Wednesday, June 24, 2015

CEO pay doesn't have much to do with talent

NakedCapitalism has an interesting article by Yves Smith on stratospheric CEO pay. It is a fascinating exploration of the ways in which CEO pay has been on the rise over at least the last 30 years.

The article is a nutshell look at CEO pay, supported by a recent study by Lawrence Mishel and Alyssa Davis of the Economic Policy Institute on the reasons for such high pay in the first place. The short summary is that it's all about peer pressure. Every company wants to be sure that their CEO is paid more than the others so that 1) they will attract talent, 2) they will not have their talent poached and, 3) CEOs just love to have bragging rights in the sauna at the club. It's also worth noting that the study is intended to bust the myth that CEOs earn the big bucks due to talent. Apparently, their pay has more to do with collusive negotiation rather than talent.

Even so, that would be fine if the productivity of the executives justified the pay. But a number of economists have noticed that pay for labor got off the track of productivity back around 1980. For employees, that meant stagnant wages. For CEOs, that meant a lot more compensation. The study referenced in the article at NakedCapitalism points to compensation consultants doing everything they can to jack up pay. This will only help increase the fees earned by the consultant, but it does nothing for productivity.

Still, it's hard to see, as economist Dean Baker points out, how any amount of talent or work could justify an $84 million pay package. Rather, Mr. Baker would have told us long ago that CEO pay is a matter between friends. How is it that friends can be so noble? Well, when you're on the board of directors of a Fortune 500 company, it's cool to take turns earning that kind of dough. It's even better if your compensation is not determined in an adversarial procedure. Why not let friends determine each other's compensation in the company?

Stratospheric pay has a lot more to do with corporate governance than talent, too. If ordinary shareholders had more say in CEO compensation, that would help to moderate pay. But there is yet another factor at work here: public policy. The Securities and Exchange Commission regulates corporate finance. They can require reports to show the gap in pay between management and employees. They can also require certain rules to allow for better control of the company by ordinary shareholders. But they haven't.

Government is happy to intervene to minimize or mitigate the power of unions and labor, but not so happy to intervene on the subject of CEO compensation. The trends in CEO pay are allowed due to government intervention in the market. Stratospheric compensation packages for top management can only be economical if the pay of everyone else is suppressed. If government intervened to regulate CEO pay the way they regulate the pay of wage earners, I suspect that the gap might not be as wide as it is today.

Unfortunately, only the top 1% have any influence on public policy, so I guess we'll have to ask them for permission to rewrite the rules.
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