Two hypotheses for why US CEO pay is so high
Saturday, January 17, 2009 at 02:56PM
Skeptic in Economics, Executive pay

Average CEO compensation in the US is more than twice the average of other advanced countries and is 56% higher than second place Switzerland.

Also, the ratio of CEO compensation to the compensation of manufacturing production workers, at 39:1, is almost twice the average of the other advanced countries.

The usual defense of high US CEO pay is that it is set by market forces. If that's true, doesn't that mean the US has a relative shortage of CEO talent compared to the other advanced countries? (A short supply of qualified candidates has driven up prices more in the US than in other countries.)  On the other hand, if US CEO talent is relatively as abundant as in other countries, doesn't that mean the US CEO pay market has failed and should be fixed to eliminate inefficiencies?

Update on Wednesday, January 28, 2009 at 10:24AM by Registered CommenterSkeptic

This post is meant to show that the US CEO pay market is probably broken.  That doesn't mean I have any enthusiasm for government capping CEO pay.  Why?  Because I think excessive CEO pay is a symptom of a larger corporate governance problem, I don't want to be distracted by palliative care for a symptom.  Let's get at the core problem, whatever it is.  There's been a discussion about CEO pay on Mark Thoma's blog, and my most extensive of several comments is here.

Update on Tuesday, April 28, 2009 at 09:38AM by Registered CommenterSkeptic

This post says "obscene Wall Street salaries are proof of market failure."

Update on Thursday, July 9, 2009 at 08:41AM by Registered CommenterSkeptic

Researchers at UPa suggest much of the difference between US and European pay is explained by the fact that US CEOs receive a greater portion of their pay in risky equity-based compensation.

Update on Thursday, December 31, 2009 at 09:05AM by Registered CommenterSkeptic

Peter Drucker had some views about executive pay, as Mike Hiltzik reminds us in this remembrance in the year Drucker would have become 100 years old.

Real leaders, Drucker observed, are leaders of teams showing respect for people and their work. Nothing destroys that as efficiently as excessive CEO compensation. He maintained that the appropriate pay range was 20 to 25 times what the rank and file earned -- it's now in the hundreds. That level of inequality foments disillusionment among mid-level managers, as he said in a 2004 Fortune interview, and corrodes mutual trust between the enterprise and society.

Excessive compensation, he wrote in 1974, is designed to create status rather than income. "It can only lead to political measures that, while doing no one any good, can seriously harm society, economy, and the manager as well."

The average hourly wage of production workers was about $18.50 in 2009, according to BLS, or about $38,500 per year.  Drucker's 20-25 rule of thumb factor would suggest an approrpriate CEO salary of $770,000 to $963,000 per year. 

Update on Sunday, September 23, 2012 at 01:41PM by Registered CommenterSkeptic

Since I wrote this post, I have learned how hard it is, at least for me, to convey sarcasm, irony, and other subtleties in a blog post.  So let me assert straight out that, yes, I do believe the US CEO pay market is so broken/captured that it really does not deserve to be called a market. Gretchen Morgenson discusses today in NYT a recent study containing data that demolishes the canard that we have to pay our CEO excessively or s/he'll defect.  This study by Charles M. Elson and Craig K. Ferrere investigated whether CEO's have transferrable skills and found that--

C.E.O. skills are very firm-specific. C.E.O.'s don't move very often, but when they do, they're flops.  

I would point out that the study doesn't address the labor market for other C-Suite and lesser officers, where it is possible, I assume, there are some fair markets.  

UPDATE 9/26/12: Posting on the Harvard Law School Forum on Corporate Governance and Financial Regulation, one of the authors says the source of the problem is neither broken markets nor captured boards but is the practice of peer grouping.  

In the paper, Executive Superstars, Peer Groups and Over-Compensation — Cause, Effect and Solution, which was recently made publicly available on SSRN, we develop a pragmatic approach to understanding the run-up in CEO compensation over the past several decades. Rather than looking to markets or captured boards for the explanation, we argue that the actual mechanical process of peer benchmarking by which pay is set is the cause of the present controversy. From this perspective, we present what we believe will be an effective solution; additionally and collaterally, some interesting lessons about executive recruitment, particularly the CEO “superstar” culture, may be gleaned from our findings. We thank the Investor Responsibility Research Center Institute, which has long funded compensation research, for their financial support and helpful assistance in the development of this paper.

The piece makes a contribution to the executive compensation literature as it offers a novel explanation for the perpetual rise in CEO pay and suggests a significantly different solution to the compensation controversy. As boards have typically looked outside the organization to set CEO pay, we argue that this approach, known as “peer grouping,” is seriously flawed as it relies on the notion of an easy transferability of executive talent which empirically, is incorrect. Therefore, boards should look within the organization itself rather than to external comparators to create an appropriate CEO pay structure. We suggest that this approach should begin to resolve the CEO compensation problem.

Click here to read the complete post . . . 

After reading the post, I would say that peer grouping is shown to be the specific way in which boards are captured, not that they are not captured. Worth reading.  

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