Help me understand CEO pay

Great Debates
1

This is somewhat inspired by the many 1% threads.

I’d like to understand more about CEO (and other senior corporate officer) pay at very large multinationals/S&P 500 type companies.

Note: I do not want to discuss “fairness” of CEO pay, just get some factual understanding of its nature.

  1. Are they in fact paid significantly more than in previous eras? There are several ways to measure this.
    Absolute/inflation adjusted terms.
    As often comes up in 1% threads, it could also be viewed as a multiple of the average worker (this is often expressed as “in the 1950s, the average CEO made X times the average worker and now it’s 100X”).
    I’d also be curious if those increased multiples change if you correct for size of the workforce (for example, if the average company now has 10 times as many workers, maybe the CEO pay in relation to the entire company payroll hasn’t changed).

  2. If CEO pay has indeed increased significantly, why the change? Do CEOs suddenly have much more effect on profitability (and therefore it is worth more to buy the very best CEO you can buy)? Are corporate officers of that talent level scarcer than they previously were? Why don’t boards drive harder bargains? If the next best CEO “costs” $10 million less, but only makes your company $5 million less per year, isn’t that worth it? A common suggestion is that CEOs have formed sort of a cartel where they sit on each other’s boards and essentially collude to raise CEO and senior corporate officer pay. While this level of greed and malfeasance seems believable, it also seems like this is a preventable phenomenon.

  3. Is there any research that shows whether boards can really pick (and reward) the very best CEOs anyway? It seems as though there is so much subjectivity, it is crazy to pay someone $50 million if you’re only 50% sure they’ll be better than someone you could get for $500,000.

  4. Certainly most (all?) people would rather make more than less for the same work, but is there research to show how much higher pay packages actually incentivize senior officers to produce? I ask this specifically because, looking at the military, competition to achieve General Officer/Flag Officer rank is intense, yet the comparative financial rewards are significantly less. Comparing only base pay (I know it’s more complicated), a 4-star General makes about 13 times a new E-1 recruit ($17,611 to $227,232 in 2011) – and only 5 times an “average” soldier (an E-6 with 10 years).

Thanks!

2

I’ve wondered this for a long time too.

On the one hand, we read often in the news about CEOs who fail spectacularly, and get fired spectacularly. Maybe they’re truly a minority of the cases and most do the excellent job that they’re being paid for. Or maybe we only hear about the spectacular ones, but in general they are incompetent.

I’d love to hear about real statistics.

3

AFLCIO cites the following statistics:

CEO pay in 1980 in USA: 42 times low level worker’s average pay
CEO pay in 2010 in USA: 343 times low level worker’s average pay (highest in the world)

So this is a recent development and it’s particularly a problem in the US.

Hopefully someone with better google-fu than I can find more cites.

4

I would suggest it’s best to compare CEOs to professional athletes. Is a $10 million athlete 10 times better than $1 million one? Unlikely, but when you can only field one, and your outcomes vary so widely, you come up with justifications to pay a premium for even small differences in perceived quality.

CEO pay also needs to be looked at in two areas. The salary and other guaranteed benefits are the premium just to get the person “on the team” but good CEOs often make more money from stock options and the like. Stock options (which are worthless unless the company’s share price goes up) are an excellent motivator if you want to maximize short-term shareholder value… but they’re not necessarily such a good motivator for long-term company health.

I suspect that CEO pay as a percentage of firm profits/revenues is probably less changed than CEO pay compared to the lowest paid worker, but I’ve never seen anyone crunch the numbers relative to profits or revenues. For publicly traded companies, that data is certainly public knowledge, but it would take work to compile it.

5

That last part is not a factually true statement.

6

Too late to edit, but a couple of pages further down on my Google results is this reportby the Cato Institute. There’s not as much of the historical comparisons, but there are lots of discussions on the present practices and plenty of cites to additional sources for research. I do see 2004 comparisons of pay to sales, market capitalization and profits. If you know of the Cato Institute, you already know that their conclusion will support a free market approach to executive compensation with minimal regulation.

7

I’m not certain, but I would assume that when we see something about “average CEO pay”, that means the average of some subset of CEOs-- probably the CEOs of the Fortune 500 or of the S&P 500. And who is considered a “worker”?

I would also be very interested in seeing exactly how CEO pay is figured, since compensation is going to be from a number of sources (pay, stock, perks, etc.). And when worker pay is calculated, is the value of benefits (health care, etc.) included? This would be especially relevant at Fortune 500 companies, many of which have generous employee benefits as compared to smaller companies.

8

China seems to be an outlier with exceptionally low CEO compensation looking at this data from reuters.
(image) bank ceo compensation by market capitalization

source article

9

Just remember that the CEO position is open to anyone. Even you and me!

If you think you have the required skills, APPLY! There’s no reason to be envious.

Its all about supply and demand. How many people in the work force can handle the job? Not many. And the few people that have the skills for such a position can ask whatever they want for a salary. The company doesn’t have to give it to them, but the the company needs some one they hope can handle a corporation that makes millions or billions of dollars a year. They are looking for a pretty special person and they have to pay up to get one.

Can you imagine to tough calls a CEO is often called on to make? And the hours? These guys are on call 24/7.

10

I can’t quite decide if that last post is serious or parody.

11

Not sure how that relates to what the OP is asking. We are looking for the change over time of the relative pay of CEOs to workers and what caused that change. What you posted is as true today as it was 50 years ago.

12

Because the boards are full of CEOs who sit on each other’s boards. There’s a lot of backscracthing going on here.

13

It’s important to understand what dataset you are talking about when you’re talking about CEO compensation.

Firstly, in many businesses even if there are only a handful of employees and the business is privately held and generates $1-3m in annual revenue, the person running it may be called the “Chief Executive Officer.” In some forms of small incorporation you need to have principal officers and even if the guy never uses the term CEO to describe himself, in a technical sense he may actually be a CEO.

For that reason it must then be recognized there are, in raw numbers, far more CEOs of small companies that no one “on the street” would even think of as a corporation (but are, legally speaking because they have chosen some form of incorporation for their business.)

If you only looked at those CEOs your perception would be that CEO pay isn’t fantastic. Likewise, the Fortune 500 is another subset of companies, and the CEOs of those companies are another subset of the whole, and if you looked only at those CEOs your perception would be that CEOs are fabulously compensated.

Finally there are two other major factors:

  1. Market
  2. Founder-CEOs

The market the Fortune 500 company operates in will often dictate wildly different rates of pay. For example someone running a Fortune 500 company that mostly owns public utilities (many major water, gas, and electric companies are on the Fortune 500) may make less than $10m/annually.

In the high-end banking sector, CEO pay is extremely high, and thus you have to decide what market segment is important when asking these questions, or are all of them? If all of them, is it only important to know the numbers for the Fortune 500? Or are other numbers of interest?

Finally, persons who have founded companies you probably shouldn’t judge their pay the same as the rest. Or even consider it the same as the rest, primarily because the OP is wanting to understand what leads boards to give CEOs x dollars. In a situation like you have at say, Oracle, where Larry Ellison is the founder of the company, his pay is what he wants it to be. He founded the company, he is one of the world’s richest men and a billionaire many times over. He controls a large number of the shares, he isn’t an employee that was hired by the board but rather the guy who started the company itself. Ellison is often at the top or near the top of CEOs, he earned around $80m in compensation in a recent year. That’s direct compensation (in various forms including salary) received from Oracle, it has to be distinguished from whatever number Ellison may have put on his tax forms for the year, as a man worth over $10bn his net worth and income will fluctuate massively based on market conditions so his wealth could literally move up or down overnight by more than his annual compensation at Oracle. But either way, since Ellison and other CEOs like him are not hired employees of boards but rather the guys who started the company and in essence “hired the board”, if you’re interested in understanding compensation boards give to CEOs it would not be instructive to include guys like Ellison.

14

  1. Yes - lots of statistics mentiond above, but keep in mind - the largest part of CEO pay today is bonus pay, especially stock options. Usually this means “we will allow you to buy X shares at $Y per share between these dates”. If Y is below where the stock trades now… instant profit. Not only that, it’s capital gains so Joe Schmoe pays half the income tax that you and I do on wages. The original theory was that it gave the exec incentive to make the stock do well. Pricing it below market value just means free cash. However, the incentive is still there - to ensure that the next few qaurterly numbers, and hence stock price, is up - no matter what it means for the company 10 or 20 years down the road when the exec will have gotten his and gotten out. It also means they can underreport the exec pay at the earlier, lower price for the stock rather than the current market price of the options.

  2. As others mentioned, CEO pay is determined by boards, full of prominent business types. Backscratch is too polite a description - it’s a circle jerk. Everyone supports higher pay because it raises the bar for them too, at the expense of the little guy. There was an author on Daily Show last month who claimed the CEO pay rates over the last decade made the difference between profit and loss for a lot of firms. Why don’t big shots cut back on corporate jets, golf club memberships, Manhattan apartments, and other perks? Because they, the board, get to wallow in it too. Look how much crap Buffet got from guys like Blumberg or Trump for suggesting the wolves go vegetarian and pay the same tax rate as the working (wo)man. That would have been a whole 17% more of their pay.

  1. WHo would sponsor such research? HP, who fired Apothekar after one disasterous year at the helm, and then paid him $25M to go away? ( HP CEO Apotheker fired, replaced by Meg Whitman - Sep. 22, 2011 ) The Wall Street bankers who crashed the entire global financial system and keep their bonuses; and even paid “retention bonuses” while the economy tanked because otherwise, these bankers might quit and only they know how to run the business? The auto or airline executives who have collectively run their businesses into the ground while taking home record salaries? It would be trivial to write performance targets into the pay contracts. The fact they don’t, or rather make them lopsided win-win conditions, says volumes. Anecdotal evidence suggests a dartboard would do a better job. They don’t pay them more because the CEO will produce better, they pay more because that’s the going rate. Unfortunately, unlike star athletes, the performance stats are not so obvious. It descends instead into things like “beating the market” or “every company will lose money in a recession”.
  1. In fact, I think it is counterintuitive; a Steve Jobs may do an execellent job (sorry) but that’s not because you pay him more. It’s because he has the passion, and has the brains to hire an excellent team. I would like to see the research that says that a company succeeds not because they hire a good CEO but mainly because they hire a good team at ground level who can implement the vision. The CEO who succeeds is the one is able to make his vision and drive reach the foot soldiers. As the old saw goes, money isn’t the way to get someone to work, bt it’s a good way to keep score. Most of these guys, it’s as much about power, getting to be top dog as it is about money - just like politicians.

Obligatory ***Dilbert ***-
Wally - “I used to be intimidated by management until I realized they were just morons with good hair…”
Generic manager - “I hope you don’t think that of me…”
Wally - “Oh, no. That looks like a bad toupee from here.”
The truth about management -
Management is not about doing a good job. Management is social politics. A manager makes his way up the ladder by schoozing, as-kissing, and otherwise persuading his fellows and superiors that he can do a good job. Often, that actually involves doing a good job - it’s difficult to be a total moron and succeed. But technical experts who are good CEO’s are few and far between.

The best guy to run your big car repair shop is not the best mechanic, but the guy who can handle manpower scheduling, ensure billing is up to date, stop the mechanics from fighting each other, etc. If he knows something about cars, that is a help but not essential. The best CEO goes to receptions and cocktail parties and schmoozes the guys who can promote him. He knows how to analyze numbers and trends to make good decisions, but most important, he knows how to make the people who promote or hire him feel like he will do a good job. Usually, that’s because he will. Sometimes, it’s because hes a master BS.

15

You have some interesting opinions, but they are not facts.

16

I read this explanation many years ago, not sure where:

Each year, most boards set CEO compensation by looking at a survey of similar companies. They decide whether their CEO is roughly as good, better, or worse than the average CEO, and correspondingly, set next year’s compensation equal to, a bit more, or a bit less than the average for those other companies’ CEOs.

It’s human nature to think the guy you hired is better than average. (The article had figures showing that “better than average” was a far more common evaluation than “worse than average”, but I can’t recall them.) So year after year, the typical board sets their CEO’s compensation to be a little higher than the average compensation for comparable companies. This feedback loop makes the average compensation increase over time.

Note that appropriate compensation would continue to increase in a recession, since most boards will think their CEO handled the challenges better than the average CEO (if not, they’d have replaced him already), and so deserves more than the average compensation.

17

These are intelligent rejoinders. Thank you for your well thought out and informative posts in this thread. Whereas others would have aggressively taken the time to refute specific points or brought facts to bare, you understand that the best defense is a passive aggressive offense.

18

With a CEO it’s even more important to get the “right” guy. Ultimately, what is the difference between Google and Webcrawler, or Dell and (insert any one of a dozen failed PC manufacturers here) or eBay and (insert any one of a dozen failed auction sites here) or Best Buy and Circuit City or Barnes & Noble and Borders?

The difference is the decisions made that guide the company, one guy (or group of execs) decides to go one direction and the company is the biggest thing since Standard Oil. A different guy in a similar company goes a different direction and the company falls apart, to be bought out for 10 cents on the dollar. Boards see that, and are willing to overpay for the “right” guy. As high as CEO pay is, at the Fortune 50 level, they’re still paid something like 1/10th of a % of the company’s revenue. from here If the “right” guy only drives 1% more revenue than your alternative choice, you can pay him twice as much and still make out.

The other aspect is, you’re not going to poach someone from their currently secure position without offering them security in a new position. That means if they suck balls and drive the company into the dirt, they still get a multi million dollar exit package.

Unfortunately, the reality is that they don’t really know who is going to be the next Lou Gerstner and who is going to be the next Carly Fiorina.

19

FWIW, the Baseball Prospectus crew looked at this issue in Baseball Between the Numbers and came to the conclusion that MLB teams were generally overpaying for stars. Sure, you can only have one person playing each position, but the typical added wins created by most superstars didn’t justify their megacontracts, and most teams would be better off with a balanced squad of roleplayers rather than a couple superstars and a fistful of mugs.

What that means to CEO pay…well, if Jonah Keri, Nate Silver, and the rest looked into it, we might learn if the same lesson applies.

20

This is GQ. Opinions cannot be proved or disproved, and I’m not going to waste my time attempting to do so.

If you have a problem with my posts, please feel free to report them to a mod.

Getting back to the OP…

Does anyone have stats on the rising pay of celebrities (movie stars, sports figures, musicians) over a similar time period that we typically see these CEO pay graphs? It would be interesting to see if there is a similar trend, and if so, perhaps there might be a similar reason.