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Executive pay fact of the day
...while overly generous executive pay may be maddening, it is a drop in the bucket compared to the size of these companies and the impact it has on shareholder prices and employee compensation. The top 50 companies alone have a market capitalization approaching $5 trillion. Limiting CEO pay, as some neopopulists propose would have little to no impact on overall wages or compensation. If every penny of the $14.4 billion earned by the "fortunate 2500" were distributed to all workers, it would amount to only $100 apiece.
That is from The New Rules Economy, a "Third Way" Project, and full of remarkable common sense. Or try this bit:
Corporate profits as a share of both corporate net income and as a share of national income were higher in the 1940s and 1960s. But that, admittedly, is splitting hairs. What they don’t highlight is that in 2001, corporate profits were at one of their lowest points in recent history.
The neat trick is that the authors invert the usual right- vs. left-wing take on living standards: "Yes, living standards are way up, that means we have lots of money to spend on creative social programs." It will make some people want to say "Whoa....living standards aren't up that much..."
Posted by Tyler Cowen on February 20, 2007 at 06:48 AM in Economics | Permalink
Comments
exec pay = penny wise,pound foolish
Posted by: sa at Feb 20, 2007 8:44:17 AM
The neat trick is that the authors invert the usual right- vs. left-wing take on living standards: "Yes, living standards are way up, that means we have lots of money to spend on creative social programs."
Yes, Brad DeLong tried just this rhetorical pirouette a few weeks ago. Shifting the goalposts from "social programs is necessary to alleviate suffering" to "social programs are a cool luxury good we should buy more of because we're wealthy" is something we'll probably see more and more of. It parallels the rhetorical shift over the last few years from "poverty" to "inequality" as the demon of choice on the left.
Posted by: Dave at Feb 20, 2007 9:30:32 AM
In your excerpt, they are picking the largest possible numbers for context. Total market cap? 2500 executives and "all workers"? It sounds like trying to persuade your sister that your allowance might be 100 times higher, but it's nothing compared to the value of your house... and if you gave everybody's sister part of your allowance, they'd only get 10 cents.
So of the share of money the corporations produce that can actually be distributed to workers each year, how big a share do the executives get? If you took the Fortune 2500 and divided their income among employees of the Fortune 500, how much would they get? I suspect still not that much, but at least you'd be comparing apples to apple trees and not the whole forest.
Posted by: Noumenon at Feb 20, 2007 9:36:01 AM
I fail to see the point of the market cap comparison, or of the redistribution calculation. Is this supposed to justify CEO pay?
Suppose an employee were caught stealing $1000 from the company. Would anyone shrug this off because of its negligible impact on the stock price? Of course not. The objection to the excesses of CEO pay is based on the idea that in many cases it is undeserved, unearned, and a consequence of a rigged system which enables the CEO and some others to help themselves to vast sums which wildly exceed their value to the corporation. In other words, it is legalized theft.
Posted by: Bernard Yomtov at Feb 20, 2007 10:46:26 AM
Compensation of the top five corporate executives now average 10% of profits up from 5% 20 yeas ago.
http://canadianlabour.ca/index.php/Corporate_Pay_and_Pr/901
This will effect the stock price and could effect salaries depending on the size or the work force and how many other high paid executives the corporation has.
Posted by: joan at Feb 20, 2007 10:58:13 AM
All other issues aside, a system that creates a small super-rich corporate elite is bad news for a democratic society. The harm that comes from this is a lot greater than just the billions they directly steal.
Posted by: David J. Balan at Feb 20, 2007 11:15:32 AM
If you listen to populist speeches, politicians are saying precisely that CEOs are somehow stealing money from the average worker. John Edwards' "Two Americas" speech said something to the effect of "One America does the work and the other reaps the benefits."
If nothing else, the fact that CEO pay makes up a small percentage blows that liberal claim out of the water.
In general, I would correlate CEO pay and, say, the salary of Peyton Manning. We've kept the same number of companies while our GDP has grown tremendously. It's the same reason that Peyton Manning earns so much more than Joe Montana did in the 80s.
Posted by: Matthew at Feb 20, 2007 11:29:35 AM
Corporate profits as a share of both corporate net income
What distinction is being drawn between "corporate profits" and "corporate net income?"
Posted by: Bernard Yomtov at Feb 20, 2007 12:07:01 PM
"Suppose an employee were caught stealing $1000 from the company. Would anyone shrug this off because of its negligible impact on the stock price?"
Whether or not I shrug it off would depend on the marginal cost of catching that employee or preventing that theft. I'd rather invest in an enterprise that tolerates such thefts and has a 10% return on investment, than in an enterprise that follows a zero-tolerance policy regarding thefts but is running at a net loss.
(Which is not to say, however, that public shaming of underperforming executives doesn't have its place.)
Posted by: jp at Feb 20, 2007 12:08:33 PM
jp,
I wasn't asking about monitoring costs, etc. I asked whether you would shrug it off once the employee was caught.
The argument made in the post is that excess pay doesn't matter because it's small in comparison to some other numbers. I say that's a ridiculous argument.
Posted by: Bernard Yomtov at Feb 20, 2007 12:35:30 PM
Just what we need - politicians and bureaucrats deciding how much people should earn. Isn't that what the Soviet Union tried, with disastrous results? And talk about ripping off the system - it would be difficult to find a more blatant example than John Edwards.
Posted by: Ned at Feb 20, 2007 12:45:38 PM
Bernard -- I see. As the argument is stated, I don't really see the force of it either. I interpret it as going to the broader point that what matters (to most investors, at least) is how well the company is doing. As an investor, I'm interested in the big picture, not whether the CEO is acting like a pig. Maybe the company could do better with a less piggy CEO, but we could conjecture all day long about what tweaks could make the company do better. If the current set-up is bringing an ROI that appears to be founded on real value, then I'm happy regardless of what the CEO makes.*
*Unless of course there are changes in compensation that raise red flags.
Posted by: jp at Feb 20, 2007 12:47:41 PM
It is not inequitable that anyone should earn far more money than someone else. The question is are they really worth it and will it produce the desired results? An entrepreneur who risks their own capital, starts their own company, or takes one from a small, unremarkable outfit to huge scale, deserves large rewards. The same is true for sportsmen, musicians and writers, even where, like a JK Rowling, the power law-driven scale of their success exceeds a reasonable assessment of their talent. That's just luck favouring the brave. Start capping those rewards and you discourage the creative risk takers on which an economy thrives.
CEO pay is different because large corporations are complex combinations of cashflows with huge long-term momentum, where market advantage already exists. The cashflows can be manipulated making it much more difficult to guage whether success will proceed into the future as a result of the CEO's actions. Surely Michael Lewis' Moneyball shows there's always a smarter way. In sum, when hiring and rewarding we should be looking for those who can create cashflows, not those who can appropriate them. The latter are usually a block to innovation and sensible risk-taking.
Posted by: knackeredhack at Feb 20, 2007 1:03:08 PM
Ned,
Just what we need - politicians and bureaucrats deciding how much people should earn.
Actually, that's what we have. What I would like to see is the shareholders - you know, the owners - making the decision.
My principal complaint is with the mechanics of corporate governance which shield top executives from accountability. These include Soviet-style elections for boards, the difficulty of mounting shareholder challenges, the outright restriction on shareholder ability to vote on compensation, the conflicts of interest that give large institutional shareholders an incentive t vote with management rather than in the interests of their clients, etc.
If you are under the impression that corporate governance operates in some sort of wonderful competitive "free market" system you are mistaken.
jp,
I don't fully agree with you. While the average direct effect on shareholders may be relatively small, excessive compensation has other problems. First, averages conceal a lot. Ask a Home Depot shareholder. Second, it often reflects the fact that the board is not doing its job of supervising management. That can be costly lots of ways. Do you need examples? And of course lack of a proper incentive structure can reduce corporate performance as well.
These points all relate to the individual corporartion. I agree with David Balan that there are pernicious social effects as well, especially when the pay is plainly undeserved. In this respect, I actually think the public is somewhat discriminating. The wealth enjoyed by Gates and Buffett, for example, does not seem to draw the kind of negative reaction that some CEO packages do. Dare I suggest that this is because they are seen as having earned it? I think the same applies to athlketes and entertainers, where the link between pay and revenue generation is much clearer.
Posted by: bernard Yomtov at Feb 20, 2007 1:18:30 PM
Bernard -- I agree that high CEO pay may signal other problems or, to put it differently, may be one factor an investor should take into account in determining whether to invest in a given company. I don't consider high pay to be a problem *in itself* for the company and its investors. With respect to the economy/society as a whole, I tend to look on executive pay the same way I look on income inequality: it's only a problem to the extent that it's perceived to be a problem. If it gets under people's skin so much that we're likely to have revolutionary changes imposed, then I would consider CEO pay a problem.
On corporate governance, I think I'm more optimistic than you are that market forces can handle it. There currently appears to be an opening for companies that want to attract investment by enacting "better" charters, bylaws, and policies. For example, Lucian Bebchuk recently got Home Depot to amend its bylaws to require independent-director approval of CEO pay, and a number of high-profile companies have adopted majority-vote provisions for election of directors. Changes of this type can have a lot of unintended consequences and should be viewed more as experiments than as unalloyed improvements. Thus, I think we should let companies that see value in them try them, let other companies take a pass, and see where the money goes.
Posted by: jp at Feb 20, 2007 1:46:42 PM
Should the rate of change of executive pay = the rate of change of non-executive pay?
If not, why not?
Adam
Posted by: Adam at Feb 20, 2007 1:56:01 PM
From the quote in TC's original post: If every penny of the $14.4 billion earned by the "fortunate 2500" were distributed to all workers, it would amount to only $100 apiece.
This is horrible framing. If these executives for some reason managed their companies for free and didn't draw a salary, then their former wages would be given to the shareholders, not the employees. The employees would not be getting an extra $100 a piece, they'd be getting an extra $0 each in the paycheck.
Thus this is not an inequality issue, it is a corporate governance issue, assuming it is an issue at all. Assuming there is something rotten in Denmark then there is a failure of the shareholders to act in their own interest.
I don't pretend to know how to "reform" the situation, but for starters shareholders ought to insist that executives of their corporation be prohibited from serving on the board of directors, unless they held a significant amount of stock themselves.
The board of directors is not there to run the company, that is what the shareholders pay the CEO to do. The board of directors is there to act as a proxy representing the owners of the corporation, and acting as a watchdog over the CEO to make sure he is bright and capable and acting in an honest manner. Thus it is a conflict of interest for the CEO (or other executives) to be on the board and policing himself.
Finally, potential CEO's won't work for a company if they can earn more elsewhere. Ben and Jerry's learned this a decade or so ago when they were forced to abolish their policy of the CEO earning no more than 10x the salary of the lowest paid employee. They simply couldn't get a quality CEO to work at those wages.
There is a market for CEO's. The biggest companies can and do pay more than others because the CEO's salary as a percentage of profits is thus smaller than paying the same CEO x dollars at a smaller competitor.
It is noteworthy that CEO's of the companies that are being bought by the private equity funds are often paid more than in the public company market. This ought to give pause to anyone who thinks that public company CEO pay is thus rigged. In some cases it is likely to be overcompensated, often by a large amount. This also need not be a result of fraud though, often times it is the result of incompetence on the board or mere indifference to the well being of the shareholders. But in other cases they (executives) may well be underpaid and still have the Left screaming Inequality! Theft! Fraud!.
Posted by: happyjuggler0 at Feb 20, 2007 3:16:08 PM
CEOs generally get paid what they and others around them think is "fair" or "what they are worth".
This is just what trade unionists like (for example) Teachers ask for. When teachers ask for it the rightwing response is that "no, you should get the market rate for your labor".
Anyone who thinks you couldn't hire all the competent executives you need with a budget of say 900k a year is living in a dream world.
The only exception is that there is a very small set of uber achievers like Steve Jobs, but most company governance groups wouldn't have the guts to hire such a dangerous choice. It is not a lack of salary but courage.
Posted by: Robb Lutton at Feb 20, 2007 3:31:01 PM
there is a failure of the shareholders to act in their own interest.
Happyjuggler,
The problem is that there are very serious obstacles to shareholders acting in their own interest.These obstacles are financial, legal, institutional, and informational. As to private equity firms, all that proves is that there are some situations and some CEO's that merit very high pay, not that the overall level is justified.
Posted by: Bernard Yomtov at Feb 20, 2007 3:46:08 PM
If someone makes or has more than someone else, that is inequality. That is the definition of inequality. What our tolerance for inequality and whether or not that inequality is fair are the questions at hand.
The latter question has largely been answered, and as a broad question it is not fair. Life is unfair or course, and there are other competing interests that we have.
The main competing interest with regard to this question is productivity. In relation to this, we have agreed to an economic system that provides incentives that, if everything works the way we wish it to, increase overall productivity. It is only within that narrow framework that inequality could be considered 'fair', or compensation 'deserved'.
This is not really that complicated, but I tend to notice a conflation of a general sense of fairness to the narrow sense described above, and it confuses the issue and should at least be recognized for what it is.
As a side note, there are some religious moral frameworks where the accumulation could be 'deserved', but on a deeper level than I think we are talking about in economics (in any scenario that I can think of the deservedness does not derive from any increased economic activity -- both of these things derive from a more deserving soul).
Posted by: theCoach at Feb 20, 2007 3:52:00 PM
"The latter question has largely been answered, and as a broad question it is not fair."
?! I must have been sick the day they taught that in semantic school.
Posted by: josh at Feb 20, 2007 4:06:45 PM
Also, we had real corporate income taxes 50 years ago.
Posted by: SocraticGadfly at Feb 20, 2007 5:01:25 PM
"Corporate profits as a share of both corporate net income and as a share of national income were higher in the 1940s and 1960s."
Wars are a useful way to boost profits.
Posted by: The Tsunami at Feb 20, 2007 5:16:33 PM
jp,
True, you are very much more optimistic than I am. Even if all public companies adopted the reforms you describe, which are hardly revolutionary, we would be a very long way from giving shareholders a reasonable degree of control of their companies.
Posted by: Bernard Yomtov at Feb 20, 2007 5:20:22 PM
Bernard -
I basically agree with your point about corporate governance - it could be a lot better. It does seem to be improving, albeit slowly (Home Depot is a good example). Some sort of legislation to improve "shareholder democracy" might be appropriate. A CEO who turns around a failing company and creates billions of dollars of shareholder value is probably worth a nine figure compensation package (Ford might be a good example here). But all too often, CEO compensation seems to bear no relationship to corporate performance. CEO's are quick to claim credit for success but blame everyone but themselves for failure. Nonetheless, I am very leery of demogogic politicians who rant on about "overpaid CEO's," even though I agree that, yes, some of them are indeed overpaid. The fix they propose, some sort of government regulation of executive pay, is a soviet-type cure that is much worse than the disease. I have much more faith in the free market than the government to ultimately do something about this, and, although advancing shareholder democracy would be a good idea, there never seems to be much talk about it. If the politicians really wanted to do something useful, they would deal with illegal immigration and the loss of our industrial base, which are hammering working class Americans much more severely than overpaid CEO's.
Posted by: Ned at Feb 20, 2007 6:52:31 PM
