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Thursday, April 12, 2007

The false problem of high CEO pay 


I am something of a partisan for high pay for public company CEOs. I report to one now and have been one in the past. I am familiar by personal experience with the processes by which board compensation committees determine the pay of the CEO and his or her senior lieutenants. I know that private companies -- which have extremely self-interested stockholders in direct control -- pay comparable CEOs even more money than public companies, which fact causes me to believe that recent increases in CEO pay have more to do with legitimate competition for talent than some structural flaw in American corporate governance. I also know from personal experience that the job is so complex, multi-dimensional, and demanding that very few people can even make a credible argument that they are able to do it. If you haven't sat in that chair, acting as CEO looks a lot easier than it is. In this regard, it is exactly like professional sports. However straightforward basketball or baseball may appear to the fans, very few people are in fact good enough to play in the NBA or Major League Baseball. Naturally, an executive who is able to perform at the corresponding level is going to demand very stiff terms before signing his multiyear contract.

With that tedious disclosure of my biases, read Megan McArdle's excellent argument that high CEO pay is simply not a problem, whatever its justice or injustice in the abstract.

CWCID: Glenn Reynolds.


5 Comments:

By Blogger Christopher Chambers, at Thu Apr 12, 12:41:00 PM:

I'm sure the single mom who just got laid off from wherever so someone can get a bonus, curry favor with a Communist Chinese gangster who'sbuilding a new plant in Hunan, would beg to differ. They vote. Count on it...  

By Blogger Escort81, at Thu Apr 12, 10:22:00 PM:

I agree that it is very difficult to be a good CEO, and that the people who are successful at that position deserve to be very well compensated. The methods and timing of compensation, and the extent to which the overall compensation package is highly correlated with a sustained increase in shareholder wealth are the proverbial devil in the details.

I read the link in the post (which seems to be authored by Jane Galt and not Megan McArdle), and she makes some interesting arguments. The point about Wagoner's Yahoo package is a good illustration of how the timing of option exercise can make for awkward moments -- he exercised a huge dollar number in a year the company's P&L was in the red. Any way you slice it, nearly a quarter of a billion is a big number for one person working for a company with a $40B market cap.

I have always had a problem with the sports comparison, because that's really the entertainment business, which is star-driven, and it is relatively easier to measure what economists term "marginal revenue product" -- in this case, the extent to which a particualr employee adds incrementally to the topline. People came to see Michael Jordan play -- one could make an argument that he was underpaid.

I have also always wondered about pay differential. I don't mean the pay differential between the CEO and the lowest paid employee -- Ben & Jerry's tried to enforce that ratio and couldn't find the right talent at the right price (and is now part of a huge conglomerate) -- I mean the differential between the CEO and his direct reports. (That should warm the cockles of TH's heart.) CEOs of larger companies (say, over a $5B market cap) tend to be less involved in the detail of all operations simply because of the sheer scale of the company. Much of the real value-add is done by the number twos or operating managers of business units, while the lead person gives speeches, deals with Wall Street, meets with the largest customers and looks at the big picture (just like Dr. Evil and Number Two!).  

By Blogger Escort81, at Fri Apr 13, 03:50:00 PM:

The notable thing about CC's comment above is that it nicely illustrates that progressives are much less willing to carry water for the PRC than was the case a generation ago with respect to the former USSR (in theory, both are/were based on Marxist doctrine). Is that because of Tibet, or because of the PRC's unique way of adopting certain capatilistic tendencies, or a host of other factors?  

By Anonymous Anonymous, at Fri Apr 13, 05:30:00 PM:

TH you are on the mark with respect to what the average person does not understand about the CEO job anymore. For instance, each CEO has to sign his name to the integrity of the financial results he is reporting. In doing this he must know inside and out all the particulars drivers of a his business irrespective of size. Within that knowledge he has to be absolutely certain that the people working for him are honest and will not cut any corners. Because if they do cut corners in order to potentially get their bonus, he can go to jail. That is one of the main reasons why CFO's are becoming almost exstinct - they cannot find or build staffs competent enough to live under such unbelievable scrutiny.

So the question must be posed - would the average guy sign up for a job that would pay him $5 - $10 million/year knowing that if the numbers are not right he will spend $10 million defending himself and then potentially wear an Orange suit and spend 10 - 20 years in the Federal Pen?

While the privately held company CEO can make that much money and have a significant stake in the equity of the business. With the added benefit of not having the burdens of being a public concern and not have such worries of reporting faulty earnings? Maybe the question should be are these guys making enough..?  

By Blogger Escort81, at Fri Apr 13, 09:08:00 PM:

5:30 PM Anon -

You are right that the SOX regs certainly raise the stakes in the game personally for the officers signing off on the financials for public company, but fraud is still a very hard crime to get a conviction on. The prosecutors couldn't even get Tyco's Kozlowski on the first go 'round (noting that that is pre-SOX). I haven't heard of anyone going to jail (yet) under SOX for incompetence or honest error in putting out bad numbers in a public company. The plaintiff's bar might roast them, but not the feds. The thing about SOX is the high cost of compliance. Every officer and director of a public company with a market cap below a few billion has to ask themselves if it's worth it -- and perhaps it is if they think they'll be bigger soon.  

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