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CEO compensation: the latest results
Here's the latest:
We analyze the long-run trends in executive compensation using a new panel dataset of top executives in large publicly-held firms from 1936 to 2005, collected from corporate reports. This historic perspective reveals several surprising new facts that conflict with inferences based only on data from the recent decades. First, the median real value of compensation was remarkably flat from the end of World War II to the mid-1970s, even during times of rapid economic expansion and aggregate firm growth. This finding contrasts sharply with the steep upward trajectory of pay over the past thirty years, which coincided with a period of similarly large increases in aggregate firm size. A second surprising finding is that the sensitivity of an executive's wealth to firm performance was not inconsequentially small for most of our sample period. Thus, recent years were not the first time when compensation arrangements served to align managerial incentives with those of shareholders. Taken together, the long-run trends in the level and structure of compensation pose a challenge to several common explanations for the widely-debated surge in executive pay of the past several decades, including changes in firms' size, rent extraction by CEOs, and increases in managerial incentives.
I don't quite think these results are "surprising" any more, though they would have been three years ago. In my view the analytically noxious "cultural factors" are looming larger in the explanation than we used to think. It's become increasingly hard to deny top producers what they, in economic terms, are worth.
Posted by Tyler Cowen on August 11, 2008 at 06:37 AM in Economics | Permalink
Comments
Surely, the pay earned by Wall Street and bank CEOs over the past five years, if nothing else, should make you pause before saying that people at the top are being "paid what they, in econmic terms, are worth." If you want to say, "what board members fantasize they are worth" you might be closer to the truth. And an important part of those fantasies is a radical overestimation of the value of the individual CEO. That's one of the real cultural factors operating here.
Posted by: K. Williams at Aug 11, 2008 6:57:29 AM
> not inconsequentially small
i.e., large enough to merit attention?
"A not unblack dog was chasing a not unsmall rabbit across a not ungreen field." (Orwell)
Posted by: A Tykhyy at Aug 11, 2008 7:21:54 AM
"top producers are paid what they, in economic terms, are worth": When did you discover the independent measure of worth and mind telling us what it is?
Unless you have adopted a new theory of value,, that sentence means that people at the top 'are paid what they are paid.' Or is it that "top producers" has some special meaning?
Posted by: J. Bogart at Aug 11, 2008 9:12:04 AM
Watching Gordon Ramsay's Kitchen Nightmares makes me hesitant to doubt the importance of a good CEO. The only thing that seems to matter at all is the competence of the restaurant owner. Of course, I am generalizing from fictional evidence.
Posted by: josh at Aug 11, 2008 9:15:24 AM
I wonder how much of "it's become increasingly hard to deny top producers what they, in economic terms, are worth" is concentrated in the financial services industry.
I think it may be particularly true in my business of hedge funds. There are the same number of bright, market-beating investors as there were 40 years ago, but 40 years ago they all had to work for a large Wall Street firm. Today it's much easier for them to work for themselves, and reap more of the benefits of their outperformance.
I blogged about this here:
http://investorsconsigliere.typepad.com/the_investors_consigliere/2008/07/thought-question-technology-and-the-explosion-of-hedge-funds.html
Posted by: Nadav Manham at Aug 11, 2008 10:00:58 AM
Sorry, as much as I hesitate to question the market's results, I can't quite agree with the "CEOs are worth a lot" hypothesis. Seriously -- look at the results of the last few years and ask if those clowns -- whose decisions have taken down their companies -- are worth that much. Like Mozilo of Countrywide, who went hog-wild with garbage mortgages and still made millions, or the heads of GM and Ford, who have made huge bets that went worse than sour (bonds maturing in 3 years yield 29%), or all the heads of the major investment houses, like Merryl Lynch, who have come close to bailout territory, or UBS, which is now having to buy back tens of billions of dollars worth of securities from customers.
And Fannie and Freddie of course.
These are the geniuses who are supposed to be getting their customers' savings to be earning returns high enough to be positive after taxes and inflation, but aren't.
And the wage competition from hedge funds? Yeah, let me know how the "hedge funds earn superior returns" hypothesis is working out ...
Posted by: Person at Aug 11, 2008 11:03:01 AM
Let's compare the CEO's salary to top division level managers within the company. I suspect those ratios to be high. CEOs are paid what they are paid because they have successfully taken over the company and as long as they are able to fend of an external takeover they can extract what they want. Really more akin to a hostage situation.
Posted by: The Pragmatist at Aug 11, 2008 11:15:57 AM
I'm joining the rest of the chorus here. What on earth in all
this shows the CEOs are getting paid "what they are worth"? The
larger size of firms resulting from mergers that reduced the
value of the stocks of the acquiring firms (with many of these
pointless acquisitions being driven by CEO ego)?
After all, when did the US economy perform better: from the end
of WW II to the mid-1970s or since then? The answer is during the
first period, when the CEO salaries were not ballooning upwards.
Such ballooning was most definitely not necessary for good performance
of the broader economy (and CEO salaries in Japan during the decades
when they grew even more rapidly remained much lower than in the US).
Posted by: Barkley Rosser at Aug 11, 2008 2:08:15 PM
I wonder if Nadav Manham's hypothesis applies to the "worth what they are paid" argument. The world population has drastically increased over the last 80 years. We expect the number of "smart" people to increase proportionately to the world population, but what if Nadav's hypothesis is right? The number of smart people may still have increased, but the number of people who are successful at being CEOs has stayed the same. Then you would have to conclude that the average pay for CEOs is too high, and the pay for the "best" is way too low.
Its just too hard to determine which CEOs are successfull because one CEO may just have good luck when it comes to moving companies before his bad leadership takes the company down. Therefore, all CEOs are worth as much as the company can afford, to try to ensure they are getting one of the "best". What is this theory called again?
Posted by: brainwarped at Aug 11, 2008 2:49:16 PM
Is Rick Wagoner (GM) earning his money? He took over the biggest company in the world and has nearly driven it to bankruptcy. You would have to go to a homeless shelter, to find someone who could do a worse job running a company.
Posted by: adam at Aug 11, 2008 10:35:23 PM
*Are* managerial incentives, in fact, aligned with those of shareholders? Or do CEOs simply gut long-term productive capability (especially human capital) in order to inflate short-term share prices (and thus game their own bonuses)?
When I think of "top producers" like Bob Nardelli, "Chainsaw Al" Dunlap, and Carly Fiorina, who systematically hollow out enterprises and then collect multi-million bonuses before they move on, I have to laugh.
Nice to know you're into faith-based economics.
Posted by: Kevin Carson at Aug 12, 2008 4:15:47 AM
Everybody that has commented here seem to think that their anecdotal evidence trumps statistical evidence. Sure, anyone can come up with an example of a highly paid CEO who drove his company into the ground. So what? I can come up with just as many (or more) examples of high paid CEOs who have done a tremendous job (see Black & Decker). If high salary is positively correlated with high performance (i.e., economic worth), then in general, CEOs are paid what they are worth. Anecdotal evidence means nothing (or virtually nothing).
Posted by: Paul at Aug 12, 2008 2:56:51 PM
Paul,
Fair enough. So how then do you explain the fact that the
US economy did better during the 1945-mid-1970s period than
since while CEO salaries were basically constant during the
first period and have been soaring ever since?
Posted by: Barkley Rosser at Aug 12, 2008 5:30:58 PM
"the sensitivity of an executive's wealth to firm performance was not inconsequentially small for most of our sample period."
This triple negative just reeks of mealy-mouthedness. Can anyone with access to the paper explain what it means?
Thanks,
Steve
Posted by: Steve Roth at Aug 13, 2008 12:48:51 PM
Paul,
The problem is with how "performance" itself is defined. The metric of "performance" by which compensation is determined, itself, promotes perverse behavior. "Performance" is generally defined as short-term profit, at the expense of long-term hollowing-out of productive capability. The corporate planned economy is driven to irrationality by its metrics in exactly the same way as the old state socialist planned economy in the USSR.
Posted by: Kevin Carson at Aug 15, 2008 4:03:54 AM
If these worthy CEOs are so adept at managing their firms then why are we in an economic crisis? Why are the banks, investment firms, and mortgage companies looking for a federal bailout?
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Posted by: aion kina at Mar 18, 2009 2:05:03 AM
Last August, Paul wrote: "If high salary is positively correlated with high performance (i.e., economic worth), then in general, CEOs are paid what they are worth."
I'd like to see a study demonstrating that such a correlation exists for large corporations in general. The studies I have seen demonstrate the opposite. For example:
http://www.abdwebsite.org/2002proceedings/p_arbogast_grundig_peri.pdf
"The paper looks at the link between CEO pay and above average corporate performance. The evidence and research do not support that there is any substantial link that executive compensation leads to better performance. CEO compensation packages make performance almost a non-issue based on the severance arrangements, “golden parachutes” and other opportunities, and the difficulty of replacing them by the Board."
Posted by: Chris Winter at Apr 5, 2009 12:05:53 PM
Is it the best result?
Posted by: bulce at May 14, 2009 8:40:51 PM
It is enlightening!
Posted by: kate at May 14, 2009 8:41:15 PM
Is it realistic?
Posted by: nick at May 14, 2009 8:41:42 PM
