Arnold Kling  

CEO Pay and Market Signals

Energy Diversification... Speaking of Rising Inequality...

Bruce Bartlett writes (from behind the NYTimeSelect firewall, unfortunately),

[Alan] Reynolds has been criticized for making too much of inherent limitations in the data that have been known for many years and for ignoring evidence that conflicts with his thesis. Most economists would probably agree with Gary Burtless of the Brookings Institution...there are too many different sources all showing a rise in income inequality...No matter how you slice it, the distribution of income has become more unequal over the last 20 years or so...

If it were costless to play Robin Hood and take from the rich and give to the poor, it would be hard to oppose. But there are costs. We really don’t want the Gateses of the world sitting around clipping coupons. We want them out there thinking of new products and businesses

I agree with Bartlett that we might as well concede that inequality has increased, and instead focus on the costs and benefits of going after high CEO pay. To me, the cost is the loss of market signal.

Suppose you set a limit on CEO compensation of, say $2 million a year (leaving aside the enforcement challenges that Bartlett highlights in his post). Then, once a CEO has hit the limit, she has no incentive to take a job with a different company. By the same token, if she is incompetent, her Board may hesitate to fire her, because they may have no way of luring anyone else to take her job. If the compensation ceiling works, you'll wind up with a lot more situations where a company is run by the wrong CEO.

Comments and Sharing

COMMENTS (9 to date)
John S. writes:
We really don’t want the Gateses of the world sitting around clipping coupons. We want them out there thinking of new products and businesses

Given the products Gates has been coming up with lately (how many folks had the Zune on their Christmas list?) I think he should go back to clipping coupons.

aaron writes:

I'm more conserned about income class mobility than inequallity. To me, it seems natural that as overall wealth and income increase, there will be more variety in the distribution. Some will settle for less, others will fight for more. When the resources to make the income class jump become prohibitively expensive, then I'll become conserned about equallity (I think we may be headed there).

I also agree with John. Most software now-a-days seems limit your ability to use your computer effectively. It seems more about control than product improvement. Most software is unecessarily complicated. It seems like outside of processing audio and video media, we were able to do much more with less computer in the past.

Boonton writes:

How would you feel about not capping CEO compensation but making it more open to the shareholders. For example, suppose shareholders were entitled to vote for a compensation range (say $25M). The Board could not exceed the range unless shareholders voted their approval.

An exceptional CEO who threatened to leave would easily win shareholder approval but a bad one who happened to be chummy with the board would have a much harder time.

As far as inequality goes I would agree it would increase. Rather than every CEO making $1M the best would easily command hundreds of millions while the worst may just be in the six figure zone. On the other hand if this makes it easier for companies to find and retain the better CEO's and to check the compensation of average or below average ones it makes the economy as a whole richer.

Vince P. writes:

I think Boonton has hit the nail on the head.

The problem is not excessive CEO pay, specifically, but rather that how shareholders of public companies are almost entirely divorced from the setting of compensation, and linking it to performance.

The historical economic struggle has been between Capital and Labor. This is no longer the case, since Labor, through pensions, retirement, and other savings essentially owns a large stake in Capital, especially in publicly traded companies. (Old school Capitalists now use their money in private equity funds like Carlyle Group, Blackstone Group, KBR, etc.)

The current economic struggle is between Labor and Management. Currently in the US, Management has the upper hand because public company board of directors are very insulated from its shareholders. The number one cause of this is because shareholders cannot, by law, vote for the board among a list of shareholder nominated candidates, but instead only vote up or down a list of candidates provided by... the board.

This board insulation is what has lead to CEO pay that is not directly excessive, but entirely unlinked to performance that is satisfactory to shareholder interests.

Randy writes:

I don't see why it would be necessary for a shareholder to vote in the boardroom when he or she can easily vote at the exchange. I suspect that CEO pay generally parallels the price of the stock - and that investors are concerned primarily with the latter.

Lord writes:

Don't make the mistake of assuming there is some finite size of potential CEOs out there. It is undoubtedly several times larger than the market for them.

What a board should do is settle on what the position is worth and then offer it to each of the top several candidates. Selecting the candidate and then determining the worth is the wrong method.

Cyrus writes:

Let the CEO take a share of profits (forward-weighted, if you like, to encourage a longer-term perspective), and post bond against the risk of losses; while this limits management of the largest companies to the already-rich, (i) this is effectively the current situation anyway; and (ii) there are companies of all sizes.

Matt writes:

How bad has a CEO ever honestly screwed up? I tend to believe that there are a lot of people who could succesfully be CEO for just a few million dollars. If they want more, give them pay packages incentivized based on increases in book value, ROE, debt reduction, etc. If someone really earns the money, they deserve it. But if they're CEO of Disney and can barely grow earnings when the market P/E goes from 15 to 30, they shouldn't earn $100s of millions because the stock went up.

Stephen writes:

Interesting hypothetical. Let's see if I remember what I learned in Economics 101: when we set a cap or ceiling below the market-clearing price, we will have a shortage of that good. If we were to cap CEO annual pay at $2 million in a year when investment banks are paying decamillion bonuses, there will be a shortage of qualified people willing to be financial institution chairmen. This is in accord with common sense---many will choose to live off their bulging portfolios rather than put up with the headaches of the job in return for what is to them a relative pittance. But this is more than a mental exercise.

Let's look at public service compensation. The difficulties of running, say, the Defense Department, Health & Human Services, or the State of California are surely (at least) equivalent to the problems of being a CEO of a Fortune 500 company. The fact that the pay is "only" several hundred thousand dollars per year limits the supply of available candidates. Which explains why we have the government that we have today.

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