…while overly generous executive pay may be maddening, it is a drop in the bucket compared to the size of these companies and the impact it has on shareholder prices and employee compensation. The top 50 companies alone have a market capitalization approaching $5 trillion. Limiting CEO pay, as some neopopulists propose would have little to no impact on overall wages or compensation. If every penny of the $14.4 billion earned by the "fortunate 2500" were distributed to all workers, it would amount to only $100 apiece.
That is from The New Rules Economy, a "Third Way" Project, and full of remarkable common sense. Or try this bit:
Corporate profits as a share of both corporate net income and as a share of national income were higher in the 1940s and 1960s. But that, admittedly, is splitting hairs. What they don’t highlight is that in 2001, corporate profits were at one of their lowest points in recent history.
The neat trick is that the authors invert the usual right- vs. left-wing take on living standards: "Yes, living standards are way up, that means we have lots of money to spend on creative social programs." It will make some people want to say "Whoa….living standards aren’t up that much…"
exec pay = penny wise,pound foolish
In your excerpt, they are picking the largest possible numbers for context. Total market cap? 2500 executives and “all workers”? It sounds like trying to persuade your sister that your allowance might be 100 times higher, but it’s nothing compared to the value of your house… and if you gave everybody’s sister part of your allowance, they’d only get 10 cents.
So of the share of money the corporations produce that can actually be distributed to workers each year, how big a share do the executives get? If you took the Fortune 2500 and divided their income among employees of the Fortune 500, how much would they get? I suspect still not that much, but at least you’d be comparing apples to apple trees and not the whole forest.
Compensation of the top five corporate executives now average 10% of profits up from 5% 20 yeas ago.
http://canadianlabour.ca/index.php/Corporate_Pay_and_Pr/901
This will effect the stock price and could effect salaries depending on the size or the work force and how many other high paid executives the corporation has.
If you listen to populist speeches, politicians are saying precisely that CEOs are somehow stealing money from the average worker. John Edwards’ “Two Americas” speech said something to the effect of “One America does the work and the other reaps the benefits.”
If nothing else, the fact that CEO pay makes up a small percentage blows that liberal claim out of the water.
In general, I would correlate CEO pay and, say, the salary of Peyton Manning. We’ve kept the same number of companies while our GDP has grown tremendously. It’s the same reason that Peyton Manning earns so much more than Joe Montana did in the 80s.
“Suppose an employee were caught stealing $1000 from the company. Would anyone shrug this off because of its negligible impact on the stock price?”
Whether or not I shrug it off would depend on the marginal cost of catching that employee or preventing that theft. I’d rather invest in an enterprise that tolerates such thefts and has a 10% return on investment, than in an enterprise that follows a zero-tolerance policy regarding thefts but is running at a net loss.
(Which is not to say, however, that public shaming of underperforming executives doesn’t have its place.)
Just what we need – politicians and bureaucrats deciding how much people should earn. Isn’t that what the Soviet Union tried, with disastrous results? And talk about ripping off the system – it would be difficult to find a more blatant example than John Edwards.
It is not inequitable that anyone should earn far more money than someone else. The question is are they really worth it and will it produce the desired results? An entrepreneur who risks their own capital, starts their own company, or takes one from a small, unremarkable outfit to huge scale, deserves large rewards. The same is true for sportsmen, musicians and writers, even where, like a JK Rowling, the power law-driven scale of their success exceeds a reasonable assessment of their talent. That’s just luck favouring the brave. Start capping those rewards and you discourage the creative risk takers on which an economy thrives.
CEO pay is different because large corporations are complex combinations of cashflows with huge long-term momentum, where market advantage already exists. The cashflows can be manipulated making it much more difficult to guage whether success will proceed into the future as a result of the CEO’s actions. Surely Michael Lewis’ Moneyball shows there’s always a smarter way. In sum, when hiring and rewarding we should be looking for those who can create cashflows, not those who can appropriate them. The latter are usually a block to innovation and sensible risk-taking.
Bernard — I agree that high CEO pay may signal other problems or, to put it differently, may be one factor an investor should take into account in determining whether to invest in a given company. I don’t consider high pay to be a problem *in itself* for the company and its investors. With respect to the economy/society as a whole, I tend to look on executive pay the same way I look on income inequality: it’s only a problem to the extent that it’s perceived to be a problem. If it gets under people’s skin so much that we’re likely to have revolutionary changes imposed, then I would consider CEO pay a problem.
On corporate governance, I think I’m more optimistic than you are that market forces can handle it. There currently appears to be an opening for companies that want to attract investment by enacting “better” charters, bylaws, and policies. For example, Lucian Bebchuk recently got Home Depot to amend its bylaws to require independent-director approval of CEO pay, and a number of high-profile companies have adopted majority-vote provisions for election of directors. Changes of this type can have a lot of unintended consequences and should be viewed more as experiments than as unalloyed improvements. Thus, I think we should let companies that see value in them try them, let other companies take a pass, and see where the money goes.
From the quote in TC’s original post: If every penny of the $14.4 billion earned by the “fortunate 2500″ were distributed to all workers, it would amount to only $100 apiece.
This is horrible framing. If these executives for some reason managed their companies for free and didn’t draw a salary, then their former wages would be given to the shareholders, not the employees. The employees would not be getting an extra $100 a piece, they’d be getting an extra $0 each in the paycheck.
Thus this is not an inequality issue, it is a corporate governance issue, assuming it is an issue at all. Assuming there is something rotten in Denmark then there is a failure of the shareholders to act in their own interest.
I don’t pretend to know how to “reform” the situation, but for starters shareholders ought to insist that executives of their corporation be prohibited from serving on the board of directors, unless they held a significant amount of stock themselves.
The board of directors is not there to run the company, that is what the shareholders pay the CEO to do. The board of directors is there to act as a proxy representing the owners of the corporation, and acting as a watchdog over the CEO to make sure he is bright and capable and acting in an honest manner. Thus it is a conflict of interest for the CEO (or other executives) to be on the board and policing himself.
Finally, potential CEO’s won’t work for a company if they can earn more elsewhere. Ben and Jerry’s learned this a decade or so ago when they were forced to abolish their policy of the CEO earning no more than 10x the salary of the lowest paid employee. They simply couldn’t get a quality CEO to work at those wages.
There is a market for CEO’s. The biggest companies can and do pay more than others because the CEO’s salary as a percentage of profits is thus smaller than paying the same CEO x dollars at a smaller competitor.
It is noteworthy that CEO’s of the companies that are being bought by the private equity funds are often paid more than in the public company market. This ought to give pause to anyone who thinks that public company CEO pay is thus rigged. In some cases it is likely to be overcompensated, often by a large amount. This also need not be a result of fraud though, often times it is the result of incompetence on the board or mere indifference to the well being of the shareholders. But in other cases they (executives) may well be underpaid and still have the Left screaming Inequality! Theft! Fraud!.
there is a failure of the shareholders to act in their own interest.
Happyjuggler,
The problem is that there are very serious obstacles to shareholders acting in their own interest.These obstacles are financial, legal, institutional, and informational. As to private equity firms, all that proves is that there are some situations and some CEO’s that merit very high pay, not that the overall level is justified.
“The latter question has largely been answered, and as a broad question it is not fair.”
?! I must have been sick the day they taught that in semantic school.
“Corporate profits as a share of both corporate net income and as a share of national income were higher in the 1940s and 1960s.”
Wars are a useful way to boost profits.
Bernard -
I basically agree with your point about corporate governance – it could be a lot better. It does seem to be improving, albeit slowly (Home Depot is a good example). Some sort of legislation to improve “shareholder democracy” might be appropriate. A CEO who turns around a failing company and creates billions of dollars of shareholder value is probably worth a nine figure compensation package (Ford might be a good example here). But all too often, CEO compensation seems to bear no relationship to corporate performance. CEO’s are quick to claim credit for success but blame everyone but themselves for failure. Nonetheless, I am very leery of demogogic politicians who rant on about “overpaid CEO’s,” even though I agree that, yes, some of them are indeed overpaid. The fix they propose, some sort of government regulation of executive pay, is a soviet-type cure that is much worse than the disease. I have much more faith in the free market than the government to ultimately do something about this, and, although advancing shareholder democracy would be a good idea, there never seems to be much talk about it. If the politicians really wanted to do something useful, they would deal with illegal immigration and the loss of our industrial base, which are hammering working class Americans much more severely than overpaid CEO’s.
I think happyjuggler’s point about private equity managers has been underappreciated. In the case of a company taken private, agency problems are much less than in the case of a public company. Managers tend to be paid more when the agency problems are reduced. This suggests their worth is higher than their pay.
One could perhaps find “competent” CEOs for $900k, but if one instead finds a CEO for $50.9M who can increase profits by $100M, it’s absolutely worth paying the higher amount. For any company with equity over $10B, that’s a 1 percentage point increase in return on equity. That’s why market cap is relevant — it’s worth paying what, compared to average salary, are large amounts of money for a small improvement if that’s a small amount of money compared to market cap. In fact, how much more the very best CEO is worth versus a “competent” one is pretty much linear with market cap.
This, of course, ignores potential incentive effects on people who are striving to become CEO, which argue even more for high CEO pay. I certainly decline to recognize anyone’s inexplicable sense of “fairness” as a good indicator as to whether or not CEOs should be paid what they are.
I think happyjuggler’s point about private equity managers has been underappreciated.
I certainly appreciate it. But I don’t think it quite proves that CEO pay is, in general, justified. There is a considerable selection bias here. Presumably, private equity investors are looking for firms with potential for major improvement. That alone means that they will be willing to pay generously for good management. But that does not generalize to all CEO’s, since not all firms have that potential.
In addition, it might be worth looking at all the terms of employment of these “private” CEO’s. I would guess that they have far less security, and are subject to much stricter performance standards, than CEO’s of public companies. Just looking at compensation does not tell the whole story.
“In the case of a company taken private, agency problems are much less than in the case of a public company.”
You could argue that in private equity the agency problem is even larger. There is less public scrutiny and that creates the question of who polices the policeman. A lot of private equity involves short-term window-dressing through changes to expense and financial structure which look good on paper but leave any subsequent owner with a property that is less likely to produce the same results in the future. Caveat emptor, of course, but presumably we’re interested in what is good for the economy and growth.
bartman — Just to be clear, dividends are already taxed as income (although we have some overly complicated federal rules allowing so-called “qualified” dividends to be taxed at a lower rate than non-qualified dividends). That is why critics of corporate income tax complain that corporate profits are taxed twice — once as income to the corporation and again as income to the stockholders when it is dividended out.
* * *
knackeredhack — You wrote, “Caveat emptor, of course, but presumably we’re interested in what is good for the economy and growth.”
The principle of caveat emptor *is* good for the economy and growth. If owner 2 buys an enterprise from owner 1 for $100 million and makes a profit of $20 million by breaking the enterprise up and selling off subsidiaries and hard assets, then owner 2′s profit is a sign that he created value — i.e., owner 1 wasn’t using the enterprise in its most efficient way. (If owner 2 doesn’t make a profit, then he calculated wrong and serves as a lesson [a useful datapoint] for himself and others.) If owner 3 then comes along and buys from owner 2 the shell that remains of the original enterprise, owner 3 is making his own calculation that the shell will be worth more in his hands than it was in owner 2′s hands. Along the way, each participant looks out for his own interests as he would in any other arm’s-length transactions. Plus, each participant has the backstop of legal remedies if the seller engages in fraud to push up the price.
jp, that is surely the way it works. But owner two may have created value for himself based on temporary market conditions. He may have destroyed value for the wider economy and served other’s short-term negative interests. Trade buyers will happily pay a premium to snap up a competitor’s subsidiary to shut it down, and possibly destroy the nascent value being created by the original owner. It’s not efficient. It’s a hard life, you have to expect that, but we too readily laud these so-called value creators for financial engineering. There needs to be no fraud to present a lower cost base over a smooth cashflow, add some debt and hold for a while. The seeds of decline may be obscured in any due diligence because the human capital may have been so weakened by creating a leaner, but more risky asset. Snake oil salesmen make profits too, so I’m not sure what that signals. Also some investments may need us to bleed money longer than we can cope with. Some sports teams take longer to build than fans will allow. Some artists take longer to mature (see Gladwell’s talk about Galenson’s view of the economics of creativity (the Eagles vs Fleetwood Mac). I guess all I am saying is, all that glisters is not gold. That goes for assets, ceos and private equity types. But then we live in an X-Factor world.
Tyler’s post draws attention to the smallness of executive comp compared to the value of the companies, which is probably an appropriate comparison given the importance of stock options in executive compensation. I think that also accounts for the apparent large size of executive compensation compared to “profits” in the URL cited by joan – that is a misleading comparison, on the other hand.
The use of imflammatory words like “legalized theft” and assertions that “outrageous CEO compensation is wrong” should be a tip off that this is primarily an emotional issue. There will always be imprecision in determining compensation for workers, from the humblest drone right up to the Supreme Leader. So what? The money isn’t coming out of my pocket if I don’t own the company’s stock, and if I do own it, exec comp is a fairly minor item in the whole scheme of things.
My favorite objection to the increase in executive compensation was hinted at by adam. It’s usually framed like “top exec earned only 10 times average worker” in some past golden era, but now, in the plutocrat-friendly 21st century, it’s 10,000 times. At last, we have found a law of economics just as solid as the law of gravity, and those bastards are violating it! There oughta be a law outlawing it!
See the list of the “Fortunate 2500 of the Fortune 500″ by typing that on any search engine, or go to jgfortunate2500list.com
The main point of my comments have been said by other posters above.
Government should not be involved in determining CEO or any other exec level pay. Period. Particulary as the corporations we are talking about are not just doing business in the US. Any regulation (which I would not support) could only address that portion of the profits earned in the US. And talk about opening up a can of worms there.
I do however believe that exec pay is out of whack. We talk about the open market determining the pay of the execs. Board members, many of whom are CEOs who are measured against other CEO’s pay, are the board members. So they vote to raise the CEO pay on the boards of which they are a member. Then their pay decreases as a measure of the average CEO pay. So they go to their board to get a raise to bring them back to the same “relative” level. And round and round it goes. BP just paid its outgoing CEO a $4M US bonus. As a BP stockholder it was not for exemplary performance. During a period of record high oil prices, BP managed to screw up multiple items taking big hits to earnings. And yet he gets a big bonus when he quits. I certainly would not expect an outsize bonus if my performance matched his.
The market must take care of it. And it will. Markets take time to react and move slowly and conservatively. Keep up the noise, keep the government out of it, and we will begin to see CEO pay become more reasonable.
Oskar: “The issue at hand is whether we can tax them CEOs as we see fit. Think marginal tax rates in the range of 50-70%.”
Confiscatory tax rates are more deserving of the label “legalized theft” than high CEO pay. Remember that the highest marginal tax rate in the US at one point was around 90%, but because people are generally not stupid (as you assume them to be) few, if any, paid this rate. Incentives matter; confiscatory tax rates will either encourage less production from the super-talented, encourage tax evasion, encourage relocation of talent to other countries, encourage compensation in forms less taxable, or some combination of these results. Very few people, I imagine, would agree to work hard just so you can decide to take 70 cents of every dollar they earn, “as (you) see fit.”
Again remind me why a third party (assuming no externalities) should have any say in matters of compensation between two private parties?
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