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Thursday, November 02, 2006


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.

    Posted by on Thursday, November 2, 2006 at 12:15 AM in Economics | Permalink  TrackBack (1)  Comments (18)


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