Why so high?

This Eugene Fama interview is a must-read if you think you've got the goods on EMH. Leaving aside our recent contretemps, however, I'll zero in on his comments on CEO pay:

Region: Another issue those papers touched on was compensation of CEOs, a controversial question in recent years. How do you view the suggestion that some CEOs are overcompensated?

Fama: If the [compensation] process gets captured by the CEO, then it can get corrupted. But if what you’re seeing is a market wage, then I don’t know why you would say it’s too high. If it’s a market wage, it’s a market wage. I don’t know of any solid evidence that the process was corrupted. So my premise would be that you’re just looking at market wages. They may be big numbers; that’s not saying they’re too high. It’s easy to say that people are paid too much, but when you’re on the other side of the fence trying to hire high-level corporate managers, it turns out not to be so easy.

The liberal rejoinder to this would be that even if it is true, this is a positional thing; if all CEO salaries were lower, you wouldn't have to pay so much to attract a good one. Of course, this doesn't mean that there is any good way to lower them; measures aimed at doing so, such as capping the amount of a CEO's salary that was tax deductible to the company, have mostly backfired, pushing compensation into things like stock options. And even if we could cap salaries, of course, that wouldn't mean that we should.

But what advocates of the idea that these salaries are necessary to attract good CEOs must contend with is the question of why CEO salaries have increased so much over time. Contrary to popular belief, CEO's are not driving inequality trends; there are too few of them, and they aren't paid that well. Nonetheless, they are much better paid than they used to be, and one wants to know why. Have the returns to having a good CEO gotten so much bigger? Is the supply of CEO's being outstripped by the demand? That latter case is pretty hard to make; there are actually slightly fewer public companies listed on the various exchanges than there used to be, and the population has grown rather rapidly.

I find Paul Krugman's argument that CEO's have simply gotten greedier, while the rest of us have become more greed-tolerant, less than compelling. Explanations I do find compelling:

1) Falling tax rates have increased the bang one gets from one's CEO salary buck

2) The size of public companies is bigger; CEO's are essentially taking a fixed piece of a larger pot

3) Being a CEO is riskier than it used to be; executives are more likely to be forced out

4) Stock options have disguised the true cost of compensation, boards spend them with the casual disregard of a tourist using a strange currency

5) Deregulation and globalization have made the economy more competitive, which means that CEOs matter more. Thus, it is more important to actually have a talented CEO, which results in a bidding war for a limited supply of human capital.

6) Advances in financial markets offer an alternative way to get really, really rich; CEO pay is bidding against Wall Street salaries for talent.

7) Deregulation means that boards are no longer afraid of attracting unfavorable government attention with lavish executive salaries.

Comments

maybe a bit of indication that the tax thing isn't as true as you expect:
Mankiw
assuming his numbers are right...

I think with CEO's the perception is that they have a great bearing in what goes on in a CO. they tend to take the bows for what happens right, and even if forced out, have a golden parachute for what went wrong... it's win/win from that standpoint. As with many MGR positions though, they don't often don't do work that is revolutionary... The vision thing is often not part of their job description, they are just trying to maintain course. Even the turn around guys... it doesn't take a PhD. to put a tourniquate on the bleeding and then amputate...

The reason they are reviled isn't as much that they make some large multiple of the salary of people who actually do THE WORK... It's that they never have to fall on their swords. It's not like they have to give back that salary if they frell up. So it looks like they do whatever they can to get their money out, and then leave the company to dangle. The worst part of that is often that in the interim, they cut thousands of jobs of people who actually do WORK, while sponging themselves. Since their salary is such a multiplier, you could keep many of those people, and figure out how to fix the company problem, and get rid of the top guy, who got you into trouble.

The Story of Chaisaw Al, and the Damage Done

I have small hope believeing anything has changed...

Posted by SwissArmyD | December 17, 2007 5:14 PM

I was reading recently that Clark Gable made $100,000 a movie back in the 30's and 40's. That is equal to $800,000 a movie today. An actor of Gable's calibre today would be pulling down 25x as much.

Now, actors provide labor, actors are members of a union, what is wrong with labor capturing more of the value they create.

The same goes for CEO's, they provide labor, they are employees, what is wrong with them extracting more of the value they create from the owners of capital?

Posted by Jmo | December 17, 2007 5:17 PM

The Efficient Market Hypothesis is not just contraversial, it is demonstrably inadequate.

For the last 30 years, proponents have been unable to adequately account for the fact that financial prices are far more volatile than seems to be justified by new information, and that financial bubbles, despite Fama's wry rejoinder, happen.

More recently, Behavioral Economics and Behavioral Finance have empirically challenged one of the main tenants of market efficiency, the idea that all investors are fully rational Homo Economicus. Of course, as Economists, what should we believe, physical reality or our theories? The graphs win every time.

In the real world, at this point EMH is little more than an old wives' tale for MBAs to convince them that their work moves the universe forward.

Posted by James H. | December 17, 2007 5:19 PM

The Efficient Market Hypothesis is not just contraversial, it is demonstrably inadequate.

For the last 30 years, proponents have been unable to adequately account for the fact that financial prices are far more volatile than seems to be justified by new information, and that financial bubbles, despite Fama's wry rejoinder, happen.

More recently, Behavioral Economics and Behavioral Finance have empirically challenged one of the main tenants of market efficiency, the idea that all investors are fully rational Homo Economicus. Of course, as Economists, what should we believe, physical reality or our theories? The graphs win every time.

In the real world, at this point EMH is little more than an old wives' tale for MBAs to convince them that their work moves the universe forward.

Posted by James H. | December 17, 2007 5:19 PM

I was on the compensation committee of a public company. The way it worked there, and, I believe, at many other firms, was for the committee to hire one or more consultants who maintained databases of CEO salaries. They would report on "comparables," based on a variety of factors (nature of business, size of company, years of experience, inflation, success at goals, etc.). While logical, the effect of this was to create a spiral within the companies receiving reports, since recommended salary levels almost had to rise every couple of years.

The result was tremendous pressure within any industry that CEO salaries would rise fast. I'm sure something like that is going on every day.

Posted by JohnF | December 17, 2007 5:28 PM

SwissArmyD: Imagine you are the CEO of company A. You've been working there for 15 years, you have been amazingly successful. You know all the people, you know the business, you know where all the skeletons are buried. In addition, you have $200 million in salary, stock options, deferred compensation etc. coming your way in the next few years.

I call to try and hire you to work for my company, company "B". What will it take to get you to leave. If you leave you give up your $200 million, you won't know the business, you won't know the people, and most importantly, you won't know where all the bodies are buried. What if you quit company A start at company B and find out things are far worse than you were led to believe.

Now, what am I going to have to offer you to leave. I would think I would have to offer a guarantee to limit the downside - or offer you a huge upside - or both, to get you to make the jump.

Posted by Jmo | December 17, 2007 5:30 PM

James,

I don't think anyone is arguing that all investors are fully rational. The point is that all investors, acting legally in their own self interest will generally yield the better result.

Its possible for you to come up with certain instances that defy this average.

Just like I might be able to roll 5 snake eyes in a row.

But generally the market takes care of things. I have food on my table and the only time I have to wait in an hour long line is at Disneyland.

I'm pretty content with the way things are, even it it means some guy is getting more than he "deserves".

Posted by Sam | December 17, 2007 5:32 PM

I'm hardly a redistributionist, but I am troubled by the payscale not because it has gotten so much larger, but because it seems largely unconnected to actual performance. I believe in a slight variation of #5 - globalization has not only made the economy more competitive, but it has also made firm operations more opaque. It's become very difficult to tell whether an executive has been successful or not in the short-term, so, instead, they are paid largely on their ability to convince board members that they're successful (thus, the predominance of 'tall guys with good hair,' to paraphrase Scott Adams).

Or, to use another famous example, Billy Beane's observation that his scouts seemed to prefer guys 'who could sell blue jeans' instead of players who could actuallly hit.

Posted by Independent George | December 17, 2007 5:38 PM

James H:

The position you mention, expounded by such notables as Robert Shiller, has always struck me as inadequate. Firstly, I find that it comes from a position which while not necessarily failing to understand the EMH, defines it differently from its proponents, by failing to show that the difference which arises between market prices and so-called "true" prices is systematically exploitable, such that a savvy investor could in fact perform inter temporal arbitrage and earn above average, non-risk adjusted returns.

Secondly, the definition of "true prices," from which stems the accusation of "excess" volatility in real prices, is itself constructed from the sort of capital-asset pricing models built by smarmy MBA's and I-bankers, whose entire argument depends on their having arbitrarily chosen discount rates which match reality. And, even if these models are accurate, as I touch upon in my first point, the presence of irrational exuberance in the market emphatically does not disprove the EMH: in order to do so future prices must shown to be systematically predictable to someone holding only past information. This is a proof I have yet to see.

Posted by Nonemoreblack | December 17, 2007 5:42 PM

Sam,

Actually EMH does assume people, on average, to be fully rational, but that is another story.

Markets do indeed tend to yield superior results, except when they don't. Systematic irregularities can and do pop up. For example, when markets begin betting on the "bigger fool" principle, rather than underlying fundamental- the system as a whole predictably tends to go out of whack. In some instances, these are systemic flaws that can be partially mitigated.

I'm uncomfortable with economists (although the best ones tend to avoid this) who fail to acknowledge that market design is a discipline for a reason.

Assuming "the markets will solve it," without reference to the design and structure of those markets, is inadequate- and tends to facilitate political interests more often than economic ends.

Posted by James H | December 17, 2007 5:48 PM

Also, I should note that due to the proximity of the 'This is your brain on drugs' post, I thought that this one was going to be on something else entirely.

Posted by Independent George | December 17, 2007 5:55 PM

dunno Jmo...

If someone tries to hire me away from my current job, I have the same downsides. The catch being that if my compensation were 2667 TIMES AS MUCH, I might be able to afford to have an executive search firm find another job for me, instead of monster.com.

I get no surety of coverage for downsides... and I am in a lot more trouble personally if it goes south.

I don't mind the coverage, actually... What I mind is the conflicts of interest in produces.

Posted by SwissArmyD | December 17, 2007 5:58 PM

Lord, grant me the fortitude to take the "risk" of becoming a CEO; and the strength of character to collect my huge salary and stock-options when I am forced out with a smile and good cheer.

Posted by d | December 17, 2007 6:10 PM

There's also the issue that there are more things that go into the headline compensation than there used to be. Deferred compensation is also used to make compensation seem larger. If they had simply been given the initial value and then invested it, the company would have "only" paid them $1M over x years instead of $200M in one year.

What I really want to know is why 10,000 pounds a year is no longer enough to be the richest man in England! No one needs more than 5 shillings a year to live as a decent merchant!

In other words, stupid filthy communists and socialists should really stop talking and learn how the world works. The whining is really exacerbating.

Posted by Hey | December 17, 2007 6:34 PM

James H. has it right. It's a lost cause, though, trying to persuade McCardle and her fellow travelers. They all rest everything on Fama's academic reputation, but Fama has been losing gorund to the behaviorists.

Fama says:

Well, economists are arrogant people. And because they can’t explain something, it becomes irrational. The way I look at it, there were two crashes in the last century. One turned out to be too small. The ’29 crash was too small; the market went down subsequently. The ’87 crash turned out to be too big; the market went up afterwards. So you have two cases: One was an underreaction; the other was an overreaction. That’s exactly what you’d expect if the market’s efficient.

The word “bubble” drives me nuts. For example, people say “the Internet bubble.” Well, if you go back to that time, most people were saying the Internet was going to revolutionize business, so companies that had a leg up on the Internet were going to become very successful.

And Thaler says:

(Fama) is the only guy on earth who doesn't think there was a bubble in the Nasdaq in 2000.

So Fama tells us there was no bubble in the Nasdaq and Thaler disagrees. Readers of this blog can judge for themselves which of these two seems to have common sense, and which has so fallen in love with the elegance of a mathematical model that he is unwilling to to admit its failings in th real world.

At least Fama is fairly clear about what he believes, though. McCardle seems totally confused. She maintains, with Fama, that markets are efficient and, with Thaler, that the Nasdaq was in a bubble. You can't have it both ways honey. No wonder you want to run to CEO pay.

Anyway, I give up. Adam Smith, Friedrich Hayek and Milton Friedman all argued, persuasively, that markets are very good. Some people like Fama took that good idea to an unreasonable extreme. And naive business school students like McCardle accepted that teaching without question.

Posted by rwe | December 17, 2007 6:36 PM

A few comments:

- The market for CEOs is a closed loop of people who "boost" each other. It is a tight circle where you will often have CEOs/friends sitting on the compensation committees of their friends. Given that the CEOs that sit on these committees have no incentive to have their own salary decrease, they opt for the upside outcome, know that it will come back to them from their other friends who sit on their compensation committees. If we had a requirement for true outside council on these committees, then I don't think we would see as many of these situations.

- Why are there no downsides for these CEOs? There should be situations where there are downsides for outcomes. Stock options were originally created to provide performance enhancements for successful CEOs - now they are tacked on in addition to a huge salary. But these CEO are given pay packages where they win regardless of outcome (Pfizer, Home Depot).

- If CEOs were compensated by outcomes, and hired on the basis of being game changers, then you wouldn't have the former head of Home Depot being hired to run a car company after he had destroyed the stock value of HD.

- The argument that it is like the pay of a movie star is interesting because in Hollywood they have the same issue: namely big time actors take a huge chunk of the backend of a movie while giving up nothing on the front end. They are essentially engaged in a riskless activity (financially speaking). And like Hollywood, this feeds on itself - meaning it is difficult to create a new star if you're only going to sign-up the old stars.

I don't care if a CEO makes a lot of money if they have helped the company grow and prosper, but if the shareholders are being sold out by these no lose situations, I don't see how that is fair - and I don't see true "market" conditions at work.

I guess the problem is that people argue they have to pay people huge amounts based on "market rate" but then they forget about the market when the outcome doesn't favor the CEO.

Posted by dmwr | December 17, 2007 6:43 PM

SwissArmyD: Or think of it this way:

Imagine you are Nokia or Sony and you want to hire the iPhone team away from Apple. What, at a minimum, are you going to have to offer? More money obviously, plus the potential value of all the current and future Apple stock options, plus a risk premium.

Now, if you were the VP of HR at Sony or Nokia how could your recruit the team without offering some sort of guarantee?

I just don't think it's possible for struggling companies to recruit successful executives without offering a golden parachute.

Posted by Jmo | December 17, 2007 7:12 PM

Jmo - I think most people would agree that you need some sort of guarantee to get the top people - but it has clearly gotten excessive.

For instance, Home Depot was hardly a struggling company - Pfizer was not struggling. Yet in both cases the compensation committees granted enormous golden parachutes in addition to the enormous upside potential.

If this is a market, it is an extremely inefficient one.

Posted by dmwr | December 17, 2007 7:27 PM

Rhakesh Khurana at HBS has a pretty good argument in "Searching for a Corporate Savior" that ties together the positional nature and the temporal trends. Basically, we've switched from an internal labor market for management to an external labor market which is driven by the shareholder value movement's demand for "change agents." Since hiring an external CEO is primarily about signaling to investors, and CEO quality is very hard to evaluate, part of the signal is in compensation. No board wants to tell the stock market that it got a bargain on its new CEO. This makes a ratchet mechanism as every new CEO has to be paid above the median, which in turn raises the median.

Posted by Gabriel Rossman | December 17, 2007 7:52 PM

Alternatively the principle-agent problem and reciprocity among those with a common interest mean that those who are in the class of people who serve on boards and vote on executive compensation all fail to rock the boat on higher and higher salaries, on the basis that each has had or will have a turn at the trough.

To paraphrase Hayek: if you're spending other people's money on other people you don't care about price or quality.

Posted by Marcin Tustin | December 17, 2007 8:02 PM

Everyone who has a great point about how greedy CEOs are and how much they are part of a small, exclusive club that acts to set their own pay... stop now.

Your point doesn't matter. It DOESN'T MATTER that the CEOs are greedy. It doesn't matter that they are only paid a fortune because other CEOs are paid.

What matters is: Why has it gone up so much? Are you saying that CEOs were generous and altruistic in the 1950s? Are you honestly believing that the captains of industry in previous generations were not as much of a "boys club" as they are now?

My own suggestion is that in previous generations, there were a lot of hidden benefits to being in upper management that have since been replaced by plain old money. Effective tenure, enourmous expense accounts, "secretaries" who had never learned to type... these were all standard at the top of the tree prior to the 1980s, and when they were phased out, plain old pay was increased to compensate.

Posted by doctorpat | December 17, 2007 9:02 PM

Something that is generally overlooked in CEO pay discussions: data is from SEC proxy statements, which limit exec pay disclosure to the top officers with specified responsibilities by pay.

By design this excludes many of the highest compensated personnel, typically marketing or other key nonexecutive revenue producers. At financial businesses, the CEO is typically not the highest paid individual in any year, and care is taken to make sure the identity and compensation of the highest paid traders or bankers is not disclosed.

When this broader pay universe is taken into account, CEO pay looks far less excessive relative to other top staff than would appear from tabulations of the SEC data alone.

Whether the implication of this is "so CEO pay is in fact a bargain" or "so they're hiding another lot of overpaid piggies" is left to the reader.

Posted by mkl | December 17, 2007 9:40 PM

"The central bank is an institution of the most deadly hostility existing against the Principles and form of our Constitution. I am an Enemy to all banks discounting bills or notes for anything but Coin. If the American People allow private banks to control the issuance of their currency, first by inflation and then by deflation, the banks and corporations that will grow up around them will deprive the People of all their Property until their Children will wake up homeless on the continent their Fathers conquered."-- Thomas Jefferson

coupled with the disintermediation of share ownership fostered by 'Mutual' Funds, Index 'investing', 'Pension' plans, et al., there should be little wonder that: "To paraphrase Hayek: if you're spending other people's money on other people you don't care about price or quality."--Marcin Tustin | December 17, 2007 8:02 PM

Posted by MEH | December 17, 2007 9:41 PM

Over the past 60 years we've seen a huge rise in the pay of CEO's, Actors, and Professional Athletes. What change have we seen for all three groups over that time? The rise of free agency.

In the 30's if MGM wanted to make a movie they looked to the actors they had under contract. They didn't bid against every other studio for the limited pool of talent.

In the 1930's if GM, or US Steel, or United Fruit needed a new President they looked to their current crop of Vice Presidents. They didn't go out and try and hire another CEO.

When the Red Sox traded Babe Ruth, he wasn't able to start a bidding war between all the MLB teams.

With the rise in free agency among all those groups we've seen labor able to grab a much bigger piece of the pie from the owners.

Posted by Jmo | December 17, 2007 9:56 PM

The difference with free agency with sports/film and current CEOs: they have to perform. Actors will work short term - but they will gradually fade. If an actor doesn't draw box office any more, then they get lower in the chain. The problem now is CEO get the money and the next job regardless of performance. The best example is Nardelli (of Home Depot) - he destroys value for shareholders, yet gets a huge payout and then a next job.

Posted by dmwr | December 17, 2007 10:55 PM

Nardelli is a prominent example, though I don't know he's the "best example". He was one of three selected for the horse race at GE to succeed Jack Welch. Given GE's famed culture for grooming management's being selected among the top three indicates that at least Jack Welch and GE's board thought he was qualified to be the CEO.

He failed at Home Depot, though IIRC, the market approved of his hiring at the time.

Now he's running Chrysler on behalf of a Private Equity owner - they clearly don't think he's going to destroy shareholder value since they went out to hire him and he wasn't entrenched management when they got him.

Those who argue the "closed loop" nature of CEO compensation, with cross-holding board seats affirming their own self-worth - what has changed over the past several decades to make the CEO multiple to average employee pay higher? Are boards more incestuous now then they used to be? SarbOx has required more independent directors and better documentation around the process.

Posted by m.jed | December 18, 2007 12:20 AM

3) Being a CEO is riskier than it used to be; executives are more likely to be forced out

Riskier relative to what, exactly? The chance of landing a $20 million golden parachute as opposed to a $200 million one? [Hat tip to commenter "d," above, who said it perfectly.]

If, by risk, you mean the risks borne by the rank-and-file employees who lose their jobs when the CEO screws the pooch, fine. But to characterize the lavish salaries and severance packages bestowed upon CEOs as anything approximating "risk" in all but the most relativistic sense, is an extraordinary act of violence against the English language. The "risk" of a CEO losing his job is one most of us would be more than happy to assume.

Posted by Immoralist | December 18, 2007 12:55 AM

Immoralist - As you know the risk managers at Goldman Sachs, along with a few traders, helped the company hedge its bets by shorting the mortgage market. They earned the company billions!

As the CEO of Merril or Bank of America - how would you recruit those people without offering lavish pay or golden parachutes? I mean, if they already have 10's of millions comming from Goldman - you'd at least have to pay them more than they were making before, right?

Posted by Jmo | December 18, 2007 1:33 AM

Like the Broken Window fallacy, one cannot stamp out the Intrinsic Value fallacy. Afer every refutation, it reappears. Prices do not indicate the "worth" of a good! Price indicates the rationing choices of many people responding to supply and demand! Arghggh!

Also, many cannot grasp the role of demand in setting prices. There aren't many people who can do the work of a CEO. Demand is high, and supply is low, so prices are very high.

This is simple stuff. Duh.

Posted by Jeff | December 18, 2007 3:23 AM

Responding to me, Jmo wrote:

As the CEO of Merril or Bank of America - how would you recruit those people without offering lavish pay or golden parachutes? I mean, if they already have 10's of millions comming from Goldman - you'd at least have to pay them more than they were making before, right?

Sure. I get what you're saying. If you want to recruit someone who's earning $20 million a year at his current job, you need to offer him $25 million as an incentive to get him to work for you. The logic of the marketplace demands it, and who am I to dispute the market's pricing of CEO labor and managerial skill?

If you're looking for someone to argue that the salaries earned by CEOs are "immoral," don't look at me. Immoralists don't care about such things ;-)

All I'm saying is, the only way you can argue that being a CEO is "risky" is by employing a highly relativistic perpective on the meaning of "risk." A CEO who gambles the value of a company and "loses" isn't placing himself at "risk" unless his contract calls for him to forfeit his salary and severance pay if he fails to turn the company around--the managerial equivalent of contingency fees for lawyers (a rare arrangement among CEO pay structures, if I'm not mistaken). Regardless of how the company turns out, the CEO is going to be sitting pretty. There's no risk to him except in the extremely relativistic sense that he might not be hired by another company in the future. But, what's it to him? He's already got his golden parachute. The only thing he's lost is a certain amount of prestige in business circles. Whoop-dee-do.

Jeff:

Also, many cannot grasp the role of demand in setting prices. There aren't many people who can do the work of a CEO. Demand is high, and supply is low, so prices are very high.

That's only because a great number of business majors fool themselves into thinking that only a select number of "charismatic" people can do the type of job that every MBA is trained to do. The only special trait anyone needs to be a CEO is the overweening self-assurance of one's own sense of superior decision-making. Trust me, Megan McArdle herself could probably perform at the same level as the vast majority of CEOs.

Posted by Immoralist | December 18, 2007 4:08 AM

Prices do not indicate the "worth" of a good! Price indicates the rationing choices of many people responding to supply and demand! Arghggh!

What people like you completely, completely fail to understand is that given that it is true that prices "do not" represent the intrinsic worth of a thing, but only many people's responses to supply and demand, there is nothing MORALLY improper about changing the system so that the operations of supply and demand will produce a different result which accords more closely with people's moral sense of what the price should be.

There may be PRACTICAL objections to doing so. But there are no moral ones. You are failing to recognize the difference between "is" and "ought".

Posted by brooksfoe | December 18, 2007 6:25 AM

The right way to lower price is to increase supply. That may only mean convincing boards that the actual supply is larger than they think...

Posted by Larry | December 18, 2007 8:43 AM

Those who argue the "closed loop" nature of CEO compensation, with cross-holding board seats affirming their own self-worth - what has changed over the past several decades to make the CEO multiple to average employee pay higher? Are boards more incestuous now then they used to be? SarbOx has required more independent directors and better documentation around the process.

If we start with the premise that the group of people qualified to be CEO is small (which company boards believe), and that the average CEO pay started out a lot higher (let's say 10x the average worker vs today's 37x), then add compensation consultants, it seems natural to me that you'd have a lot of acceleration in their salaries as they competed for this limited resource. As the pay package of one goes up, the others follow, then, to hire away a CEO, the cost goes up again. Wash, rinse, repeat.

Posted by dmwr | December 18, 2007 8:43 AM

dmwr - So then, you would argue that the factors driving actor salaries and athlete salaries are different than what is driving CEO salaries.

For me, I find it odd that Clark Gable made 50x the average salary per movie in 1940, and George Cloney makes 500x the average salary per move now. If we look at CEO pay we also see that 50x to 500x salary multiple. Something tells me that the same factor is involved. However, it could, I guess, be purely coincidental...

Posted by Jmo | December 18, 2007 8:59 AM

I love the CEO as free-agent athlete comparison; to complete the analogy, I think the problem is that it's free-agency in the pre-Bill James era, where nobody knows what the heck they're paying for, except that they have to pay a lot for it, right NOW!

Skyrocketing CEO salaries doesn't seem to be a problem in and of itself, but the fact that pay seems to be completely unrelated to actual performance can't be a good thing. Not that I have a better idea, but in terms of abilities, there doesn't seem to be a way of separating the good, lucky, and incompetent until after the damage is done.

Posted by Independent George | December 18, 2007 9:01 AM

dmwr - So then, you would argue that the factors driving actor salaries and athlete salaries are different than what is driving CEO salaries.

They are somewhat similar - in that there is a real or perceived limited supply of talent. However, athletes and actors have to perform in order to continue to capture their salaries. CEOs, I would argue, do not.

When the stock of a company can be cut in half and they still get a huge payout, there is something wrong. Now, one could look at, say, the Red Sox taking on a huge salary of a player over a multi-year contract and note that there is a cost to the team if they dump the player to another team, but it isn't a guarantee and they must play for the other team.

Posted by dmwr | December 18, 2007 9:31 AM

dmwr - Daisuke Matsuzaka got a 2million signing bonus and 6 million a year. Isn't a signing bonus the same as a golden parachute just on the front end rather than the back end.

If he totally sucks - he still keeps the 2 million.

Dont' actors (for example) get $10 million and 10% of the gross? So, if the movie is a bomb they still get paid. And, of course, if the movie is a smash they get %10 of the profits.

Also, look at David Beckham - he gets $250 million even though everyone knows he's past his prime and has barely been able to play for the Galaxy.

Actors and Athletes are signing multi year contracts and multi picture deals with the same sort of gurantees as CEO's.

Posted by Jmo | December 18, 2007 9:45 AM

Jmo - agreed - they are similar. A couple of points:

- A signing bonus, structurally, is the same - the dollars get paid. However, they are different from a perception point of view - but they are very similar.

- Actors getting the front end and back end is the same - and studios are increasingly trying to moving away from these deals if possible. I would also argue that these deals go away if an actor no longer performs. A CEO, on the other hand, can crash a company and still get an amazing deal at his next job.

- The Beckham deal was really yet another attempt to jump-start soccer here in the US - so there are other factors at work.

In general, however, I agree with your point. However, there seems to me to be much greater accountability for making large deals that don't work out. So if a GM makes a deal for a player and it doesn't work out, they are on the block along with the player.

The public also cares more about sports than CEOs! :)

Posted by dmwr | December 18, 2007 10:01 AM

I think that there is a lot of cross-pollination between the people who hire and decide CEO salary and those who become CEOs. Not to mention the CEO is the ceiling of salary compensation, so the higher you boost his pay, the higher he can boost your pay. There isn't a decent feedback loop in the market of CEO pay. If I was responsible for hiring my boss, I'd want to boost his salary as well so when I get to that level the bar is set higher in compensation.

Posted by JordanT | December 18, 2007 10:28 AM

I'm highly skeptical of the "free agent" explanation. As an engineer, I'm a free agent. In fact, I've got a number of people who are actively looking for better jobs for me whether I want them to or not. Theoretically, my salary should be skyrocketing.

In fact, I think that a lot of the reason why CEOs get paid a lot has to do with the lack of consequences of failure as mentioned above. As a share holder, I wish that I could hold the board of directors accountable for hiring a CEO for a huge salary with a huge golden parachute. It seems like a serious conflict of interest to pay someone a lot of money even if they fail.

Professional athletes are paid by sports organizations that receive financial support from local municipalities. I'd love to see that stop. They might still get paid as much, but at least the money would all come from people who wanted to watch and not everyone in the city...

Having said that, though, the last thing I want to see is the government start meddling in CEO compensation. Markets may not be perfect, but government regulation is often worse.

EI

Posted by Earnest Iconoclast | December 18, 2007 10:52 AM

Earnest Iconoclast - how long have you been at your present job? The guys I work with who move jobs ever 2-3 years are making 2x as much as the guys who've been here 10 years.

All those offers you are getting are presumably for more. If you took one for 2 years and moved on, you would (I assume) ask for more at each move.

I have one friend who goes job hunting every 2 years. For the past 6 years he's been at the same company. He gets an offer, tries to quit, his company offers to match the new offer, plus 10k, plus work at home 2 days a week, plus 1 week extra vacation etc.

If you were willing to leverage your free agency I think you could make significantly more than you are now. But, you need to ask for the raise when you are irreplaceable on a project, etc. etc.

From what I see, most people really don't care enough to make the effort to move up. I've tried to hire engineers and offer them 50% raises, work from home, etc. They tell me, nah, I'm happy here. They don't even use my offer for leverage during their reviews.

I really don't understand it. But it seems CEO's are just more into money - if people lower down asked for more they would get it. They just don't ask... I really can't understand why.

Posted by Jmo | December 18, 2007 11:15 AM

The only special trait anyone needs to be a CEO is the overweening self-assurance of one's own sense of superior decision-making.

Naw, that's the only trait someone needs to be a commenter on a blog forum. There may be a limited subset of industry where the CEO position is mostly figurehead and button pushing, but in the real world, CEOs generally do carry a lot of responsibility, and a company's long-term success or failure rests upon whether or not that person can effectively integrate into the corporate culture and drive forward risky, but generally good, decisions.

Companies that don't find the right CEO can and do disappear, while companies that do find the right CEO tend to grow steadily over the long term.

Posted by anony-mouse | December 18, 2007 11:19 AM

How about college football coaches? They're hired by university administrators and boards who are distinctly to the left of the American public as a whole. And football coaches don't sit on each other's boards of reagents or compensation committees. And yet salaries are rising very rapidly, and football coaches at top division 1 schools make several times more than university presidents. Seems like a pretty clear case of market wages rather than corruption, doesn't it?

Posted by Slocum | December 18, 2007 12:49 PM

Is the supply of CEO's being outstripped by the demand?

That latter case is pretty hard to make; there are actually slightly fewer public companies listed on the various exchanges than there used to be, and the population has grown rather rapidly.

But not all of those people are very active in the market for CEOs. Is something happening to reduce the supply of people who could be CEOs? Are people being excluded in some way?

Posted by ad | December 18, 2007 1:12 PM

"Contrary to popular belief, CEO's are not driving inequality trends; there are too few of them, and they aren't paid that well."

I'm willing to stipulate the first two points (or at least not take exception to them) but "they aren't paid that well" is laughable. In comparison to whom? Saudi princes?

Sorry, Megan, I've seen the list of people who "aren't paid that well," and CEOs are not on there. They're on the other list, the "paid very well" one.

Posted by Herb | December 18, 2007 3:59 PM

I've seen the list of people who "aren't paid that well," and CEOs are not on there. They're on the other list, the "paid very well" one.

If you're looking at the upper eschlons of the Fortune 500, sure. But there are countless thousands of smaller companies out there, many of them running a business worth only a few million. Is their pay commesurate to the levels of stress, time commitment, and travel that the job typically requires?

I don't know; maybe somebody has done the study. But the basic problem with arguments made in that vein is that the arguer is usually looking at a few dozen people who are essentially the corporate equivalent of a top-grossing rock star, and then making foolish extrapolations that ignore at least two important things:

1. Most CEO positions are not as glamorous as those few.

2. Regarding those few: What is the income-earning value of a person who can keep a very large empire worth as much as $100B, maintaining salaries and benefits for 100,000+ people around the globe plus directly indrectly keeping countless thousands of suppliers and contractors in business (HP, IBM...Intel is getting there IIRC), steered in the right course?

Posted by anony-mouse | December 18, 2007 4:23 PM

Herb:

They are underpaid in comparison to the job alternatives available to best talent.

Posted by Jim Manzi | December 18, 2007 4:26 PM

My explanation is a derivative of #1;

Less-sloped marginal rates of income tax make tournament-structured compensation systems more desirable; CEO pay is now overwhelmingly tournament-structured.

Posted by SamChevre | December 18, 2007 4:49 PM

Taking into account the disparities between the upper-echelon and your average every day CEO...there is still no basis to say that CEOs aren't paid well.

One could argue that most MLB players aren't paid well either, considering that most of them don't make A-Rod type money. And yet the minimum salary in the MLB is over $300K...

In comparison to A-Rod, yeah, that $300K looks pretty paltry. But in comparison to nearly everyone else, including most well-paid professions, $300K looks pretty dang good.

Tell you what, though, show me a company whose CEO isn't one of the most compensated individuals in the organization, and you just might convince me.

Posted by Herb | December 18, 2007 8:08 PM

My CEO makes 1.2M a year and he is a fraking idiot who has actively destroyed company value.

Posted by mickslam | December 19, 2007 4:54 AM

Herb: "In comparison to A-Rod, yeah, that $300K looks pretty paltry. But in comparison to nearly everyone else, including most well-paid professions, $300K looks pretty dang good."

You have to keep in mind that a Dr./Lawyer/MBA/CPA etc. can make 300k for 50 years. While an athlete's career is usually over by 35. Considering how much effort you need to put in to reach that level, the pay kind of sucks.

Posted by Jmo | December 19, 2007 8:43 AM

I've come to the conclusion that being the CEO of a company is an unpleasant experience. Even with all the perqs, it must be no fun. My own job is apparently in high demand as even with job changes, my salary hasn't skyrocketed and it's well known that my employer and it's competitors pay less than some of the other parts of the industry. It's also well known that the jobs in my specific group are more fun for engineers than those higher paying jobs.

But then, if my company fails, I have almost no chance of going to jail or having my picture in the paper as having robbed old ladies and retirees of their pensions. The money they make compensates for that, certainly.

I guess I've changed my mind... CEOs probably aren't grossly overcompensated. I still don't like the golden parachutes that give them no cost for screwing up.

EI

Posted by Earnest Iconoclast | December 19, 2007 10:32 AM

Brooksfoe - Re: "there is nothing MORALLY improper about changing the system so that the operations of supply and demand will produce a different result which accords more closely with people's moral sense of what the price should be.

There may be PRACTICAL objections to doing so. But there are no moral ones."

There certainly are moral objections if the changing of the system, is forced by the government or otherwise isn't a voluntary choice by the people involved in the system.

Posted by Tim Fowler | December 21, 2007 3:15 PM