CEO Salary Justification Season Is Open

By James Kwak

Proxy season is over. Then comes the annual compilation of executive compensation data. Equilar and the Times, for example, reported that the compensation of the median CEO at a large public company was more than $15 million in 2012.

This means that now we are into the season of justifying these stratospheric numbers—and particularly the high rate of growth of those numbers. (2012 median compensation was 16 percent higher than in 2012.) For example, there was Steven Kaplan’s unconvincing attempt to justify high CEO pay by comparing it to . . . high pay among the top 0.1% (see Brad DeLong for a summary).

This ground has been trodden over a million times, and there’s little new that anyone can say about the issue. The common defense of high CEO pay is that it’s a justifiable investment given the market for talent. This is how Robert Shiller put it in Finance and the Good Society (p. 22):

“So it is plausible in turn that the board of Corporation B would offer a really attractive package to lure the CEO—a package that might, say, offer options on the company’s stock potentially worth $30–50 million if he is successful. That amount is not enormous relative to the earnings of a large company. A diligent board . . . might consider a highly qualified, proven CEO worth all of this.”

Let’s pause for a moment to note that “$30–50 million if he is successful” is actually a pretty miserly compensation package by today’s standards. The 2012 median compensation of $15 million reflects the current value of stock and option grants, not their value “if he is successful,” which is much higher. And $15 million is the median annual compensation, not the total for the CEO’s tenure.

Moreover, the standard argument that the market forces you to pay people what they are worth to your company is simply wrong. A very good developer can be worth millions of dollars a year to a software company. But she can’t command that much in salary because there are plenty of almost-just-as-good developers (and probably some just-as-good developers) who will work for, say, $150,000 per year. When you buy anything, you compare its value to that of the next best available alternative. Or, at least, that’s what you’re supposed to do.

How does this work for CEOs? Let’s assume for the moment that there is some potential CEO who, on an expected basis, can make the company worth $100 million more than it is worth under the current CEO. Should you be willing to pay her up to $99 million to work for you? No—because there are probably lots of other people out there who can also make the company worth $100 million more, or at least some large fraction thereof. It’s not the $100 million that matters—it’s $100 million minus the value of the next best available alternative.

Now, you might think that only one person in the whole world—let’s call him Ron Johnson—can increase the value of your company by $100 million, and no one else can come close. But unless Ron already has some deep connection to your company (e.g., Steve Jobs returning to Apple—and even in that case, his success was hard to foresee), you are almost certainly wrong. The marginal impact of a CEO is extremely hard to estimate in advance, and any expected value you come up with will be swamped by the standard deviation. The only honest answer is to say that there are a bunch of people who could probably help your company a lot, and that implies that you should hire the one who will do the job for the least money.

Instead, however, the directors manage to convince themselves that Ron is the only person who can save their company, and saving the company is worth $100 million, so he should get $99 million. They do this by making all sorts of basic errors of thinking, like converting their vague, irrational intuitions into certainties. Then they justify a specific transaction—overpaying Ron—by referring to a conceptual possibility.

Sure, CEOs are important, and some are highly valuable to their companies. But we’re not talking about LeBron James or Leo Messi here—there are a lot of people who can do the same job roughly as well as each other. There’s no reason the rules of ordinary labor markets should be suspended for them.

35 responses to “CEO Salary Justification Season Is Open

  1. Anonyomouse

    This is my field of expertise, and a very large part of todays problem. Starting shortly after the 1971 default on our currency, the unions wanted more money and benifits to continue being Americas physcial engine. By the early 80’s the white collars were all to happy to critize the decision in public, yet support it behind closed doors. And by giving in too the demands of the unions they could also increase the future rate of their own saleries.

  2. Anonyomouse

    In addition, the products being made were being designed to break or require constant maintenance increasing cost and the turnover rate. With a full generation of citizens recieveing far more than they were actually worth, and the need to find yeild for their new found wealth, the last option was to incresae the amount of interest on borrowed to widen the gap on the financialization of the economy.

  3. Anonyomouse

    All this becomes a burdon to the citizens who were not able to land that cushy job with a union or corporation, and has lead to the hyperinflated prices around the world in search of high yielding inwestments. With the failure of politicians (and economists) economic flawed policy’s we come full circle once again to create more flawed policy. Lets just say winnie the pooh has a big clean up ahead of him, once he’s done we can get home from there. Silly browser won’t load properly too, that’s why 3 posts.

  4. I’ve never found the textbook explanation of CEO pay, framed in the context of economic rents, to be all that persuasive. It makes sense for star athletes, not so much for CEOs. The reason CEOs make obscene salaries is that the CEO club is a small and exclusive network – they all sit on each others’ BODs and vote on each others’ comp packages. In effect, they determine their own salaries.

  5. For mature companies the CEO is usually an adroit politician who controls his or her pay by appointing the members of the compensation committee. Amenable consultants are hired to provide cover for the CEO and his or her compensation committee. These practices have been around for a very long time and need to be changed if we ever hope to stop CEO pay from sucking too much value out of the economy.

  6. ” The reason CEOs make obscene salaries is that the CEO club is a small and exclusive network – they all sit on each others’ BODs and vote on each others’ comp packages. In effect, they determine their own salaries.”

    This. It’s really this simple.

  7. US CEO pay is roughly twice as high as CEO pay in other advanced nations. Comparison chart here: http://www.realitybase.org/journal/2009/1/17/two-hypotheses-for-why-us-ceo-pay-is-so-high.html Anyone who thinks US CEO pay is set in a well-working market needs to explain why the US seems to have a shortage of CEO talent compared to other advanced nations.

  8. Anonyomouse

    Not that simple, first you become an A student (meaning you think too much), then you are entitled to what ever it is that makes you so called productive. You practice Reagonomics (non-linear entitlement), retire, boast about how no one took better care of themselves, their finances, or family, then just hide the pain w/(dry powder), give your money to the dealer, and die lonely. Now that’s simple.

  9. I can’t stop laughing at “making them go in opposite directions” – definitely a CEO talent:

    http://rt.com/shows/keiser-report/episode-466-max-keiser-651/

  10. How often has a CEOs salary request been rejected by their board ? I bet it doesn’t happen very often which gives you an idea of how corrupt the system is. Much like 95 percent of major league starting pitchers all pitching a no hitter on the same night .

  11. Very good analysis, but I suspect another dynamic is: If I scratch your back, maybe someone else will scratch my back later.

  12. Moses Herzog

    Well no one can doubt that “These people wouldn’t get where they are in life if they weren’t good at what they do”.

    http://www.alternet.org/story/148629/how_meg_whitman_failed_her_way_to_the_top_at_ebay,_collecting_billions_while_nearly_destroying_the_company

    But really the good thing about Meg Whitman is she finally gave the ONLY real world example of Ronald Reagan’s “trickle down economics”. From Clare O’Connor of Forbes magazine:
    “her failed bid to become Governor of California in November’s midterms, shelling out $177 million overall — $144 million of which was her own money,”

    And nobody but nobody, can say that CEOs aren’t very “efficient” in knowing how to stretch and make the most out of every dollar spent:

    http://californiawatch.org/dailyreport/whitman-lost-payday-was-sweet-many-8567

    From Lance Williams’ article in California Watchdog:
    “Other Whitman payouts were hefty as well. Republican campaign strategist Scott Howell was paid $5.5 million. The corporate jets of ACM Aviation cost $1.1 million. The campaign staff was well compensated: campaign manager Jill Hasner ($948,000); senior adviser Jeff Randle ($550,000); finance director Sara Myers ($439,438); deputy campaign managers W. Todd Cranney ($389,000) and Tucker Bounds ($324,572.)”

    In all, 21 vendors were paid more than $500,000 each. Here they are, from the secretary of state’s office (the numbers again from Lance Williams’ article):

    PAYEE

    AMOUNT

    SMART MEDIA GROUP

    $118,531,201.11

    ARENA COMMUNICATIONS

    $6,188,580.40

    MAJORITY STRATEGIES, INC.

    $5,922,129.82

    SCOTT HOWELL & COMPANY, INC.

    $5,542,231.76

    TOKONI, INC.

    $3,883,353.27

    INTUITIVE TECHNOLOGY SOLUTIONS

    $1,714,399.41

    SJZ, INC.

    $1,387,182.78

    BONAPARTE FILMS, LLC

    $1,329,028.72

    CALIFORNIA BANK & TRUST

    $1,148,388.95

    ACM AVIATION, LLC

    $1,129,902.32

    HSG COMMUNICATIONS, LLC

    $983,243.88

    HASNER, JILLIAN

    $948,218.97

    BELL, MCANDREWS & HILTACHK, LLP

    $931,694.42

    MCLAUGHLIN & ASSOCIATES, INC.

    $886,075.02

    CARDINAL COMMUNICATIONS STRATEGIES, LLC

    $849,467.11

    HILL RESEARCH CONSULTANTS

    $781,751.52

    HUETER AND ASSOCIATES

    $736,932.94

    DG FASTCHANNEL, INC.

    $716,724.63

    BLUESWARM, LLC

    $688,714.87

    ON TARGET FUNDRAISING

    $560,130.67

    RANDLE, JEFF

    $550,000.00
    ———————————————–

    After spending all this money and still losing the Governor’s race, no one can doubt Meg Whitman is a master of public relations and marketing anymore than they could doubt Jamie Dimon has excellent supervision and system safeguards of JP Morgan’s trading desks.

  13. Moses Herzog

    Here’s another good one. I’m lifting verbatim a pretty large chunk of an article by Dina Overland at “fiercehealthpayer.com”
    “WellPoint’s former CEO Angela Braly, who resigned amid strong shareholder scrutiny last August, received a 55 percent raise to earn a total of $20.6 million in 2012.

    Braly was paid a $1.2 million salary, only slighty more than her $1.1 million salary in 2011, and a performance-related bonus of almost $1.4 million. The rest of her earnings came from stock options and awards, adding up to $17.8 million, according to WellPoint’s 2013 proxy statement released Tuesday.

    The former CEO walked away with higher compensation after coming under fire from shareholders and analysts for her management of WellPoint, which ultimately led to her forced resignation from the chief executive post of the second largest insurer.

    Despite being terminated without cause, Braly is receiving a severance package worth twice her yearly salary in addition to her target annual incentive. She also gets a pro-rated retirement bonus, as well as healthcare coverage, financial planning services and outplacement counseling during her severance period.”

    http://www.fiercehealthpayer.com/story/ex-wellpoint-ceo-angela-braly-earns-20m-despite-forced-resignation/2013-04-05

    I guess it’s easy to raise your CEO salary when you jack-up rates 39% for individual’s health care plans, circa April 2010 from Duke Helfand and Walter Hamilton of LA Times:
    “WellPoint Inc. revealed Friday that it boosted its chief executive’s compensation 51% last year, even as the health insurance giant prepared massive rate increases in California that embroiled it in a national controversy over skyrocketing health insurance costs.

    The proposed rate increases of up to 39% in individual policies turned the insurer into a flash point in the healthcare overhaul battle,”

    http://articles.latimes.com/2010/apr/02/business/la-fi-wellpoint3-2010apr03

    Thank God we have wonderful people like Mitt Romney, Paul Ryan, and Jeb Bush fighting to defend these huge conglomerate insurance companies and their “efficient” use of health care resources. It’s frightening to think what life would be like without them, isn’t it?? By the way, if there are any Tea Party J A C K A S S E S out there, or am radio hosts reading this, could any of you IDIOTS tell us where your fictional “death panels” went?? I been looking clear to hell’s creation and I can’t find any.

  14. As an investor, I generally believe that it should be illegal to compensate senior C-level people or board of directors anything at all for large public companies. The reason is that the laws of economics strongly suggest that there are billions of people who would take the job at zero compensation, due to social status and honors alone. Out of those, many thousands would qualify also in terms in skills and work experience, again, because it is such an honor and would allow an impact on history, open any doors in the future, etc. Further, because public companies are widely owned by the American (and foreign) public, any conflict of interest between the principals and the agents that are allowed to develop should be held up to a very strong ethical litmus test and resolved in favor of the principals. Because C-level compensation could be a very significant economic drag on stock returns among the widely owned large corporations, and corruption and rent-seeking are believed to widely occur in this situation (similar to mutual fund managers vs say index funds), it’s better to altogether remove the temptation of conflicts of interest from the picture, and insist on people being proper “public servants” here.

    So basically if you are at high level management in a large public company you should be paid what economics and the public interest suggests, which is zero.

  15. Why worry about those huge compensation packages? If we operated the nation under the same sort of tax policies we used 60 years ago where the marginal rate on huge incomes was over 90%, a ‘Ron Johnson’ could be making $99 million but we could appreciate him as a ‘winner’, rather than being offended by his pay. He might be receiving a pay package of $99 million but he would be giving better than $85 million of it to the betterment of the country…. contributing to charitable causes or paying his taxes. He would still have all his bragging rights but would also be a real financial hero for his contributions to the public good!

    Raising the marginal tax rate on incomes, as they rise, can change our amoral social condition for the better.

  16. Anonyomouse

    He would argue that with that high of a tax rate he would work less so he would pay less in taxes and then you (or the complany), would make less because he is such a proficient worker. So in theory the BOD boosts pay all around to satisify the stake holders and cooks the books to keep the mirage ponzi healthy. Finding ways to tap citizens wealth is a talent which is greatly appriciated in a highly for profit world.

  17. “….Finding ways to tap citizens wealth is a talent which is greatly appriciated in a highly for profit world….”

    We’ll see how easy that continues to be when the IRS and NSA don’t just hand over their “metadata” to the yidsocial…

  18. “A very good developer can be worth millions of dollars a year to a software company. But she can’t command that much in salary because there are plenty of almost-just-as-good developers ”

    Empirical research suggests that this is false: there aren’t plenty of almost-just-as-good developers.

    Good software developers are literally ten times more productive than average developers. The original research by Sackman, Erikson, and Grant in the 60s suggested 25 times more productive, but more recent work suggests it’s more like 10 times. Developer productivity is important, so this is an active area of research: I suggest you read up on it.

    The interesting point (relevant to your post on CEO pay) is that software developer pay scales and management practices do not match this vast productivity difference. This is true even within companies whose main business is software development. If really good software developers are 10 times more productive, and relatively rare, why aren’t they paid vastly more than average developers? The standard reason given is that “Measuring productivity of developers is very hard.” But obviously the difficulty in measuring CEO quality does not stop CEO pay from skyrocketing (likewise pay for financiers, lawyers and specialist doctors).

  19. Moses Herzog

    Anyone want to know why A S S H * L E S like David Gregory of “Meet The Press” are so quick to demonize Glenn Greenwald and Edward Snowden?? Because David Gregory is NOT a journalist. Gregory is a gatekeeper who government officials tell what are “acceptable” government leaks and what are “unacceptable” government leaks. Of course as long as Gregory plays nice with government officials he might get the “acceptable” leaks before others who don’t know how to “play ball”. This cartoon explains it very well:

    http://www.nytimes.com/slideshow/2012/07/08/opinion/sunday/the-strip.html?smid=tw-share#1

  20. Moses Herzog

    The link below is related to the Snowden revelations. I particularly hope/pray the “Associate Professor of Law” at University of Connecticut will read this, along with the good people who regularly read Baselinescenario blog:

    http://digbysblog.blogspot.com.br/2013/07/star-chamber-2013.html

  21. Anonyomouse

    I think Snowden is a misinformation campaign by both the politicians, and the media, his secrets are about as valuable as an open book on 21st century patriotism by the NSA. Our short memory will forget all about him the next time a plane drops out of the sky too quickly.

  22. Whatever happened to that common explanation that used to be so common fifty years ago that obscene salaries of elites are worth it because they WORK SO HARD! Harder of course than any coal miner or farmer. But they used to say it with a straight face.

    And what about the obscenely overpaid public employees like city managers such as Oakland with $275,000 for a job that any bright college grad could do. You could get qualified, trained, conscientious people to do that job for $40,000 easy, and the job is nothing but office management and politics, but the cadre of public officials and overpaid consultants scratch each others backs.

  23. 480 USA citizens are worth a collective total of 2.08 TRILLION.

    They made their money the old-fashioned way – throwing another person getting paid some kind of salary that took into account silicon valley’s impact on cost of living – into the concentration camp of “permanently unemployed”.

    How much was the “manager” of a death camp during WWII paid? And after the war, with the inflow of USA $$ to rebuild, did it work against the re-building efforts to increase the salary by less than 10%? Did fields not get planted, or water not cleaned up, or unexploded ordinance not cleared or Doctors not having medicine to treat the diseases of war-induced poverty – did all that activity of beating swords back into ploughshares not happen because it DEPENDED on a mouseturd setting the salary at 40K so that he can pocket the 230K to support a MEDIA campaign to prove a “religious right” to land in between Egypt and the Persian Empire?

    DELUSIONAL. Sadistic. Nihilistic. When you have TRILLIONS, what scientific basis – MATH formula – is there for STILL PICKING ON ONE MORE PUBLIC SERVANT?

    Not that anyone would ever actually WANT the metadata as proof – but 80% of the 7 billion population are because of BRUTE FORCE impregnation of the female. And it doesn’t end there – ALL her HONEST LABOR $$ is subject to institutional brute force extraction – tax collectors, or mafia protection rackets, take your pick – so that HER money can be used to support a “security apparatus that determines when she goes into the concentration camp of the permanently unemployed JUST WHEN she finally figured out a way to tackle the cancer that is the GIFT of “petrol dollar” economic power – the one foot layer deep – planet wide – of plastic garbage left for “nature” to decompose.

    You are a MONSTER, mouseyturd. 100% brain possessed by INIQUITY monster.

  24. Anonyomouse

    Oh I feel your pain Annie, NOT!

  25. Of course a MONSTER feels nothing….! Doh.

  26. Anonyomouse

    Well here’s to you then, perhaps you believe you are a modern Fanshaw. Good luck to ya in any case.

  27. Annie: I wrote the comment you objected to. I think you objected but I really couldn’t figure out what you were saying. How about simple declarative sentences, setting out logical statements and connections. Would you want to give it another try without the endless sarcasm and denigrations? If that’s even what it was.

    You seemed to be bothered by my mentioning a public official (not servant – master is closer to reality). Oakland is bankrupt but it pays obscene salaries for simple work to corrupt employees. That is just a failing of the way salaries are set in the higher echelons of the public bureaucracy. Not the lower levels. Just the higher echelons where they stroke each other’s inflated expectations.

    Having said that, I am not for one moment suggesting that the public sector is any major contributor to the horrible economic depression we live under. I oppose all of the attacks on the public sector and especially their unions. The reason we are all paying the economic costs of depression is because of rich elites determined to take all of the power and all of the money for their greedy selves. The greed of the rich seems to have no discernible limits. They don’t have enough yet in bloated stocks, interest free loans, taxpayer bailouts, payback of their onerous debts through imposed worldwide austerity programs or capital gains. So they want more in destroying uinions, destroying the post office, destroying the climate, outlawing credit unions and stealing the social security funds and much more.

    And yet, if public bureaucracies and labor unions were not mired in corruption themselves, they would be more robust, more activist and more able to respond to the attacks on them. Just because the rich elites of the world are the source of almost all economic theft and oppression, does not mean that public bureaucracies and unions should get a pass for corruption and bloated salaries.

    Is this more acceptable to you as an explanation? Or are you still going to be obsessed with calling mouseturd, whatever that means to you?

  28. What a pathetic slapper you are – there is NO PLAN to beat the swords back into ploughshares – that is the EVIDENCE I keep presenting that you cannot DENY.

  29. Okay Annie, I give up. I have no idea what you are fulminating about.

  30. http://en.wikipedia.org/wiki/Comcast

    Here’s the thing that all the sturm and drang is obfuscating – the NSA (and the IRS and the FBI and everybody else and their uncle around the planet who are in the HIGH pay grade in “service” to Global War/Drug/Slave Lords,

    the NSA was allowing the choice of WHO to put on the “watch” list based on the recommendation of *someone* inside COMCAST.

    Now COMCAST – anti-union, but all of a sudden, PRO legalizing prostitution in order to – almost LITERALLY – shove their chosen-one candidate’s schlong inside the voter’s mouth (btw, exactly HOW do you give a “full-throat-ed” support with that in your mouth?!).

    The same people, the same company from whom the NSA receives its metadata – what kind of *data*? Eating habits of pro-union, anti-prostitution 50 something female scientists who did NOT commit suicide, as predicted based on CIA’s assertions,

    so NOW that makes her even MORE of a “threat” to their political candidate’s election into a very specific position of total control over tax payer budgets that should to be allotted to stuff like cleaning up the Gowanus and not ending up in the laundry with CIA drug money in the Middle East!?

    How is it possible to follow this web of ABSOLUTE criminality? You PAY Comcast for the internet, and they YOUR tax dollars have ALSO been going – in the BILLIONS – to Comcast from the NSA (or whoever – that’s a secret ledger) because Comcast got paid a certain amount, per person.

    Paying TWICE to be financially wiped out – once for internet service, then, via taxes (Treasury to FRB hand off of “profit”). That’s MORE than JUST CAUSE for fulminating, okay?

    And the FINAL thing to note – the QE printing press? NONE of that FIAT cash is ALLOWED to be given out to Main Street business in the form of a LOAN. That would be *ILLEGAL*.

    Corzine set it all up – the new circle jerk of EMBEZZLEMENT.

    Yeah, legalizing prostitution would bring in the $$ that they assumed the IRS could squeeze out as fines from the Affordable Health Act….

    Crowd source funding to pay Snowden for NAMES should be no problem. The entire Middle Class needs to get their hands on the NAMES – inside Comcast – AND ALL OTHERS, INCLUDING VERIZON, GOOGLE, FACESLAP, etc – metadata *providers*. What was going on was so EVIL, it cannot go on. It just can’t.

    JUST WAR – and I AM talking full on brute killing in one shot force – against having that thing shoved in your mouth by monkey-brain cretins and calling that an “election”…

    Or getting a Union Of Ethical Scientists to take over the MATERIAL WORLD before there is nothing left of it from the FIAT $$ mis-management of REALITY.

    Your choice.

  31. There Will be a balancing and a reckoning, and there will be blood!!!

  32. why a comments to long?

  33. @TonyF – all of a sudden, the steroid-pumped “gizmo-rules” age group is running around in a DELUSIONAL fog reminiscent of 9/12/2001 paranoia. They’re only tough stuff when it comes to CONTROLLING their drugged out women – psychologically, physically, financially. So much taliban-envy….

    I’m not placing my bets on them winning the rumble you think is coming – the whole “there will be blood” thingy….they are happily building their own “smart-phone” controlled concentration camps where a machine will wipe their ass – so if you give them a free e-coupon to a camp already built, considering their off the chart LAZINESS, you will peacefully have herded them into the institutionalized setting they so richly deserve. All *managers*, all the time and on a “secret” internet highway to nowhere – kinda like that Star Trek Episode where Moriarty lives in that flash drive hologram as long as the lights stay on…oooops….

    Truly devolved into a pure animal state, with a 50 word vocabulary – no COURAGE to speak of, much less any cerebral cortex activity that can solve the REAL problems of sustainable life-maintenance.

    Look at how it’s bubbling in as Prima Facie evidence – that pilot in training that crashed the 777 in SF NEVER LOOKED OUT THE WINDOW because he was such a gadget-dependent retard…more to come…

    FEMEN might need to bump up their target date for a world takeover :-)

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