Why Are US CEOs so Grossly Overpaid?

[Fotheringay-Phipps]

My assumption that they are is based on the fact that by comparison with European and Asian CEOs, they are paid significantly more, for performing what are presumably the same functions.

I would guess that at least part of the problem is that the boards of these companies makes these decisions, playing with other people’s money, and also because a large portion of their compensation is in the form of stock options, which are effectively the same as a tax on the shares of current shareholders (since their value becomes diluted) but which are not nearly as blatant as direct payouts.

But I also think a big portion of it is that people in America, including but not limited to members of the boards of directors of corporations, have a tendency to focus on the actions of a few key players at the expense of the unseen masses, and to attribute the success or failure of massive enterprises to these few individuals.

When considering history, there are competing schools of thought - one school is the Great Man school of history, which looks at historical events as being the work of a relative few outstanding individuals who shaped the course of history by their outsize impact. The other school (I’m not sure of the name, if it has one) tends to look at historical events as being shaped by millions of individual factors, forces, and people, which combine to produce the circumstances in which a few more outstanding individuals are thrust into pivotal roles. ISTM that the cultural attitudes in the US are very much in the first camp.

This manifests itself in many ways. You have many pop-culture (movies, books etc.) depictions of great events boiling down to the impact of one hero, a tendency to view key politicians (presidents, governors) as being fully responsible for the success or failure in matters over which they have relatively little impact, a tendency to attribute all the problems in foreign countries to the specific tyrant that heads it (Duvalier, Marcos, Hussein et al), even the inordinate focus on the person of Osama bin Ladin, and so on.

And so it is with corporations. There are many factors that determine the success and failure of corporations, and the specific guy running the company is one small part of it. General economic conditions, legal changes, currency fluctuations, technological developments, commodity prices and other factors have a huge impact on the corporation, but there’s little a CEO can do about them. (And even when the CEO has an impact, it’s by having other people do the actual work. If a CEO manages to get his employees to work harder and more productively, the success of the company is based on the hard work and productivity of the employees much more than the encouragement of the CEO.) But yet, you frequently see people attributing the entire success of the company to the CEO and justifying his compensation on these grounds (“so-and-so raised the stock price/profit for his company by $2 billion, so the $400 million that he was paid is well worth it”).

(Along the same lines, a far too great emphasis is placed on managers and head coaches of sports teams IMHO, and they are given far too much credit when their teams do well, and far too much blame when they don’t.)

For this reason, I think some of the proposed solutions to the problem miss the point (or at least this part of it). Many of the solutions involve giving shareholders greater influence over pay decisions, but the shareholders, who presumably hold largely the same attitudes as everyone else, are also apt to attribute too much of the company’s performance to senior leadership, and thus over-reward good performance and under-reward bad performance. Similarly, proposals to tie CEO pay more closely to company performance miss the mark for the same reasons.

If the most brilliant CEO took over control of one of the US automakers, they are not going to be able to turn things around anytime soon, because they face structural problems that are beyond the ability of a CEO to eliminate, no matter how well he functions, and if you give the dumbest fool the top job at Home Depot, he will “produce” dramatic results once the economy turns around and homebuilding picks up again.

So what is the answer? I have no idea.

[Voyager]

Dan Ariely had an interesting explanation in Predictably Irrational. A few years ago they started requiring that CEO compensation be published, which was supposed to shame them into keeping it in rational territory. What it actually did was create a competition between CEOs for who got paid the most. CEO A went to his board and said that he was doing a better job than CEO B, and it was shameful that he was being paid less. Since boards likely will have a hard time disagreeing, this boosted compensation.

There are plenty of other explanations of how they get away with it, but this is a reasonable basis without crying greed and evil.

[Algher]

Early 90s CEO comp (and all others from the Top 5) was put into a simple table in the Def-14A proxy filing with the SEC. This added visibility, and allowed for easier comparisons of exec pay levels. I have posted in similar threads that I made a good living writing exec comp plans during that time.

Second factor - Congress decided to eliminate the tax deduction for CEO SALARY when above $1 million, but it was OK for performance based plans. Companies started looking towards more variable pay.

Third Factor - Boards started wanted CEOs to have “skin in the game,” and started looking for more stock based pay. Some firms went so far as to REQUIRE that a CEO hold a number of shares equal to a multiple of their salary (4x to 10x).

Fourth Factor - Stock Options became REALLY popular, and had NO cost impact (only a dilution impact). CEOs started getting option packages, which were then combined with a great stock market.

Fifth Factor - stupid media. The media would not report on the option GRANTS, they would report on the option EXERCISES. So I could get options every year, then exercise all of them in one year. The media would report my gains just from that exercise, even if the options were from 9 years ago. Those numbers confused the general public.

[Chimera]

Same reason California is going under, same reason national debts in the Democratic West are absurd, same reason Congress just gave itself a raise.

When people have the ability to vote themselves free money, they will.

[Labrador_Deceiver]

@Chimera

Same reason California is going under, same reason national debts in the Democratic West are absurd, same reason Congress just gave itself a raise.

When people have the ability to vote themselves free money, they will.

How, exactly, does a CEO vote himself more money?

[ITR_champion]

I’m largely in agreement with what Chimera said. Those at the top of the corporate food chain gives themselves huge sums of money because they can. The concepts of propriety, modesty, and shame simply don’t exist in the world of corporate executives. As for why American CEOs earn more than those in Europe or Japan, it may simply be because American corporations are bigger.

[Labrador_Deceiver]

@ITR_champion

I’m largely in agreement with what Chimera said. Those at the top of the corporate food chain gives themselves huge sums of money because they can.

Again, how does a CEO give him or herself more money?

[Chimera]

@Labrador_Deceiver

How, exactly, does a CEO vote himself more money?

Most of those folks are also Chairman of the Board.

Or they sit on the boards of other companies, the Executives of which sit on THEIR board. Incestuous relationship all around. You give me 12 buckets of money and I’ll do the same for you. You vote me down and I’ll remember it when you’re asking for money.
I always say that companies have two definitions of “competetive” when it comes to wages. When they refer to competetive wages for you and me, it lies in competing to pay us as little as possible and still be able to fill the position. When it comes to Executive Compensation, it’s a competition to get as much as possible.

[Ruminator]

@ITR_champion

The concepts of propriety, modesty, and shame simply don’t exist in the world of corporate executives.

The implied sainthood of the poor always amuse me.

Corporate big wigs do not have exclusive monopoly on propriety, modesty & shame. Trailer park residents and middle-class suburbanites are all looking out for themselves. Let’s get real here.

If CEOs are grossly overpaid, that means everyone in the chain all the way down to the line worker is overpaid. Nobody holds a gun to anyone’s head to force a particular salary. Salaries are negotiated and can be refused by the employer or employee.

[Mighty_Mouse]

In all three large publicly traded companies I have worked for, the compensation committee, and indeed the entire board of directors are in the pocket of the CEO. There is all kinds of self dealing going on, with the company enriching the BOD (outside of the direct remuneration) and the BOD enriching the CEO. At least in the US, it is practically impossible for the shareholders to unseat a single board member that enjoys the support of the CEO, never mind make enough changes to hold them accountable in any meaningful way.

One of the CEOs in questions is actually in prison, but for financial fraud, basically misstating the accounts. Of course the reason he did that was to inflate the stock price, and hence the value of his options and stock holdings. Once the board met to give him a huge (hundreds of millions) loan, and at the same meeting various members of the board were given millions in “goodies” by the company. All this apparently was perfectly legal, or at least quite safe from prosecution or proof.

In my personal experience with publicly traded Indian and Chinese (really Hong Kong/Singapore/Taiwan-based) companies, there are all kinds of ways for the controlling families to reward themselves in ways that are simply not reported as compensation. Family members will usually own private firms that do business with the public company on very advantageous terms. Disclosure requirement in the US are actually quite high by Asian standards. Self dealing is more the rule than the exception in some markets.

[Labrador_Deceiver]

@Chimera

Most of those folks are also Chairman of the Board.

Or they sit on the boards of other companies, the Executives of which sit on THEIR board. Incestuous relationship all around. You give me 12 buckets of money and I’ll do the same for you. You vote me down and I’ll remember it when you’re asking for money.

I doubt it seriously. As CEO’s salaries have gone up, more companies have moved to independent chairmen. I think Algher’s post is a much more accurate portrayal of what is going on in the real world.

[Mighty_Mouse]

@Ruminator

The implied sainthood of the poor always amuse me.

Corporate big wigs do not have exclusive monopoly on propriety, modesty & shame. Trailer park residents and middle-class suburbanites are all looking out for themselves. Let’s get real here.

If CEOs are grossly overpaid, that means everyone in the chain all the way down to the line worker is overpaid. Nobody holds a gun to anyone’s head to force a particular salary. Salaries are negotiated and can be refused by the employer or employee.

Not in the case of a CEO. The shareholders do not have effective control of a corporation. The only way to replace the CEO is to pay him even more mind-boggling sums to go away. In case of a hostile take-over, the severance packages are usually even richer.

The CEO can use the company’s money to bribe the BOD to increase his salary. At BEST it is a gigantic game of “I’ll scratch your back, and you scratch mine.”

No such opportunities are available to the trailer park resident or middle-class suburbanite.

[Labrador_Deceiver]

@Mighty_Mouse

Not in the case of a CEO. The shareholders do not have effective control of a corporation. The only way to replace the CEO is to pay him even more mind-boggling sums to go away. In case of a hostile take-over, the severance packages are usually even richer.

The CEO can use the company’s money to bribe the BOD to increase his salary. At BEST it is a gigantic game of “I’ll scratch your back, and you scratch mine.”

No such opportunities are available to the trailer park resident or middle-class suburbanite.

What you say may be true in some instances, but it is far from universal. There are many companies where the CEO & Board are at each others’ throats.

[Robot_Arm]

@Chimera

Most of those folks are also Chairman of the Board.

Or they sit on the boards of other companies, the Executives of which sit on THEIR board. Incestuous relationship all around. You give me 12 buckets of money and I’ll do the same for you. You vote me down and I’ll remember it when you’re asking for money.

Even if there’s not a direct quid pro quo, Dan Ariely’s theory (as conveyed in Voyager’s post) comes in to play. A board member of one company can vote to increase the CEO’s salary, and (if he is also a CEO at a different company) use that number to convince his own board that his salary must rise to stay competitive.

Perhaps there is an operational way to look at this question. If free enterprise is a system of competing interests, in whose interest is it to keep CEO’s salaries low? Probably the shareholders. What prevents them from getting it done?

[Whack-a-Mole]

@Robot_Arm

Perhaps there is an operational way to look at this question. If free enterprise is a system of competing interests, in whose interest is it to keep CEO’s salaries low? Probably the shareholders. What prevents them from getting it done?

I think it is because most shares are diluted across a great many people while some significant percentage is in the hands of a relative few. These relative few tend to call the shots. Moreso since I think the majority of shareholders either have no direct say (their shares are in a fund so the fund controls the votes those shares get) or people can’t be arsed to do their homework and give up their votes to a proxy.

In the end there is no convenient way for the one million (or whatever) shareholders to communicate and study options and vote as a unified block to overcome entrenched interests.

[ITR_champion]

There was an article in The New Yorker a few weeks ago looking at why boards have not been able to reign in obscene executive salaries. While the incestuous relationships among companies is a problem, the bigger problem is simply time. Board members are busy people. A typical one is sitting on the board for multiple companies while also working a full-time job elsewhere plus probably writing a book, teaching a college course and also squeezing in trips to exclusive beach resorts in the the Bahamas or sports lodges in Alaska. Given that schedule, the board members don’t want to wage prolonged fights about executive compensation (or anything else); it’s so much easier to just rubber stamp whatever the CEO wants.

[Algher]

@Chimera

Most of those folks are also Chairman of the Board.

Or they sit on the boards of other companies, the Executives of which sit on THEIR board. Incestuous relationship all around. You give me 12 buckets of money and I’ll do the same for you. You vote me down and I’ll remember it when you’re asking for money.
I always say that companies have two definitions of “competetive” when it comes to wages. When they refer to competetive wages for you and me, it lies in competing to pay us as little as possible and still be able to fill the position. When it comes to Executive Compensation, it’s a competition to get as much as possible.

Interlocks are reported to the SEC, and are not that common. The comp committee is outside directors, using a comp consulting firm. You do NOT find a CEOs voting each other raises.

[Crawlspace]

@Ruminator

The implied sainthood of the poor always amuse me.

Corporate big wigs do not have exclusive monopoly on propriety, modesty & shame. Trailer park residents and middle-class suburbanites are all looking out for themselves. Let’s get real here.

If CEOs are grossly overpaid, that means everyone in the chain all the way down to the line worker is overpaid. Nobody holds a gun to anyone’s head to force a particular salary. Salaries are negotiated and can be refused by the employer or employee.

There’s no implied sainthood, just the realization that morality cannot truly exist if there is no opportunity to be amoral. Trailer park residents have no power in the corporation and so take the pay offered to them. Sure, know one is holding a gun to their head, but many of them have developed a pesky dependence on food, clothing, and shelter. The CEO’s have met those needs for themselves many times over and still clamor for every cent they can get.

[Whack-a-Mole]

@Algher

Interlocks are reported to the SEC, and are not that common. The comp committee is outside directors, using a comp consulting firm. You do NOT find a CEOs voting each other raises.

Seems interlocks and other CEO/Board power relationships is all over the board. In the article linked below (very long) they note at the beginning you can find studies supporting both sides. I just quote the final paragraph here as I have not had time to read the whole 20-page article but you may find it enlightening.

We began our study by asking why increased board independence and control over top management may have spread to some organizations and not to others. We sought to answer this question by developing a cross-level theory of interlock tie creation and dissolution that explains the simultaneous coexistence and persistence of both board-controlled and CEO-controlled firms. Specifically, we showed how powerful CEOs and powerful board members seek directors whose prior director experiences (i.e., reputation) suggest a shared belief about board passivity or activity, respectively, and how this politically rational “matching” and segmentation process of like-minded individuals can influence the dynamic formation and dissolution of corporate interlock ties. These dynamics help to explain the fractured diffusion of increased board independence across large U.S. corporations. More generally, the findings illustrate the promise of developing “meso-level” theoretical frameworks integrating micropolitical factors and macro-social factors to explain organizational behavior. While such “meso-level” frameworks may be more complex than frameworks that address only micro or macro factors, they may offer the greatest potential to account for the simultaneous existence of what appear to be contradictory or opposing organizational phenomena.

SOURCE: http://findarticles.com/p/articles/mi_m4035/is_n3_v41/ai_18905155/?tag=content;col1

[cmosdes]

I’m a little confused as to why there seems to be a general acceptance that CEO salaries are out of whack. If you could pay someone $50 milllion in exchange for making the company an extra $1 billion, I don’t think anyone would turn that down. The same holds true for any job. If you aren’t making the company more money than they pay you, the company would be crazy to keep you around. Or the inverse, if you are making the company millions they would be crazy not to give you a fare portion of that.