April 11, 2007
From the desk of Jane Galt:The real question about CEO pay is . . .
Who cares?
CEO pay just isn't a huge problem. There are fewer than 500 of them making more than $1 million a year, which for most companies is probably the average centre-left liberals' golden average of 40X the lowest-paid employee, and considerably less than 40X the salary of the median full-time employee. The really huge pay packages are usually five-year or more deals, so that the top of the list varies from year to year; i.e. the head of Yahoo made $230 million in 2005, but that was almost equal to his total 5-year compensation; 2005 just happened to be the year his options hit.
$50 million a year is still a huge sum, especially considering that Yahoo lost money that year. But that's on revenues of $717 million. The worst, most abusive pay package out there cost shareholders less than $50 apiece--except it didn't, because the stock price didn't tank when it was announced. (Almost all of that deal was in stock, not cash; it didn't strip any real assets out of the firm.) And most CEOs made nowhere near that much. They didn't cost their shareholders very much: spread Rick Wagoner's $8 million a year over the 550 million outstanding shares, and his services cost each share a very affordable $0.01 apiece. Spread it out over his 327,000 employees, and you could give them each a whopping $24 a year.
On a social level, this is even less of a problem. There are fewer than 500 of these guys in a country of 300 million. And it's not like we're in Latin America, and these guys are hogging all the arable land. What exactly are the institutional problems these CEO's are creating? Even if Rick Wagoner made absolutely nothing, he'd still be the head of GM, with all the institutional pull that position creates. The problem is not that he has money. It's that only 500 people can head up the world's 500 largest companies. When he retires, no matter how much cash he has on hand, he'll just be one more guy on the rubber-chicken-talk circuit.
Maybe they're using their money to buy influence? Oh yeah? When Rick Wagoner goes up against the UAW, even in a Republican dominated congress, who do you think wins? (I will give you a broad hint: it is not the head of GM).
But just think of how much you could buy with $250 million for people who really need it! my critics will say. This confuses cash with resources. Status aside, the only sense in which these CEOs can be said to be depriving the poor of anything is to the extent that they use their money to consume scarce resources that the poor need . . . like arable land in Latin America. Money represents a claim on those scarce resources. But CEO's don't cash that claim in: they don't consume very much more of things the poor need than the poor do. Redistributing Terry Semel's "excess" health care, clothing, food and housing to the poor wouldn't produce any noticeable difference in national poverty outcomes; it would make, at best, one other person happier and healthier.
Most of their "extra" consumption lies in things that are rare, and hence not redistributable (fancy gems, harrier planes), or which don't actually cost much more in resources to produce (Hermes handbags). You can move the money around, but that won't give us more doctors, hospital beds, day care workers, policemen, parks, high-quality teachers, museums, etc. Those things can be produced only by shifting people and raw materials currently being used for something else into education, law enforcement, medical construction, and so forth. The laws of arithmetic being what they are, that means a large number of ordinary people giving something up, if only leisure time, in order to free up the resources for other uses.
The problem with income inequality--and I do see one--is the current worry about lack of mobility. But it isn't CEO's choking the opportunity pipeline with their plenitudinous offspring. It's nice upper middle class people like my parents . . . and every single academic with children who complains about inequality while simultaneously reinforcing and extending the meritocratic educational system that has become the largest single obstacle to intergenerational movement. I don't say, mind you, that this system is wrong or should be abolished; that's a question for another day. Nor is it a "tu quoque"; I am worried by the lack of intergenerational income mobility at the same time as I am prepared to do everything I can to give any kids I may have a leg up in the meritocracy. But the focus on CEO pay is a comforting distraction. The real problem with income inequality is not a few hundred CEO's hogging everything; it's a few million affluent people ensuring that their offspring always come out on top.
Posted by Jane Galt at April 11, 2007 4:15 PM | TrackBack | Technorati inbound links"); ?>There are fewer than 500 of them making more than $1 million a year
This is incorrect. The list only tells me that some Fortune 500 CEOs make less than $1 million a year. The CEOs of the top 500 companies by revenue are not the same as the top 500 highest-paid CEOs.
Posted by: AT on April 11, 2007 5:29 PM>>>>The real problem with income inequality is not a few hundred CEO's hogging everything; it's a few million affluent people ensuring that their offspring always come out on top.
I'm an attorney. Not fabulously rich, but probably in the top 10% income-wise. I probably wouldn't be working half as hard as I am if I couldn't pour love and resources into my kids. My daughter is a bright, intelligent, poised college freshman (yes, Ivy League) who will no doubt go on to great things and will help a lot of other people along the way. This is a "problem" exactly why?
Posted by: Stuart on April 11, 2007 5:39 PMI've always subscribed to the tournament theory of high CEO pay: only 500 people get it, but it makes millions work harder because they want to be one of the 500 winners. If working endless hours for the company to land the top job only got you 8x the pay of the shop floor worker, then only the insane, the power hungry or the Japanese would bother.
In a world where dim-bulb athletes and entertainers can make upwards of $25 million a year for playing games or singing songs, forking out $10 million to the head of a 50,000 person work force doesn't strike me as much of an outrage.
Posted by: DRB on April 11, 2007 5:57 PMStuart,
I'm positive that Jane would not say that is a problem. However, there are somewhat significant barriers to intergenerational mobility, such as the education system, that the middle and upper class are not concerned with.
Perhaps, for completeness sake, we should identify the reasons that intergenerational mobility is desirable. Also, I've seen statistics that indicate that there is substantial intergenerational mobility. Many rich people (ignoring dynastic wealth) do not produce particularly capable offspring, while the pool of talented lower class offspring is larger in absolute terms. To sum up, I'm not convinced mobility is a problem, though it could be better.
P.S. Perhaps Jane suffers from the availability heuristic on this issue? We are able to see many poor people now, but we rarely actually witness economic advancement.
Posted by: B.S. on April 11, 2007 6:06 PMThe problem with CEO pay, to the extent that one exists (and I agree with Jane that class mobility is a much more important issue), is that it tends to increase as you serve on more boards. That is, there is a "networking" component that has nothing to do with company or individual performance.
Posted by: Amber on April 11, 2007 6:17 PMI wouldn't take "CEO" so literally. CEOs are easy to measure and their pay makes for nice charts, but it's really executive pay in general that's the issue. And if you take a look at the total compensation of, say, the top 20 or 30 executives at all F500 companies, the amount of money they make is a pretty substantial percentage of corporate profits.
But of course, even that's not really the issue, I think. The real issue is why corporate profits have skyrocked for the past few decades but average worker pay has stagnated. Some people don't care about that, but a lot of us do. If workers were getting a cut of the productivity boom, I think most liberals wouldn't really care how much the CEO was taking home.
Posted by: Kevin Drum on April 11, 2007 6:21 PMI wouldn't take "CEO" so literally. CEOs are easy to measure and their pay makes for nice charts, but it's really executive pay in general that's the issue. ...
But of course, even that's not really the issue,
Hey, what are you doing? Where are you taking those? Stop. STOP! The goalposts are supposed to be right where they are!
CEO pay is ridiculous. Not necessarily because the sums that they make are obscene (even though they are), but because of how the compensation is determined. More and more power is being removed from the shareholders, and compensation is increasingly determined by incestual compensation committees that have a self-interest in offering each other higher pay packages. If I sit on your board, and you sit on mine, then our incentives are to mutually increase the "market compensation" for CEOs. This collusion may not be explicit, but there is a reason why people like Warren Buffett, who are genetically programmed to maximize shareholder value, are never asked to sit on compensation committees. That alone shows that something is awry. Get real people...this is just one part of the whole corporate governance issue in this country.
Posted by: woodstock on April 11, 2007 6:32 PMTop executive pay is so high because of a very basic economic principle: supply and demand. Lower workers are readily available; top executives are not.
This is showing up in school districts too. Superintendents make a lot more than teachers (well, that's true with certain exceptions such as Long Island, Westchester County, etc.--they still make more, but not a lot more, and if hours worked are factored in, the superintendents make less than a lot of teachers). There are tons of teachers out there, and tons of good ones enter the work force every year. Superintendents have to work their way up the ranks--several years teaching, then into the administrative ranks, moving from principal to district job to asst. super. to superintendent. After a few years as a new superintendent, then can go to a larger district which pays more.
Even so, in New York State, the District Superintendent (who is half a direct rep of the State Education Department and half the super of a consolidated special/vocational education district that provides services to a large goruping of individual school districts) has his/her salary capped by law. It used to be that the District Superintendent (DS) was the top salary in the area. No longer. So now instead of getting the most experienced superintendents as the DS, less experienced superintendents are the Ds's. While still doing a good job, the ability to "mentor" other superintendents has suffered greatly.
Another distortion of the "free" market.
Posted by: Rex on April 11, 2007 7:12 PMThis is a minor nit, and it does not weaken your argument [it strengthens it by making the Yahoo CEO's pay a smaller percentage of the company's resources] but Yahoo did not lose money during 2005 or at all recently. To be fair, they haven't made as much as wall street might want, but they are doing reasonably well with some setbacks.
http://finance.yahoo.com/q/is?s=YHOO&annual
This is of course a biased source but I strongly suspect they don't monkey with Yahoo finance data.
-dk
The real issue is why corporate profits have skyrocked for the past few decades but average worker pay has stagnated. ... If workers were getting a cut of the productivity boom, I think most liberals wouldn't really care how much the CEO was taking home. - Kevin DrumI know it's always dangerous to disagree with Kevin, but I plan on doing so anyway. It's not too much of a mystery why executive pay has grown more quickly than has the pay of rank and file workers. The value workers bring to a company has stagnated along with their pay. Executives are difference makers. A firm's success is largely determined by the quality of it's management. Think how much difference Steve Jobs has made to the fortunes of Apple. How much difference does having stellar (rather than merely competent) file clerks make to a firm's destiny? Is Ford having problems because it's workforce is unproductive or because it's management has made too many poor choices and not enough good ones? The answer is the problems at Ford lay mostly at the door of management (which includes responsibility for the costs embedded in its labor contracts). We might think it unfair that poor management is rewarded with good pay, but even the "worst" shortstop in major league baseball gets paid a ton of money -- except when compared to the best shortstops. What's been going on for the last few decades is that the relative value of management has increased and so has its pay.
Alternative theories, such as executive pay has grown because the pay is set by insular boards, make no sense. Did executives and boards suddenly learn that they could collaborate to enrichen the executives? Were prior generations not greedy? If anything, corporate governance is MUCH more open than it was in the past. Today, executive pay plans are subject to extensive disclosure and require shareholder approval. Many more shareholders are willing to criticize and to vote against pay plans that are felt to be too rich. The explanation for increased executive pay cannot be that these reforms have led to the increase in pay based on the universal conclusion that executives have historically been underpaid!
No, the explanation for this change in the sharing of corporate revenues has to be elsewhere. As noted above, I think that part of the explanation is that executives have become relatively more valuable over time. (This is similar to what we see happening to the average earnings of the college educated when compared to those with high school diplomas.) However, I think it's fair to lay part of the blame on a prior well meaning reform: As a general rule, for income tax purposes, a company cannot deduct compensation paid to an executive in excess of $1 million -- unless that compensation is "performance based". This tax law change is one of the factors that led to the increased use of stock based (options, phantom stock, stock appreciation rights, etc.) compensation plans. Such pay plans are much "riskier" from the executive's perspective. Is it really surprising that the market would reward the executives for taking on additional risk?
The statements on CEO pay are either irrelevant or misleading. Since CEO compensation is so much larger than CEO pay (Steve Jobs? Larry Page? etc.) this is a complete red herring. It's much more efficient to extract money from a corporation by using options since they are much more tax advantaged (i.e. 15% rather than 30%). The CEO of my company, and corporate officers all clear more than $1M a year in compensation... mostly in options.
The use of options has another perverse effect. Although they are intended to align the interests of the CEO with that of the company or stock holder they do not! But 'no', you say, 'I've heard that they do so they must'.
Consider the value of options granted for company which the CEO manages to consistently grow 100% over a 5 year period. If granted $5M in options over the period the CEO would make some fraction of the $5M gain (not all of it because some of them were issued at higher prices). Well that's not much!
Ahhh, but what if the CEO manages to crash the stock to 10% of its nominal value some time during the 5years, and then lets it recover to 50% of its original value before the end... he's made $5M on just one (crash) years options, and even better if he times things right;^)
The value of options is largely in their volatility so the CEOs interests are the same as those of the day traders not of regular stockholders, the company, or the employees. Oops, sorry, bad incentive, bad behavior, and we all get a bad outcome. Only the honesty and good heart of CEOs everywhere has put us in a less bad situation than we have today.
Posted by: joeblo on April 11, 2007 10:57 PMOh, just to clarify. I don't work at a fortune 500 company, probably not even a fortune 2000 company. Our yearly profits are $250M, with margins of ~50% so there are ~$500M in sales. Totaly executive staff compensation is easily in the ~$10-20M range which corresponds to 2-4% of total income and 1-2% of total costs. For a lot of customers a 1-2% cost reduction would be significant. Certainly, if we had competitors it would be significant.
I'm not sure that it's even particularly motivating, since good engineers wouldn't be considered for a senior management position. Even if they were, it's largely a lottery dependent on good hair, network of friends/college, personality, and only partially competence. The biggest effect it has on hard working engineers is to leave and found a different company. That may help the engineer (even society), but it's hardly good for the company. So how is high CEO pay (or compensation) good for the stock holder?
Posted by: joeblo on April 11, 2007 11:12 PMFirst as others have pointed out it is not just CEO pay it is top executive pay in general. There are certainly many more than 500 executives making more than $1 million a year. I also don't trust the linked list without an explanation of how it was derived.
As to why executive pay has exploded, I think a big factor was the officially sanctioned failure to properly expense stock option grants allowing top executives to disguise just how badly they were ripping off the shareholders.
Posted by: James B. Shearer on April 11, 2007 11:52 PMwoodstock:
More and more power is being removed from the shareholders, and compensation is increasingly determined by incestual compensation committees that have a self-interest in offering each other higher pay packages. If I sit on your board, and you sit on mine, then our incentives are to mutually increase the "market compensation" for CEOs.
Any such relationships must be disclosed in a proxy under "Compensation Committee Interlocks and Insider Participation." For example, if executive A at company A sits on company B's board, and executive B at company B sits on company A's compensation committee, this must be disclosed. This disclosure would be embarrassing, so companies avoid these relationships.
This collusion may not be explicit, but there is a reason why people like Warren Buffett, who are genetically programmed to maximize shareholder value, are never asked to sit on compensation committees.
I thought it was more that (a) Buffett basically owns his whole company, doesn't need to be paid, and is unfamiliar with the idea of manager as agent, and (b) he's a crabby old jerk who doesn't think that anyone else should be allowed to make money.
David Walser:
If anything, corporate governance is MUCH more open than it was in the past. Today, executive pay plans are subject to extensive disclosure and require shareholder approval.
Indeed. People interested in this topic should check out by looking at some of this year's proxies. The executive compensation disclosure rules are all new this year. Companies have to put every type of compensation into one table, give a dollar value to each, and give a single total for all compensation. This includes perks, which must be itemized, snf Black-Scholes value of options. It is quite easy now to see total comp and compare it across companies.
joeblo:
The CEO of my company, and corporate officers all clear more than $1M a year in compensation... mostly in options.
Is gain upon exercise or in grant date value? They may get a lot when they cash in, but the fair-market value of these options when issued can be calculated and must be disclosed. Options typically aren't granted with an exercise price of less than the grant date stock price. The grant date value is what you should look at over time.
Ahhh, but what if the CEO manages to crash the stock to 10% of its nominal value some time during the 5years, and then lets it recover to 50% of its original value before the end... he's made $5M on just one (crash) years options, and even better if he times things right;^)
First of all, the CEO would be fired. Second, the options granted before the stock tanked would be worthless. Third, his options would most likely vest over four years, so he would only be able to exercise a quarter of the options that he got at the minimum. Yes, any year-over-year increase will help the CEO make money, even if long-term performance is terrible, but compensation is divided between short-term rewards (bonus) and long-term incentives (options, vesting over a period of years) to avoid this problem.
The value of options is largely in their volatility so the CEOs interests are the same as those of the day traders not of regular stockholders, the company, or the employees.
Yes, but the CEO can't sell the option, so he can't take advantage of that the same way a day trader could. He has to exercise to get anything.
I don't think high CEO is caused by overt collusion, corruption, disclosure failures, or anything of the sort. I don't think regulation can do anything about it, either.
Think about a typical board. It will have some combination of working and retired executives in the industry, community bigwigs, token non-profit types, a business professor, a lawyer and/or an accountant, and a crazy old lady or two. The directors will have served for a number of years, since except in highly unusual circumstances, they are nominated for re-election until they retire. They will consider the other directors and management their colleagues, if not their friends. They will probably have known at least someone in senior management before they were nominated, since how else would anyone know about them in the first place? They will take their duties fairly seriously, more seriously than the casual cynic might expect. They will generally be aware of their fiduciary duties; if not what they are, at least that they have them. They'll flip through the presentation materials they're given in advance, and some of them will ask management about positive and negative trends and performance issues that concern them. They will be probably be paid $20,000 to $50,000 a year for their efforts and will own some stock, and will not think that they are beholden to the company. So why does CEO pay keep going up?
It may be because of supply and demand in the market for talent. I think that's probably the primary reason. But I think part of it is just that the board has the same problems that any organization has. The comp committee doesn't monkey around on Excel and Bloomberg for days and days to figure out exactly what is a fair and optimally incentivizing pay package. They hire compensation consultants who will tell them what CEOs at similar companies get paid. They will probably want to pay their CEO a bit above average, because he's such a nice guy and a hard worker, unless it's been a bad year, when they'll probably want to pay him just a bit below average, because he's such a nice guy and a hard worker. They could fire him if he's a disaster, but firing a CEO is rare enough that it will be in the news, and it will inevitably cause some trauma among management. If they're not going to fire him, they're also not going to pay him a $5 bonus and no stock options, because he might quit, and they'd look like fools for doing something so obviously insulting without firing him. No, they'll just nudge pay down a little and wait and see what happens. Plus, like most people in the workplace, they're nonconfrontational, want everyone to get along, and really, just don't want trouble. When someone working for you screws up, do you yell at him and write it up, or do you just let it slide, because that's the easier thing to do?
Posted by: regular poster on April 12, 2007 1:45 AMThe value of options is largely in their volatility
If we were to award CEOs fully-tradeable (or hedge-able), instantly-vesting options, this statement would be relevant.
As it stands now, everyone with a brain knows that EVA is better than options as an executive comp mechanism. Unless these people with brains think that changes in the term structure and equity risk premium ought to be the primary drivers of compensation.
Posted by: Bob Dobalina on April 12, 2007 1:46 AMBut of course, even that's not really the issue, I think. The real issue is why corporate profits have skyrocked for the past few decades but average worker pay has stagnated.
Is that accounting for the portion of employee compensation that is consumed in the form of ever-increasing health care benefits, or just payroll itself?
Posted by: anony-mouse on April 12, 2007 4:16 AM"We might think it unfair that poor management is rewarded with good pay, but even the "worst" shortstop in major league baseball gets paid a ton of money "
To sleepy to be coherent, so I'll let the NY Times editorial page speak for me (this time):
"If there is a single, logical justification for the wild executive compensation packages that have become standard at large American companies, it is performance. In too many cases, pay has little or nothing to do with results, and some of the most jaw-dropping packages are for executives who have been told to hand over the reins.
This pay-for-failure is embodied by the $210 million package given Robert Nardelli, the former Home Depot chief executive. As Eric Dash reported recently in The Times, including Mr. Nardelli’s rich goodbye on the first workday of 2007, 36 chief executives ousted last year walked out with over a billion dollars between them. Mr. Dash points out that Hank McKinnell left as chairman and chief executive at Pfizer with an exit package worth nearly $200 million despite the fact that the company’s market capitalization dropped by over $137 billion while he was in charge."
"Even the worst shortstop gets a ton of money" is a reasonable point, but only because of what follows after the em dash -- " except when compared to the best shortstops". As that comparative relationship weakens, it starts looking weirder and weirder.
(being also in a rush, I'll not enage with the standard-issue CEO-worship in that comment, something that does start from rational grounds, but has mutated into something quite irrational (except, of course, for top corporate executives) and rather damaging to business itself . . .
Posted by: Dan S. on April 12, 2007 7:56 AMKevin Drum -
The real issue is why corporate profits have skyrocked for the past few decades but average worker pay has stagnated. Some people don't care about that, but a lot of us do. If workers were getting a cut of the productivity boom, I think most liberals wouldn't really care how much the CEO was taking home.
Of course, workers are getting a cut of the productivity boom. They just aren't necessarily American workers. Wages and living standards are rising all over the developing world, or at least in any place that can deliver competent manufacturing. That may make for a political problem in the rich democracies because a larger proportion of the "social goods" produced by big OECD corporations are now being exported (along with the attendant negative externalities, if you want a tip of the hat to the anti-globalization activists), but for those of you concerned with the future of humanity as a whole, it is a good thing.
I am constantly amazed how the left and right vascilate between parochialism and world citizenship, depending on the cause. When it comes to alleviating some humanitarian or environmental crisis in a part of the world where the United States has little or no interest, the left is all globalist. God forbid, though, that Western corporations should export the economic benefits of productivity gains to the workers in poor countries. Meanwhile, the internationalist right gets all "America alone" on matters of geopolitics, but quickly finds its common cause with the world's poor when it comes to opening markets.
Me, I'm the second kind of hypocrite.
Posted by: TigerHawk on April 12, 2007 8:51 AMI would suggest that the only reason there is even much talk of this is because there are many liberals who can't earn the same amount as CEO's, and they "want to level the playing field," thereby allowing themselves to be closer to the top in income and by that, inflating their egos. In reality those liberals are nothing more than socialists. In the great scheme of things the pay of CEO's will make little difference except to give the socialists something to yap about.
Of more concern is the problem of those yappers gaining enough of a following to get complete control and make fundamental changes in our form of capitalism. Socialism has never been successful, and its followers know nothing of economics even though they like to write lofty sounding articles claiming they do. Only when basic human behavior changes will socialism be successful.
David Walser has it. When an additional percent share of market is worth in the neighborhood of a billion dollars, then the rare person who can credibly bring that to the company's bottom line is worth a pretty penny.
Performance based, Dan S.? When outcomes are uncertain and beyond the ability of even the most talented to control? Remember, these are people with options, including the option of going to work for your chief competition or even starting businesses of their own in competition with you.
Posted by: Charlie Tips on April 12, 2007 8:56 AMI spent 11 years as an engineer in an electronics manufacturer which, at its peak, made about $300M in revenue.
I got to see all of the usual managerial BS up close, just on a somewhat smaller scale.
The way the system seem rigged to make 'em money coming and going, in a distortion of "performance based pay", in times when the company was struggling, was outrageous.
Instead of just offering incentives for *real*, bottom line, good performance it quickly morphed into:
"We have to pay managers an arm and a leg to come here and offer killer golden parachutes because *they're* taking a risk."
Fine if that netted good executives-- but it never seemed to...
I've been gone 5 years and all that is left is a tiny skeleton crew piggybacked on a much larger company.
BTW, these complaints are coming from a libertarian-conservative.
Something *does* seem amiss. More of the usual sorts of strangulating regulations are certainly NOT the answer. I imagine that there are some foundational problems, due in part to prior regulation.
About someone's earlier managers-vs-engineers point, it's mostly true -- the business management types in charge tend to undervalue anyone who does not also share their "I want to be the boss" mindset. They don't appreciate "get" those who instead value actual, demonstrable expertise.
I absolutely appreciate the value of a truly good executive type, more now than I did 20 years ago (recognizing some of the necessary traits I lack), but the fact is they are few and far between.
Posted by: newscaper on April 12, 2007 8:57 AMThe problem that I see with executive pay is that it creates an insulating factor. Every employee may have an idea to save money, increase productivity, or even the next great product. However, the pay gap seems to make executives only believe in their own brilliance.
It can keep a millionaire with a staff of nannies from understanding why an employee has to take off a day when their child is sick.
Posted by: John Davies on April 12, 2007 9:05 AMRegarding young Jane's Economist blog post, young Ezra Klein, like many who complain about executive pay (the same people who use Marxist terms like "workers"), is ironically also stuck in the 50s and 60s in their conception of the economy. CEOs may have been at the apex of the pyramid then, but they're not now. $18 million is a lot of money, but while only a few CEOs get paid that much, it's only what a somewhat above-average partner MD at Goldman Sachs or a runt hedgehog got paid last year. Three people at Goldman took home home over $100 million, and there are hundreds of hedge fund and other money managers who took home that much. Has the Left just not gotten around to complaining about them with the same passion?
Posted by: AT on April 12, 2007 9:26 AMRex: "More and more power is being removed from the shareholders, and compensation is increasingly determined by incestual compensation committees that have a self-interest in offering each other higher pay packages. If I sit on your board, and you sit on mine, then our incentives are to mutually increase the "market compensation" for CEOs."
David: "What's been going on for the last few decades is that the relative value of management has increased and so has its pay."
If executive pay reflects the real relative value, then it shouldn't be hard to find companies getting into bidding wars over a particularly good CEO candidate. David, know of any examples?
Posted by: markm on April 12, 2007 9:40 AMI'm one of those people who doesn't care. Making lots of money (legally) is not a sin or a moral failing and shouldn't be punished. It's not my money and unless I'm a shareholder it's certainly not my place to dictate how much people are allowed to make at their jobs.
But from the tone of these comments it seems like the issue isn't really that many CEOs make too much money, but rather that many expensive CEOs aren't effective or responsible leaders. When people pay for quality they expect to get it.
In theory, it does make sense that a risky, high-profile position like a CEO should be very well paid. Unfortunately it often seems like they aren't actually willing to risk their jobs no matter how much they make. I'm pretty sure that GM didn't get into today's mess because it had too many wild, maverick CEOs taking crazy risks with the company. They've generally been content let the company be run by a stagnant corporate bureaucracy and a union workforce they're scared to confront in any meaningful way. That sort of non-leadership is not worth the pay.
Posted by: Bryan C on April 12, 2007 9:52 AMmarkm, to answer your question, bidding wars over employees (even CEOs) are usually done discreetly, and very rarely get reported on. But you can see a lot of examples of CEOs being hired away by another company (presumably for more compensation) - just do a web search on "CEO poached".
Posted by: Floyd on April 12, 2007 9:53 AMIn response to some of the above posts referring to the value of CEO performance, I absolutely understand why executives get paid so much more than the average employee, but what I don't understand is why that gap has increased so profoundly in the last several years. I could understand if it were just within the largest corporations (because the mega-corporations control so much more income as percent of GDP than ever before, and still just have one guy in charge) but it seems to be the case even outside of the major multinational corporations. When you hear reference to AVERAGE CEO pay being so extravagant, that must mean that even the CEOs of smaller companies are getting paid more than ever before. I just don't see where this supposed extra CEO value is coming from in your average company. Maybe it's just like any other bubble, and once the stock market really starts to suffer things will change...
Posted by: woodstock on April 12, 2007 10:05 AMWhen you hear reference to AVERAGE CEO pay being so extravagant, that must mean that even the CEOs of smaller companies are getting paid more than ever before.
No, that's not necessarily true at all. That's the difference between "average" and "median" in a nutshell.
Posted by: Floyd on April 12, 2007 10:14 AMLet's not forget studio executives and actors- where's the Left and the Press (the Left and the Left) on how much Ben Affleck gets paid to make bad movies? It's an outrage! There oughtta be Congressional hearings.
DD
Most of their "extra" consumption lies in things that are rare, and hence not redistributable (fancy gems, harrier planes), or which don't actually cost much more in resources to produce (Hermes handbags). You can move the money around, but that won't give us more doctors, hospital beds, day care workers, policemen, parks, high-quality teachers, museums, etc.
This is a ridiculous statement, and I'm surprised Ms. Galt let it slip past her internal editor.
If we confiscated all the money made by someone with a high income and gave it to poor people, the total production and consumption of status goods and luxuries would fall and the total production and consumption of necessities would rise. The rich wouldn't buy as many jet airplanes (because they couldn't afford them because we'd taken all their money away), so fewer people would build jet airplanes. The pool of labor and capital would shift from airplane building to, say, food production and health care... since that's what the poor people would be spending their new-found extra money on.
Sure, you can quibble about elasticities and income effects and inferior goods and so forth, and probably the poor would spend some quantity of their gains on luxuries like CDs and iPods and concert tickets. But the basic story is still essentially true: taking money from the rich and giving it to the poor will give the poor more of the things that they want and will cause more of those things to be produced.
That's still not a sufficient reason to do it, of course.
"It's much more efficient to extract money from a corporation by using options since they are much more tax advantaged (i.e. 15% rather than 30%). The CEO of my company, and corporate officers all clear more than $1M a year in compensation... mostly in options."
This is a common mistake. Generally speaking, stock options for CEOs are not tax preferred. The executive recognizes ordinary income -- not capital gain -- when s/he exercises a stock option. Next time you read a proxy asking you to approve an option plan, read the tax discussion.
Posted by: Think38 on April 12, 2007 11:31 AMEddie, I'm not arguing that there would be absolutely no effect. I'm just arguing that it would be statistically indistinguishable from zero. There are 500 of these guys. The resources needed to make every single one of them one private jet every ten years, and then run it, are trivial compared to the resources required to, say, make any noticeable difference in the consumption of 30 million people below the poverty line.
Posted by: Jane Galt on April 12, 2007 11:33 AMWithout getting into the issue of divorcing market performance from company pay and performance, which I think is the underlying issue with CEO pay, I'd like to ask a question about the economics behind the argument made above. (I hope this doesn't reveal too much of my ignorance.)
If there are a "super-rich" class of people who eat no more than average, but spend money on luxuries, that seems good for the economy, because it helps employment, and gets money back into the system. On the other hand, if they didn't get the money in the first place, there would be no incentive for workers to produce luxuries like million dollar dresses and handbags worth more than the GDP of small countries - and that would mean that more people would be doing the "productive work" of getting more out of natural resources.
In part this has to do with the false assumption of a zero-sum natural resource game, but in part it has to do with labor markets that value toys for the rich more than food for the poor, because the money is so concentrated at the top of the income chain. There are fewer doctors because college students know more money is made in finance, and fewer farmers because making Gucci bags pays better. By eliminating some luxuries by reducing the income gap, don't we modify the economics of making luxuries and help the markets that matter for the rest of us?
If y'all can't answer, I can ask my Econ professor when I get back to school after spring break.
Posted by: David Manheim on April 12, 2007 11:40 AMCEO pay is directly linked to cutting costs and raising shareholder value. We would not have outsourcing of tech jobs to India without skyrocketing CEO pay.
So yeah, I guess it doesn't matter - IF YOU ARE A CEO!
Posted by: John on April 12, 2007 12:30 PMHow do you "reduc(e) the income gap"? Someone earning $1.2 million a year produces something valued (by someone) at at least $1.2 million. If you, say, confiscated all of his earnings over $100,000 a year, what's to prevent him working just one month a year? You've reduced the income gap by reducing production in the economy. He's hurt. No one is helped.
Posted by: Scott Wood on April 12, 2007 12:46 PMAllow me to briefly respond to the comments of Dan S. and markm:
Markm suggests that there should be examples of companies bidding up the compensation for CEOs if executive talent is increasingly valuable. He then challenges me to cite some examples. Dan S. quotes the ever reliable editorial page of the NYT for the proposition that CEOs are often overcompensated for failure. (Dan's post was in response to my pointing out that even the worst shortstop in the major leagues is highly compensated.) I won't respond directly to markm's challenge for fear that some might think I'm responding based on knowledge gained through personal experience. (Over the last 2 decades, I've been involved with the negotiations of employment agreements of several CEOs of publicly traded companies.) Instead, I'll use Robert Nardelli, who was mentioned in the NYT's editorial, as an example of a failed CEO getting a huge payoff. Mr. Nardelli was hired to run Home Depot in 2000. Presumptively, Home Depot thought they had acquired the right person to lead the company and thought his pay package was fair at the time he was hired. From 2000 to 2005, Nardelli revamped Home Depot's management structure, streamlined operations, and installed modern inventory ordering and control systems. These efforts drove costs out of Home Depot's and increased revenues. In this period, Home Depot's sales rose from $45.7 billion to $81.7 billion and profits rose from $2.6 billion to $5.8 billion (all these numbers are from Wikipedia). As a percentage of revenues, profit rose from 5.7% to 7.1%. Despite this financial success, Nardelli's management style was not well received by those who had been immersed in Home Depot's culture. When Home Depot's stock price stagnated in 2006, Nardelli came under pressure from within and without Home Depot and he resigned in January of this year. His exit package is estimated to cost Home Depot $210 million. The NYT thinks that's a high price to pay for failure. Failure? As CEO, Nardelli's vision and management talent, more than any other factor, led to Home Depot's profit doubling in 5 years. The man added billions of profit! Still, why pay him so much on the way out the door? Because his employment contract (negotiated in 2000 and updated since then) called for it, that's why. (I don't know that for sure. Mr. Nardelli is not a client of mine and I have no personal knowledge of the matter. However, I've seen the process up close and personal a number of times and I'd be flabbergasted to learn that Mr. Nardelli's severance package is not based on his employment agreement with Home Depot.)
For an example of an employment agreement that, with 20/20 hindsight, looks to be too rich, let's switch industries and go back to baseball. Alex Rodriguez became an all star playing short stop for the Seattle Mariners. In 2000, the Texas Rangers out bid the rest of baseball for A-Rod's services, signing him to the richest contract in the history of the game: $252 million over 10 years. Despite putting up more than decent numbers for Texas, the team almost immediately had buyers remorse and tried to trade him to Boston after the 2003 season. Eventually, a deal was worked out and the Yankees took Rodriguez and his expensive contract from Texas. Is A-Rod worth $25 million a year? The Rangers thought he was in 2000. If they had cut him from the roster at the end of 2003, the team would still have had to pay him for the remaining 7 years on his contract -- that would have been a huge severance package! The point is, being paid one dime to run a company into the ditch (or to strike out with the bases loaded) is being paid too much. No one thinks that's what's going to happen when the CEO or shortstop is hired. The company and employee think there will be a long term relationship and they sign a long term contract. When things don't work out as planned, the company sometimes has to buy out the rest of the contract, resulting in a large severance package.
Jane Galt:
"... There are 500 of these guys. ..."
As has already been pointed out this is not accurate. It is not just the CEOs who are overpaid but other top executives as well.
Posted by: James B. Shearer on April 12, 2007 1:04 PMForbes.com sez (1/3/07):
"Robert Nardelli resigned as chief executive of Home Depot on Wednesday, after months of wrangling with investors over his heavyweight salary and the poor performance of the company's stock.
. . . since Nardelli joined the company in December 2000, the home improvement retail giant's stock has fallen about 5.6%. Over that period, Nardelli managed to pull in $123.7 million in compensation.
At the company's 2006 annual meeting last spring, shareholders were looking to weigh in on the matter, but they were met with nothing but silence. Save for Nardelli, not a single member of Home Depot's board attended the meeting, and Nardelli refused to comment on his salary.
. . . Gary Balter, an analyst for Credit Suisse, said in a Wednesday note that Nardelli originally bolstered the company by "centralizing purchasing, investing in systems, capping wage levels and in general bringing a stronger infrastructure to the company."
Yet his autocratic style of management and enormous salary, coupled with a weaker than necessary presence in the retail market, hindered the company, Balter said . . ."
Posted by: Dan S. on April 12, 2007 1:45 PMSo Nardelli made his company $3.2 billion YEARLY in marginal profit after 5 years. His compensation for this is $120 million, plus a $210 million dollar severence package. Looking at the income statement, over the fiver years from 01 to 06, it's about $100 billion in marginal net profit.
If I had a company and was told I could get $300 for every dollar I spent on a particular new employee, over 5 years, I would probably go for it - even if it ruffled some feathers of current employees jealous of his paycheck. I understand that this oversimplifies the situation, but it looks like it was a good hire for Home Depot.
On another note, in the same vein, an executive I know at Home Depot said Nardelli was needed at the time, even though now they did need to get rid of him, or, basically, they would piss too many people off. As an insider, he said they did what they should have done.
Posted by: David Manheim on April 12, 2007 2:51 PMJane:
I'm not arguing that there would be absolutely no effect. I'm just arguing that it would be statistically indistinguishable from zero.
True enough, and you made that argument (convincingly) in your first and second paragraphs: the benefit to the poor would be insignificant because there's very few very rich and very many very poor. But you made a subtly different and, I believe, incorrect argument in paragraphs five and six: that there wouldn't be any benefit because the rich buy different stuff than the poor, and shifting money around won't make any more of the stuff the poor need. The first argument is good math, but the second argument is bad economics.
Prices go up either because of increased demand or restricted supply. Everyone here is more or less aware of the demand side of the equation, but no one seems to be focussing on the supply side.
As high as CEO/executive pay is now, it's very likely to go even higher with the increased regulatory interference and personal liability under Sarbanes-Oxley.
As Alex Epstein asks: "Is it any wonder that misery among top executives is reported throughout corporate America, that top executives are departing at record rates, that more and more public companies are going private, that only a small fraction of the largest IPOs last year took place in the United States?"
In this increasingly "guilty-until-proven-innocent" regulatory climate, I'm not surprised that there are all kinds of stories about incompetent/criminal executives; when demand outstrips supply due to the latter being artificially constricted, not only does the price go up, but the quality bar gets lower. All heavily-regulated-but-not-yet-socialized-markets, such as health care, show these traits.
So I say, if you want to know why CEO's are so expensive, I suggest you take a look at what it really takes to BE one. There are a lot of people out there who could be brilliant, creating all kinds of wealth... but who opt out of the field because its personal and spiritual price is too high.
Posted by: Seerak on April 12, 2007 3:01 PMPrices go up either because of increased demand or restricted supply. Everyone here is more or less aware of the demand side of the equation, but no one seems to be focussing on the supply side.
As high as CEO/executive pay is now, it's very likely to go even higher with the increased regulatory interference and personal liability under Sarbanes-Oxley.
As Alex Epstein asks: "Is it any wonder that misery among top executives is reported throughout corporate America, that top executives are departing at record rates, that more and more public companies are going private, that only a small fraction of the largest IPOs last year took place in the United States?"
In this increasingly "guilty-until-proven-innocent" regulatory climate, I'm not surprised that there are all kinds of stories about incompetent/criminal executives; when demand outstrips supply due to the latter being artificially constricted, not only does the price go up, but the quality bar gets lower. All heavily-regulated-but-not-yet-socialized-markets, such as health care, show these traits.
So I say, if you want to know why CEO's are so expensive, I suggest you take a look at what it really takes to BE one. There are a lot of people out there who could be brilliant, creating all kinds of wealth... but we never ever hear from them, because they simply turn away from fields whose personal and spiritual price has become too high.
Posted by: Seerak on April 12, 2007 3:02 PMDavid Manheim:
If there are a "super-rich" class of people who eat no more than average, but spend money on luxuries, that seems good for the economy, because it helps employment, and gets money back into the system.
The goodness of an economy isn't measured by its employment or by how much money "gets back into the system". The latter is essentially meaningless, and the former would count things like unproductive make-work as a benefit. The goodness of an economy is measured by its productive capacity: how much stuff does it make, and how much do people value the stuff that's made?
You're right that if we took away the rich people's money and gave it to the poor there would be more doctors and fewer handbag makers. Contra your first assumption, putting handbag makers out of work isn't necessarily a bad thing - the idea that they get the rich people's money back into the system is irrelevant. But contra your second assumption, it isn't necessarily a good thing either.
More doctors for poor people instead of handbag makers for rich people sure sounds good, right? But you only get there by destroying the incentive for rich people to provide the very valuable goods and services that made them rich. In the short run, sure, you've taken a billion bucks from a thousand rich people and given everyone else in America $4 each. Woo hoo. As Jane points out, the numbers involved make the benefits of redistribution insignificant.
To make the benefits add up to something worthwhile, you've got to take a lot more money from a lot more people... and the more you do that, the more you disincent people from doing things that would make them rich. Things like going to med school or starting a business or inventing something worth patenting. Things that make life easier and cheaper and better for everyone, rich and poor alike. At which point, congratulations: your effort to help the poor in the short run has made them poorer in the long run.
You'd have done better by letting the CEOs and rock stars spend their mind-numbing fortunes on useless crap. The benefits from them doing so don't come from the jobs they create in the crap-making business; they come from giving everyone a reason to try to become a CEO or rock star - or even just to be better off than they were last year.
And I thought America tolerated no Kings.
Since when did sucking up to the powerful become orthodoxy? Ah, since always in human history.
I always looked to the American example - that when the King became tyrannical and heeded not the opinions of his people, he should lose his throne.
Clearly, that only applies when crowns and sceptres are involved. If our Kings come clad in Armani, yelling the great battlecry of "You're fired!", it's acceptable for free men to bow at their feet.
Something is horribly wrong with the world when the worst of us are exalted as our exemplars, and we hurl ourselves down in obeisance.
Speaking as a Scotsman, my Grandfather was able to raise a family on one blue-collar wage, take holidays every year, run two cars and die with a healthy inheritance awaiting his children.
In the modern age, the above median wages of my girlfriend and I aren't sufficient to buy a one-bedroomed flat in the city in which we were born.
Thanks, Reagan! A million hosannas unto Thatcher!
They've bequeathed us the first empire in modern history where the common man gladly threw himself upon the backside of the wealthy man to lavish it with kisses.
History will judge us as dupes, fools and idiots, gulled by wide-screen TVs and holidays on the Med whilst our Plutocrats revelled.
And the animals outside looked from Russian to American, and from American to Russian, and from Russian to American again, but already they could not tell the difference.
Posted by: Flying Rodent on April 12, 2007 5:40 PMSeerak has put his finger on the issue. Being a CEO used to be a job where you got to focus on making the company better at creating economic value, you had privacy, you were hard to fire, and you were generally kissed up to in public and private. Now it's a job where you spend most of your time soothing outside constituencies (analysts, hedge-fund cowboys, regulators, pressure groups, etc.), you have to be the public face of your company, your job tenure is extremely short and precarious (turnover among CEOs has grown significantly), and your reputation is subject to trashing by vociferous critics in the financial and journalistic communities.
Look at the beating Nardelli's taking because he did what he was hired to do at Home Depot (even if he isn't lovable). From the standpoint of enjoying one's life as an executive, being an SBU president or a COO seems like a better deal than being a CEO--you actually get to think about marketing and operations and finance and innovation, topics you are probably pretty interested in.
Nobody should feel sorry for these folks, but their incentives are to negotiate the best severance package they can on the way in when their leverage is highest. Most of the top candidates for CEO already have enough money that they don't need the new job to meet their consumption needs. They can wait for a better offer or stick in their current jobs longer or even retire in many cases.
So yeah, they are getting paid more. It's called a compensating differential.
Posted by: srp on April 12, 2007 8:00 PMA firm's success is largely determined by the quality of it's management.
That's only one piece of the puzzle. You need clueful people to design/build some products that people will actually pay money for.
Someone above mentioned Steve Jobs -- Jobs is not management in the way I view management. Jobs is a corporate advocate rather than a manager. A glorified salesman.
I once saved IBM about a million bucks in manufacturing costs piddling around doing some off plan renegade work for a couple of months. A bad manager would have told me to stop because that work wasn't "in the plan", a good one (which I had) let me run free off the books.
There are damn few really good managers who know how to make that call correctly. The "safe" answer is always "no".
Posted by: Purple Avenger on April 12, 2007 9:09 PM"Top executive pay is so high because of a very basic economic principle: supply and demand. Lower workers are readily available; top executives are not.
This is showing up in school districts too. Superintendents make a lot more than teachers"
The above may work in the business world, but I really wish that weren't true in the schools. There's entirely too much money in education being spent on people who don't even teach anything (or haven't done so for perhaps as much as 20 or 30 years). This causes that sense of disconnect that a few commenters have already mentioned, so that we end up with situations like this:
"The problem that I see with executive pay is that it creates an insulating factor. Every employee may have an idea to save money, increase productivity, or even the next great product. However, the pay gap seems to make executives only believe in their own brilliance."
If I ran a school district, I would require all the administrators to teach at least one class in addition to their "executive" duties. Running a school system like a business doesn't really work from this angle, because the educated young people we're trying to create are much more than a mere "product."
Posted by: Kev on April 12, 2007 11:42 PMSome people don't care about that, but a lot of us do. If workers were getting a cut of the productivity boom, I think most liberals wouldn't really care how much the CEO was taking home.
2 words bull and shit. All libs should learn and adhere to the 10th Commandment.
Eddie:
I've heard the argument. Are you seriously proposing that people will try less hard if Bill Gates made 1/10 as much money? Of course there is an incentive factor, but don't over weight it.
More than that, don't assume that there is a natural law of some sort that assures us that CEOs need to be making that much money - the system under which the "supply and demand" in this market exists is completely artificial; it is a response to tax law, legal executive culpability, and lack of enforcement on the part of the FTC of the monopoly laws that allow companies to continually swallow one another, making these mega-corporations.
The question, I think, not one of taxing away profit, but rather revisiting the way that we run corporations. But I think that is a separate discussion.
Posted by: David Manheim on April 13, 2007 8:44 AMAre you seriously proposing that people will try less hard if Bill Gates made 1/10 as much money?
"People" might not, but Bill Gates might.
Taking away the earnings of a very few very rich gives you very little money to give away relative to the number of people you want to give it to. So while taking away Gates' pile won't disincent too many other people, it also won't help anyone very much.
To collect enough taxes to give any significant benefit to anyone, you've got to collect it from enough people that you do create a significant disincentive for productive work - and in the most productive sector, no less. Bear in mind that we're now moving well beyond CEOs.
Go ahead, do the math. Pick some group of people that you think makes obscene and undeserved incomes. Add up their total income, and divide by a quarter billion to find out how much better off each person in the America will be after you've split the proceeds. I bet the result will hardly seem worth the effort.