Contra Tyler, it is, of course, perfectly reasonable to compare a CEO with his or her likely replacement. Board of Directors do this all the time. If the Board finds that revenues would be the same with a new CEO the theory doesn’t say that the current CEO should get a zero wage (as Tyler oddly suggests). It says that the current CEO should not be paid more than the wage necessary to hire the replacement. If the current CEO is paid more, he may be out a job. If the current CEO is paid less, he may move.
Tyler argues that CEOs are paid far too little (less than 1% of their marginal product). I say that as a result of the process described above CEOs are paid more or less their marginal product on average. Indeed, according to one astute writer, Gabaix and Landier find that replacing “replacing the No. 250 chief executive with the No. 1 will increase the value of the company by only 0.014 percent.” More or less means that principal agent problems, risk aversion and uncertainty also matter but they matter within a range determined by the usual process. I also believe that the case for some CEOs being overpaid because they choose friendly board members is far stronger than Tyler’s case that CEOs on average are radically underpaid.
Addendum: Tyler’s points about tax incidence are well taken and need not rely on an underpayment argument.