex F]

"The market cap of U.S. companies rose mightily from the 1940s through the 1970s, yet CEO compensation didn't soar much faster than the typical worker's pay."

This is perhaps more of a question for David Wessel or Mr. Gabaix than for you, but if CEO pay remained more or less stable from the 1940s through the 1970s while market capitalization rose, then this implies that they were either heavily overpaid in the 1940s or they were heavily underpaid in the 1980s. (Or some combination of the two). If the former, why should that have been? The columnist seems to be suggesting the latter, however, that compensation was out of whack in the 1970s due to fear. So if compensation and market capitalization have risen proportionally since then, that implies that CEOs are just as underpaid now relative to the "no fear" market wage.

In other words, if CEO pay "naturally" rises proportional with market cap, but fear of labor unrest (and high marginal tax rates, according to Wessel) drove CEO pay down in the past, then shouldn't the lifting of such constraints mean that CEO pay would have risen much more than proportionally since 1980?

Something doesn't seem right here.

[reason]

I'm sure I saw this before, and I commented then as now - is the size of companies really relevant? If markets are more concentrated (implied since the growth of the companies in question exceeds the growth of the economy as whole) then there may be monopoly profits to divide up, but then there should be also more competition for the positions.

But as to the superstar issue, it implies that you can know in advance who will do a better job, I dispute that, and from what I remember of studies that looked into it, the facts are on my side.

But that is exactly the issue isn't it, you have no way of knowing who will (or even has) made a positive contribution to the company. (If I got given the job and outsourced it to McKinsey might I not be more cost effective?)

The boards have two things on their mind I think:
1. Risk aversion, the company is big, means losses can be very big, better find a safe option to run it. There are not so many people around who have run big companies without making big mistakes.
2. Pay them a whole lot, so they don't move in the same circles as employees they may "have" to sack.

[reason]

By the way, the argument in the article (which I dispute anyway), is surely also an argument for high income taxes on such superstars (as they are earning rent). And an argument for a vigorous anti-trust policy.

[spencer]

Why should CEO compensation be related to stock market capitalization since the bulk of stock market moves are driven by changes in the market PE that are a function of inflation and interest rates that CEO have no impact on?

Make CEO compensation a function of something they do influence like earnings.

[save_the_rustbelt]

Is the CEO the only employee in the corporation?

[evagrius]

save the rusbelt;

"Is the CEO the only employee in the corporation?"

Of course!

[save_the_rustbelt]

The very well paid new CEO at Ford is really revving up his chainsaw, not that he caused three decades of problems, but for guy who knows nothing about autos he certainly is confidant in his ability to reshape the company.

Ford will be shrunk down and then sold/merged within three years, and then a new overpaid CEO with a new vision can take charge.

[calmo]

Such a stroke: 'Is the CEO the only employee in the corporation?'
Thank you Rusty for making me think (I'm sure that's what it is. It happens. It could happen to you...with a little help from our friends.) about the relationship between officers, employees and corporations.
I need time to collect my thoughts and regain my composure for not paying closer attention to STR. I do.

[donna]

So easy to justify the greed, isn't it?

[Lafayette]

"CEOs aren't better than they were a quarter century ago, and there isn't much difference among them. But being a little bit better CEO than your competitor is worth a lot of money, just as it is to superstars in opera or baseball."

One CEO is no better than other without talented people responsible for the execution of the tactics employed to achieve a strategy.

We will see in the future that "leadership from behind" will become a predominant trait, by which teams establish their strategic objectives and perform the tactical means to them - but it is all orchestrated by one conductor (the CEO).

Successful CEO's don't give orders. They listen to the music and make sure that the harmony persists in its execution. Businesses are very much the same, like playing/singing music ... all of the same sheet.

In fact, execution is far more important than CEO decision making since the former is a constant but the latter is only punctual.

[robd]

Indeed Donna, it all seems to indicate a culture of greed.
If pay was linked to size or performance, the CEO at Toyota would get more than the CEO at GM.
The culture makes the difference.

[wcw]

Then there is my going hypothesis: it's the Jack Welch technique of executive compensation, writ large. Cf http://papers.ssrn.com/sol3/papers.cfm?abstract_id=869811

'And this was brought home to me when I was at a boot camp for CEOs where the audience was being lectured on how to be a CEO by Jack Welch, who had just retired. And, when asked who should chair the compensation committee on the board, Welch said, "Put someone in charge who is nearing the end of their career, so they're not jealous of you as a younger CEO, is immensely rich, much richer than you, and enjoys seeing other people get rich." And someone raised their hand and said, "I had a distinguished academic as my compensation chair." And everyone else in the room just shook their heads and sort of held their heads in their hands, and Welch said, "Never, ever make a distinguished academic your compensation committee chair because you'll be a poor man by the end of it."'

I find my portfolio tends to perform better when it is underexposed to companies with overpaid CEOs. Probably just coincidence, though. I am sure it has been coincidental and that they are all actually Bonds/Ruth-like superstars, and not just utterly fungible executive talent.

[save_the_rustbelt]

calmo:

Today's NYT featured Jack Welsh and his trophy wife, and how they are spreading the Gospel of Jack to the world.

Mrs. is selling herself as a leadership expert, although her greatest career acheivement to date was screwing Jack while he was married to someone else and she was supposed to be a journalist doing an interview.

Jack of course, is the great jehovah guru of CEOS.

His basic advice, fire lots of people frequently and be absolutely ruthless.

It is a great world, right?

[anne]

http://www.nytimes.com/2006/11/02/business/02welch.html?ex=1320123600&en=bf8b2d695b924ac4&ei=5090&partner=rssuserland&emc=rss

November 2, 2006

On the Road With Jack and Suzy
By LANDON THOMAS Jr.

BOSTON — It’s a cold fall morning and the first stop for the Jack and Suzy show is Boston’s old city morgue. John F. Welch Jr. and his wife, Suzy, each with a personal assistant in tow, plunge into a throng of local notables gathered to break ground for a new homeless shelter that the couple helped finance.

Mr. Welch, 70, the former General Electric chief executive, wears a conservative blue suit and works the drafty room with the vigor of a ward politician hunting for votes.

Ms. Welch, 47, a writer, cuts her own swath through the crowd in a sharp pantsuit while flashing a big diamond ring. With Mr. Welch looking on, she delivers a passionate speech about helping the homeless in which she quotes, in order, her husband, Jesus Christ and her daughter.

The cult of the imperial chief executive may be on the wane, but if Jack Welch L.L.C., the name of his consulting firm, were a stock, it would be hitting a record high.

While many chief executives take the opportunity of retirement to enjoy a more sedate existence of golf and charity events, Mr. Welch has embarked on a frantic second career and life, replete with a new wife and family, books, magazine columns and speaking engagements that have added to his already considerable celebrity as well as net worth — Boston magazine has estimated his fortune at $720 million.

The Welches have a new book on management coming out, a successor to last year’s “Winning,” a best seller that offers fairly basic nostrums about how to get ahead — be candid; don’t be afraid to fire people. On the public speaking circuit, Mr. Welch commands a fee of $150,000 an appearance....

[evagrius]

"On the Road With Jack and Suzy
By LANDON THOMAS Jr.

BOSTON — It’s a cold fall morning and the first stop for the Jack and Suzy show is Boston’s old city morgue. John F. Welch Jr. and his wife, Suzy, each with a personal assistant in tow, plunge into a throng of local notables gathered to break ground for a new homeless shelter that the couple helped finance."

A morgue. A fitting place, don't ya think?

[lonesome moderate]

But being a little bit better CEO than your competitor is worth a lot of money, just as it is to superstars in opera or baseball.

If the No. 1 CEO -- the best -- was replaced by No. 250, how much difference would that make to the No. 1 company's market cap? It would fall ... nearly $58 million. "Very small talent differences translate into considerable compensation difference as they are magnified by firm size," they argue.

This might be a plausible explanation if the correlation between pay and performance was as strong for CEOs as it was for baseball players. But it's not. Probably not even close.

The only realistic explanation for current CEO pay practices is corruption.

[fiskhus jim]

Utter BS.

There are plenty of people who would be capable of running an enterprise that do not require exploiting the workers and the public to provide their pay.

The average ratio of CEO pay to productive worker pay is 412/1. This means that the average CEO values each and every day he (or she) simply shows up at more than 2 years of actual productive labor.

There is NO justification for such a disparity.

As an aside, this do nothing Congress, the 109th, has met for lass than 100 days. So, Copngress values it's own clearly unproductive "work" at 4 times that of an actual producing laborer.

I suggest that is an inappropriate imbalance in attitudes toward productive labor that result in this imbalance in pay.

[Elvis]

Any way you cut it, compensation levels of US top brass smells pretty bad.

You don't need a PhD to recognize crapola. It's a wonder, however, that shareholders don't try to get a little more value for their money.