Responding to my earlier post, Greg Forster writes:
The number of people in the world who are capable of doing a good job running Apple or Exxon or Wal-Mart is extremely small; the consequences of those companies being poorly run would be catastrophic for millions of people; therefore the tiny group of people capable of running those companies well is going to command extreme salaries. This would be true regardless of our economic system, law, policy, or what set of moral values predominated in the culture. . . .
Executive salaries were kept in check during [the post-World War II era] mostly because the executives were much less capable. They weren’t worth paying as much.
I don’t deny that society benefits from having capable CEOs, but the rise in executive pay is due to many factors, not merely to an increase in their productivity or abilities. One such factor is peer benchmarking, which (as the Washington Post explains) started as a way for companies to retain talented executives, but now boosts the pay of just about all executives, regardless of their success:
At Amgen and at the vast majority of large U.S. companies, boards aim to pay their executives at levels equal to or above the median for executives at similar companies.
The idea behind setting executive pay this way, known as “peer benchmarking,” is to keep talented bosses from leaving.
But the practice has long been controversial because, as critics have pointed out, if every company tries to keep up with or exceed the median pay for executives, executive compensation will spiral upward, regardless of performance. Few if any corporate boards consider their executive teams to be below average, so the result has become known as the “Lake Wobegon” effect. . . .
Researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.
The reason board members may be unwilling to stop using peer benchmarking is another factor in CEO pay: board members’ personal relationships with executives. From the same Post article:
On a typical board, the chief executive considers about about 33 percent of the board of directors as “friends” rather than as mere “acquaintances,”according to a survey of chief executives at about 350 S&P 1500 corporations conducted over 15 years by University of Michigan business professor James Westphal.
More tellingly, the chief executive is likely to find even more friends on the compensation committees of corporate boards — almost 50 percent.
Other factors, which Megan McArdle draws from Tim Harford’s book The Logic of Life, may include employee motivation:
Many economists believe that CEO pay is structured as it is not to spur the CEO to ever greater heights of achievement, but rather pour encourager les autres. Michael Eisner might work just as hard for $1 million a year [as he does for $800 million a year] . . . but the gigantic payoff to becoming CEO spurs those beneath him to ever-greater heights of achievement. Basically, Michael Eisner has won the employment lottery. And because the prize is so big, all of his subordinates are dutifully beavering away, vying for a chance at the gravy train.
And shareholders, McArdle continues, are unlikely to object: “As Mr. Harford explains, each shareholder’s contribution to even a truly outlandish CEO pricetag is too small for them to take much interest in holding it down.”
McArdle herself suggests that in addition to those factors, “changes in financial theory, the stock market boom, deregulation, dilution of shareholder interest by changes in the capital markets, even a cultural shift” could have contributed to the rise in executive pay.
And if that rise is not merely the result of executive talent or the natural move of the free market, then we could try to rein in CEOs’ compensation without suffering dire economic consequences.
February 21st, 2013 | 1:23 pm
This is another great post, Anna. Thank you.
I posted on the Forster response a more verbose comment. But, in short, I find the following reason to be myopic:
“The number of people in the world who are capable of doing a good job running Apple or Exxon or Wal-Mart is extremely small”
Most executives are not running the world’s largest companies, yet their compensation still dramatically dwarfs the pay of their staff.
February 21st, 2013 | 1:51 pm
Peer Benchmarking: is that where Garrison Keillor got his idea for Lake Wobegon’s children?
February 21st, 2013 | 2:15 pm
There’s plenty of crudity in how it’s phrased, but this essay does make a couple salient points.
“Hey, I work hard for what I have!” is perfectly true. It’s also insulting… for the exact same reason “Hey, I love my country!” is insulting: It implies that the listener doesn’t. Otherwise there’d be no reason to say it. It implies a bizarre alternate reality where society rewards you purely based on how much effort you exert, rather than according to how well your specific talents fit in with the needs of the marketplace in the particular era and part of the world in which you were born. It implies that the great investment banker makes 10 times more than a great nurse only because the banker works 10 times as hard.
You can reply that if some other field paid more, you’d have just simply switched to it and been equally successful, due to your smarts and determination. You know, like how the smart and determined Michael Jordan was equally successful as a basketball player (six titles, $70 million a year) and baseball player (batted .202 in the minors) and team owner (his Charlotte Bobcats are currently 4-28).
Hmm … wait a second. Man, it’s almost like Michael’s hard work and determination wouldn’t have made him rich if he hadn’t happened to have been born in the one place and one time in human history where a man could get rich throwing a rubber ball through a small metal hoop.
February 21st, 2013 | 3:08 pm
In the NBA, they use leather balls. I see what you mean about crudity.
February 21st, 2013 | 3:29 pm
Peer benchmarking and personal relationships with board members. This is just another flavor of “they do it because they can and get away with it”.
The sense of stigma for what is perceived to be out of bounds compensation in the past included board members and the way that compensation was arrived at for executives. Those social expectations have changed and this is a big factor in how it is done.
February 21st, 2013 | 3:34 pm
Benchmarking is another word for competition. Competing for your talent necessarily means paying more than others are willing to pay. Absolutely nothing wrong with that.
Corporate governance is a problem with no easy solution. One idea is to make board membership a licensed profession. Another is to reserve a seat for a union rep or consumer advocacy group.
I’d point out that part of the problem is that corporate governance is regulated primarily by state law. There’s no better example of a race to the bottom.
February 21st, 2013 | 4:04 pm
@John, you may be interested in this article in the policy journal Democracy on reforming corporate governance—it describes the problems with that race to the bottom. It’s aimed at liberals (the article and the journal), but I think there’s a lot in there that many conservatives could support.
February 22nd, 2013 | 7:05 am
Why doesn’t the article mention just how many execs were talking about, and some names, and just how much these salaries are? (I’m glad Eisner was mentioned. He is one of the more egregious examples for sure.) Are we talking about a million execs, no. How about a hundred thousand? Don’t think so. How about a thousand execs whose pay is way over the top? Perhaps, but that would be a stretch. And of those top execs how many are decent moral men and women who give back to their communities? And how much money are we talking about anyway? I know Eisner some time in the nineties, one year had a total compensation of around 230 million dollars and no one said a thing. I don’t think most of these execs today make any where near that. Most of these people annually salary is on par with the top atheletes. If it’s ok for atheletes why isn’t it ok for executives who run corporations that employ ten’s of thousands of people?
February 22nd, 2013 | 7:10 am
There is a myth that when money is involved professionals take a more measured and rational approach to the tasks and matters before them. The opposite is true. Board members are given to fads, superstitions, and hire consultants for tens of thousands of dollars to sell them reports of new “revelations” which are in fact what the employees had been trying to tell their superiors for a long time. And boards will hire top ranked “power” executives who failed at their previous company.
On the one hand, one can say that, if the leadership in charge of the various institutions want to be fools, let them. But when we look at the incomes of the top leadership and those their employees, even the most libertarian among us knows there is something wrong. When we look at the severance payouts to failed top executives given the boot and note that the payout is more than the company’s employees can ever hope to earn in their lifetimes, something is really wrong.
Government intervention is not the answer; but there must be something we can do.
.
February 22nd, 2013 | 4:50 pm
The fast-paced global competitive marketplace disincentivizes putting down roots that make corporate execs accountable to employees and the community they serve. Knowledge of the company and the market it serves is also more difficult since many come from different areas of the country or from different markets. Such an uprooted lifestyle, disassociated from place, is not preferable to one committed to home, family, and community. But boatloads of cash do much to offset this drawback.
February 23rd, 2013 | 5:45 am
Let’s first talk about peer benchmarking as a means of setting government employee pay.
Whatever the complaints of Anna Williams are about executive pay, she’s not being shaken down for the money on threat of imprisonment as is the case for government employee pay.
Frankly, when I see someone bawling about how much money top executives of S&P 500 companies make I suspect envy is burning in that someone’s heart.
February 24th, 2013 | 7:12 am
Jesus Christ was born in a stable and worked HIS ministry and founded HIS Church without salary and worldly compensations. He walked everywhere (except the one time He rode on an ass into Jerusalem a week before His Passion/crucifixion) His ministry took Him. Any wealthy convert/follower of Jesus during His ministry (Mary Magdalene, Lazarus, Nicodemus and others) disposed of their wealth and used it for Church needs and assisting the poor and needy. Many CEOs probably do not even go to church or synagogue or think twice about the poor and needy unless their personal/corporate public recognition and/or financial gain. Many Ceos (even though corporate executive has become their “state in life” have what God might call superfluous wealth.
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