A contrarian look at CEO pay

Is it valid to relate CEO pay to market capitalization since they have little to do with the value of stocks?

why not just relate it to the earnings growth where they do play a major role in determining what happens.

For example if you look at the S&P 500 from the 1949 bottom to the 2000 peak the S&P 500 PE on trailing operating earnings rose from 5.9 to 26.5 and accounted for some 78.5% of the increase in the S&P 500 capitalization. Why should CEO compensation be related to inflation and/or monetary policy that largely determine the PE when their actions have little or no impact on them. EPS is what they influence strongly, and that accounted for only 21.5% of the rise in market capitalization.

If you look at a different period in the 1975 to 2000 period EPS only accounted for 27% of the rise in market capitalization.

We have had a sharp growth in CEO compensation but there is essentially no evidence that EPS growth has changed significantly from its long term trend — 7.5% for the S&P 500, 7.8% for after tax profits reported by BEA, etc.

Interestingly, if you look at pre-tax profits the trend growth rate has actually slowed.

It looks to me like stock owners have a major agent problem.

I also think the productivity argument is a complete red herring. We know that France’s productivity is roughly the same as the U.S.’, yet American executives are paid vastly more.

More important, American productivity growth was massive during the period 1946-1973, earnings growth was exceptional , etc., yet somehow CEOs were paid significantly less in relative terms than they are today. What changed?

‘ More important, American productivity growth was massive during the period 1946-1973, earnings growth was exceptional , etc., yet somehow CEOs were paid significantly less in relative terms than they are today. What changed?’

Income tax laws. The top marginal rate in that period was between 90% and 70%. Since 1983 it’s been as low as 28%, and as high as 50%.

The idea that CEOs get paid for performance is hard to empirically distinguish from the idea that they (with the help of their buddies on the board) pay themselves as much as they can get away with until someone squawks. A few years ago Marianne Bertrand and Sendhil Mullainathan came up with a very clever way to distinguish between these two stories in a paper entitled “Are Ceos Rewarded for Luck? The Ones without Principles Are.” No pay-for-performance scheme would ever pay a CEO for something completely beyond his/her control (e.g., a change in oil prices in an oil-consuming industry), because that only adds risk to the CEO without improving incentives. But luck might play a role under the “steal until someone squawks” story–when there’s more money around, even due to pure luck, there’s more to help yourself to before someone gets excited about it. They find that CEOs do indeed get paid for luck, unless they work for a firm in which a single shareholder owns a substantial fraction of the firm. The idea is that in those cases, there is some individual who has a sufficient incentive to monitor CEO pay, whereas this is not the case when ownership is diffuse.

There is also a paper by Kevin Hallock called “Reciprocally Interlocking Boards of Directors and Executive Compensation.” He finds that if you are on the board of the company that I’m the CEO of, and vice-versa, we both end up getting paid more.
I don’t know about this new research, and I’m open to revising my opinion, but I am at least tentatively convinced that a lot of CEO pay really is rich guys paying themselves and each other lots of money.

OTH, why doesn’t CEO No. 1 hire CEO No. 250 to run a division, which might be larger than the 250th largest company?

“One still has to show why executive pays grew with market capitalization while non-executive pay did not. Unless one wants to say that labor productivity do not contribute to market capitalization.”

I’m perfectly willing to believe that CEOs are overpaid. But the reason why the labor productivity issue you raise isn’t related to market capitalization is that in most cases as the firm expands more people will be hired so the per person contribution of non-executives is not increasing.

“I also think the productivity argument is a complete red herring. We know that France’s productivity is roughly the same as the U.S.’, yet American executives are paid vastly more.†

No, the US has 30% higher productivity. France has the same productivity PER HOUR, because they are forced to work few hours, and because the least productive are unemployed and not part of the statistics.

The “agency theory† argument is not very strong. Have agency problems become worse? Remember you are trying to explain growth. By the way high salaries can also be a effective way to solve agency problems.

Three further points:

†¢ All of the economy has seen skill biased wage growth and superstar economics, not only CEO:s. The share of the top 0.1% income that goes to professionals and entrepreneurs has gone up sharply. Maybe you need a more general explanation (larger markets and non-divisibility, value of top human capital higher as complement to rest of economy etc.)

†¢ Do Japanese and European stockowners do worse than Americans? Looking at firm from start should give you the average return of capital, which is what you want. Does anyone want to bet there is no effect with CEO pay? (you could argue the CEO pay as a share of firm costs is small).

†¢ The market capitalization argument is actually pretty interesting. The cost of making bad decisions (and value of good decisions) goes up when one person runs a larger firm. The one person part is the key.

Non-divisibility of superstar talent, you can’t hire 5 CEO:s, plus larger and larger firms may well be the key. The 300 billion dollar firm can only have one CEO, and wants the best available. Firms bid up, as they become larger the value of top management goes up.

Really CEO:s are underpaid if you think about it. 63% of American billionaires are self made. If you startup a firm and add value you can become a billionaire, shouldn’t the market give that as a salary to a CEO that can add a few percentage to firm value?

One additional thought: as stock options and stock grants were considered CEO compensation in the research study, increases in market capitalization would directly increase CEO pay. As stock options become a larger percentage of CEO compensation the effect will increase. Seems like the same variable is being used in both sides of the equation.

Teller, you say solution, I say manifestation.

I don know but why i don find such informative and profitable blogs so often,I suspect blogging world is becoming so small that we cant find such lucrative blogs like this one.

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information about medicines:
Butalbital and aspirin combination is a pain reliever and relaxant. It is used to treat tension headaches. Butalbital belongs to the group of medicines called barbiturates . Barbiturates act in the central nervous system (CNS) to produce their effects.

Dosing

The dose of butalbital and aspirin combination medicines will be different for different patients. Follow your doctor’s orders or the directions on the label . The following information includes only the average doses of the medicine. If your dose is different, do not change it unless your doctor tells you to do so.

For Butalbital and Aspirin combination

For oral dosage form (tablets):

For tension headaches:

Adults—One tablet every four hours as needed. You should not take more than six tablets a day.

Children—Dose must be determined by your doctor.

For Butalbital, Aspirin, and Caffeine combination

For oral dosage forms (capsules or tablets):

For tension headaches:

Adults—One or 2 capsules or tablets every four hours as needed. You should not take more than six capsules or tablets a day.

Children—Dose must be determined by your doctor.

Missed dose

If your doctor has ordered you to take this medicine according to a regular schedule and you miss a dose, take it as soon as you remember. However, if it is almost time for your next dose, skip the missed dose and go back to your regular dosing schedule. Do not double doses.
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