Business and Economics

Two Opposing Views on CEO Pay 6/25/16

Article: ""CEO Pay: Neither rigged nor fair"  

CEO pay was considered problematic in the 1970’s by none other than Peter Drucker when the ratio between it and the average company worker was edging up over 20-1. Now it is a staggering 150 to 350-1, depending on who you talk to. Thomas Piketty blames the disparity for the growing issue of income inequality. There are 2 camps. Pro side (Steven Kaplan of University of Chicago) says pay is market-driven and that abuses are outliers. Evidence: value of firms up 425%, CEO pay up 405%. Evidence: when shareholders have a say on pay, they rarely reject CEO compensation (1.5% rejection rate). “Tournament theory” of pay: high pay is an efficient way of incentivizing subordinates. Evidence: CEO candidates could make as much at a blue-chip law firm or consultant group with less headache, thus the pay is appropriate.

And the con side (Lucian Bebchuk at Harvard) says the market is broken as CEO pay is typically decided by boards made up of CEO peers or recommended by consultants from that same peer group. Evidence: 350-1 ratio mentioned above demonstrates conflict of interest. Evidence: no “clawback” of compensation from CEO’s who have demonstrated incompetence and damaged share prices. 

Personal note: I am reminded of the Thaler paper on NFL draft picks and this quote: “In fact, football teams almost certainly are in a better position to predict performance than most employers choosing workers. Teams get to watch their job candidates perform a very similar task at the college level and then get to administer additional tests on highly diagnostic traits such as strength and speed. Finally, once hired, performance can and is graded, with every action visible on film from multiple angles! Compare that to a company looking to hire a new CEO (or an investment bank hiring an analyst, a law firm hiring an associate, etc.). Candidates from outside the firm will have been performing much of their job out of view. Outside observers see only a portion of the choices made, and options not taken are rarely visible externally. And, even once a CEO is hired, the company’s board of directors is unlikely to be able measure his or her performance nearly as accurately as a team can evaluate its quarterback. In our judgment, there is little reason to think that the market for CEOs is more efficient than the market for football players. Perhaps innovative boards of directors should start looking for the next Tom Brady as CEO rather than Eli Manning”.