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Saturday, September 15, 2007

Reich: CEOs Deserve Their Pay

Can't say I'm in agreement with this one. This is Robert Reich:

CEOs Deserve Their Pay, by Robert Reich, Commentary, WSJ: ...The typical CEO of a Fortune 500 company ...[makes] more than 364 times the pay of an average employee. Forty years ago, top CEOs earned 20 to 30 times what average workers earned. The trend has ignited a flurry of attention in Washington. ...[But]... Hold on.

There's an economic case for the stratospheric level of CEO pay which suggests shareholders -- even if they had full say -- would not reduce it. In fact, they're likely to let CEO pay continue to soar. That's because of a fundamental shift in the structure of the economy over the last four decades, from oligopolistic capitalism to super-competitive capitalism. CEO pay has risen astronomically over the interval, but so have investor returns.

The CEO of a big corporation 40 years ago was mostly a bureaucrat in charge of a large, high-volume production system whose rules were standardized and whose competitors were docile. It was the era of stable oligopolies, big unions, predictable markets and lackluster share performance. The CEO of a modern company is in a different situation. Oligopolies are mostly gone and entry barriers are low. Rivals are impinging all the time -- threatening to lure away consumers all too willing to be lured away, and threatening to hijack investors eager to jump ship at the slightest hint of an upturn in a rival's share price. ...

So how does the modern corporation attract and keep consumers and investors...? How does it distinguish itself? More and more, that depends on its CEO -- who has to be sufficiently clever, ruthless and driven to find and pull the levers that will deliver competitive advantage.

There are no standard textbook moves, no well-established strategies to draw upon. If there were, rivals would already be using them. The pool of proven talent is small because so few executives have been tested and succeeded. And the boards of major companies do not want to risk error. The cost of recruiting the wrong person can be very large -- and readily apparent in the deteriorating value of a company's shares. ...

The proof is in the numbers. Between 1980 and 2003, the average CEO in America's 500 largest companies rose sixfold, adjusted for inflation. Outrageous? Not to investors. The average value of those 500 companies also rose by a factor of six, adjusted for inflation. ...

As the economy has shifted toward supercapitalism, CEOs have become less like top bureaucrats and more like Hollywood celebrities who get a share of the house. ...

If you assume shareholders would rein in CEO pay, take a look at the United Kingdom. Since 2003, changes in British securities law have given investors more say over what British CEOs are paid. Nonetheless, executive pay there has continued to skyrocket, on the way to matching the pay of American CEOs. ...

This economic explanation for sky-high CEO pay does not justify it socially or morally. It only means that investors think CEOs are worth it. ... But if America wants to rein in executive pay, the answer isn't more shareholder rights..., the answer ... is a higher marginal tax rate on the super pay of those in super demand.

There are lots of reasons to believe CEO pay does not reflect underlying fundamentals and hence is inconsistent with the best interests of shareholders (e.g. agency issues). In addition, I am not as convinced as he is that market structure - the degree of competitiveness - faced by a typical firm has changed as much as claimed over the last 40 years. Firms have certainly gained leverage on the input side as the decline of unions and Wal-Mart's ability to pressure suppliers will attest, so market power in input markets may be more not less unbalanced, and oligopolistic and monopolistically competitive output markets are still common features of the marketplace. In addition, the fact that the top firms are now six times bigger can perhaps be explained by changes in the efficient scale of operation due to changes in technology, but in and of itself the presence of bigger firms does not imply more competitive markets (and as to the "proof is in the numbers," there is evidence that the relationship between CEO pay and firm size is not stable over time).

While a higher marginal tax rate is one answer to reining in CEO pay, doing what we can to ensure that CEO compensation contracts are consistent with shareholder interests, that firms operate in competitive input and output markets, and that business interests do not have undue influence over legislation and other political decisions might also make a difference. The issue extends beyond CEOs, when power is unbalanced of course people are going to take advantage of that, and we need to do more than we have in recent years to ensure that no individual or firm has the opportunity or ability to influence market and political outcomes.

    Posted by on Saturday, September 15, 2007 at 02:25 AM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (77)


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