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July 18, 2007

Is CEO Pay a Positional Good? (or Money Talks)

Costco CEO James Sinegal certainly thinks so:

“I think that most of the people running companies today are motivated and pay is a small portion of the motivation,” Mr. Sinegal said. So why so much pressure for ever higher pay?

“Because everyone else is getting it,” he said. “It is as simple as that. If somehow a proclamation were made that C.E.O.’s could only make a maximum of $300,000 a year, you would not have any shortage of very qualified men and women seeking the jobs.”

If all the other CEOs are making $10 million, and you're making $5 million, it's not that your salary is insufficient, but that the status it confers is insufficient. If your income is supposed to speak to your value, then it can, at a point, cease being about the money and begin being about what the money says. Hence skyrocketing CEO pay: You can't go to a new job, even a better new job, if the specifics of the deal (your salary and options) will harm your status. So CEO's constantly need better deals in order to retain their relative position, which means all the other CEOs need better deals to retain their relative position, and so on, until the pay is utterly obscene and, in fact, completely beside the point.

Update: In comments, Tyro adds three important points:

Note that many corporations also probably regard their own status as being insufficient if they are paying their CEO less. Who wants to be the one to say, "yes, our CEO is worth less than the average for the industry" ?

Also, in an environment full of hostile takeovers and cut-throat competition, ever-escalating salaries for CEOs are regarded as signals of corporate strength. Paying them less then their competitors could be regarded as an outward sign of weakness.

If CEOs were paid more based on their managerial added value, we'd see salaries for executive vice presidents spiraling upwards at the same rate, but we don't. The only difference between the two is their public profile, and the public profile for CEOs is much higher than for the people directly under him.

I've not seen data for lower-level executives, but it would be interesting to examine how it tracks changes in CEO pay. As for the other points, Tyro is right on: CEO pay is not merely positional among CEOs, but among firms.

July 18, 2007 in Economics, Inequality | Permalink

Comments

Note that many corporations also probably regard their own status as being insufficient if they are paying their CEO less. Who wants to be the one to say, "yes, our CEO is worth less than the average for the industry" ?

Also, in an environment full of hostile takeovers and cut-throat competition, ever-escalating salaries for CEOs are regarded as signals of corporate strength. Paying them less then their competitors could be regarded as an outward sign of weakness.

If CEOs were paid more based on their managerial added value, we'd see salaries for executive vice presidents spiraling upwards at the same rate, but we don't. The only difference between the two is their public profile, and the public profile for CEOs is much higher than for the people directly under him.

Posted by: Tyro | Jul 18, 2007 2:02:07 PM

I would submit this goes far beyond just CEO's, but it's obviously greater and more public with them. At some point pay is all about what you make relative to your peers and not relative to your needs. Why do you think companies tend to frown on employees sharing compensation information? If you found out your colleague was making more than you, even though your pay was sufficient to get by, you'd be right in your boss’s office asking for a raise.

I like Tyro’s point re: signaling as well.

Posted by: DM | Jul 18, 2007 2:12:52 PM

I have to say I lie awake weeping at night for the three losers who ordered Boeing 747-800is as personal jets now that a real lateral-thinking winner will soon have an Airbus A380 "flying palace" (their own marketing term).

Cranky

No joke; it is believed on is on order for personal use.

Posted by: Cranky Observer | Jul 18, 2007 2:17:21 PM

It's actually not unheard of for activist shareholders (institutional investors mostly, and especially the CALPERS kind of investors) to be really quite concerned with excessive executive comp. I don't think there's really as much of an emotional need to be paying as much as the rest of the market as you might think, but certainly the answer to "Who wants to be the one to say, 'yes, our CEO is worth less than the average for the industry'?" is not a null set. Or rather: There are quite a few investors who would be comfortable saying, "Our CEO is worth about what the average for the industry is worth---we're just the only ones not overpaying for her."

Securities and corporate lawyers in the audience, and anyone insane enough to read Edgar filings for fun, may want to think about the new executive comp disclosure rules that took effect last December, and how the increase disclosure requirements for how filers determine their executive compensation levels will impact what CEOs make in the future. Everyone assumes that the increased transparency will result in shareholder pressure to keep salaries down, but it's not unthinkable that the increased disclosure will give CEOs more leverage to point to what their company's competitors are paying and demand a comparable package. Meh---just my disorganized $0.02.

Posted by: Jack Roy | Jul 18, 2007 2:28:10 PM

It's actually not unheard of for activist shareholders (institutional investors mostly, and especially the CALPERS kind of investors) to be really quite concerned with excessive executive comp.

This is very true, and it's a market-based solution. I used to write a column for an institutional investor newsletter and it's amazing how many roadblocks get thrown in the way of investor proposals.

Posted by: Steve | Jul 18, 2007 2:36:50 PM

There is a close correlation between the pay of a CEO and the total income of members of the board. In other words, the richer your board members are, the more you are likely to be paid as a CEO. This holds true among profit-making companies and non-profits as well. I assume that ultra-wealthy board members tend to view whatever the CEO makes as not all that much compared to what they make and hence rubber-stamp excessive pay packages without realizing that they are excessive.

Posted by: Bruce Bartlett | Jul 18, 2007 3:10:14 PM

"Because everyone else is getting it" isn't just about status. If CEOs aren't just doing it for the money, or even mostly for the money, that doesn't mean they won't chose to work for the company that... pays them the most to be its CEO!!!

The reason executive pay is increasing so much faster than other wages is that executives get paid in stock, and the market has been doing pretty well for the last few years. Google pays many of its employees with options, and those who've been there for a while are making a killing for that very reason.

Another point: most CEOs don't make squat compared to money managers, who generally don't have to face public scrutiny for their salaries. If they mostly cared about money and they had the skills, that's what CEOs would be doing. Though I'm not sure your average CEO has the chops.

Posted by: Cliff Mason | Jul 18, 2007 3:15:10 PM

"At some point pay is all about what you make relative to your peers and not relative to your needs."

Well, I would contend that actors and others in the entertainment industry do consider needs, many want the independence of financing their own productions.

Tyro said most of it.

Posted by: bob mcmanus | Jul 18, 2007 4:03:32 PM

There's also the theory that as managerial techniques become more universal from company to company (thanks to burgeoning technology) that executive pay has to match not only the industry, but the entire economy. So if companies like HP and Boeing are all "bidding" from the same small pool of "talent," instead of just the auto industry bidding amongst themselves, then the "price" of one of those elite CEOs will obviously be greater.

Of course, any economist will say it's a little of both. Gotta love that "on the other hand-ism."

Posted by: senior | Jul 18, 2007 4:07:54 PM

This is more or less what I thought about Kozlowski and his $6000 shower curtain. It's not that the shower curtain is so great; it's that if you settle for the $5000 one, the other CEOs will laugh at you.

Posted by: Hogan | Jul 18, 2007 4:28:22 PM

Well- I believe the guy from CostCo and other execs- or maybe not costco- he prides himself on not taking a salary that's out whack with his employees. But then his strategy isn't based on how high stock prices are per quarter so he's been punished- again if I am remembering the right guy- for being unorthodox. It's interesting to me how people talk about the rationality of the market, but what they real meaning is the psychology of the market- which isn't necessarily very rational at all. Well unless you use some loose definition of the word to mean anything the market does is rational like some conservatives do.

Posted by: akaison | Jul 18, 2007 5:44:48 PM

1. Speaking as an executive vice president, I am outraged that my own pay has not spiraled upward.

2. That said, there is at least some truth in virtually everything said here, whether in the original post or the comments.

3. There is also a genuine shortage of good CEOs. It is phenomenally difficult and demanding to be effective as the CEO of a large public company. Trust me, I've been there and not been successful. This fact does not mean that CEOs "deserve" huge pay, but several consequences flow from it. First, as with baseball players, the bidding for the good CEOs pulls up the pay of the merely average and even the profoundly lame. Second, public company CEOs get a lot of attention because their pay is disclosed in detail, but the pay of other people in business and the professions has also risen dramatically in the last decade or two. Investment banking executives and partners in big law firms make absurd amount of money compared to 20 years ago (have you looked at what a managing director at Goldman makes these days?). The boom in private equity (brought on, in part, by Sarbanes Oxley) has (1) massively raised the income of private equity fund managers, and (2) created a bidding war for good CEOs who would rather work for a private company. Executives in portfolio companies owned by private equity firms -- where many of the "status" issues cited here do not apply because compensation is not disclosed -- are earning much more money than they were. Not as much as the public guys, but their jobs are easier and they usually have a shot at a truly massive home run if the exit works out well.

4. The answer to all of this is to make hostile takeovers much easier. Progressives did not much like them back in the '60s-'80s because they created a lot of uncertainty for workers, but I think that issue has gone away, uncertainty being a central feature of private sector employment regardless of hostile-takeover risk. Get rid of all the various regulations that tend to entrench management, and then get out of the way. An overpaid CEO doing a terrible job is a delectible "synergy," but only if the deal is hostile.

Posted by: TigerHawk | Jul 18, 2007 10:59:47 PM

TheyRule.net

Institutional investors usually have executives who want executive pay: state pension funds with a say are in the minority. Compensation committees are drawn from corporate boards. It's a glorious dick-swinging, back-slapping circle.

Posted by: pseudonymous in nc | Jul 19, 2007 1:47:44 AM

Although I'm unconvinced of the merit of increased hostile takeovers, I like what TigerHawk had to say. I'll willingly concede that uncertainty is a feature not a bug. I feel dirty just for using something so cliche. Anyway. I'm not sure latent uncertainty means we should give the green light to even more uncertainty. Know what I mean?

Tyro's comment was spot on. A little more to add on it. The current trend in business management theory is frames. No shit, right?

Four frames are usually discussed:

1)Structural- the formal shape of the organization, rules, procedures, who has authority, etc.
2)Human Resources- people's needs and wants. Cf. Mazlow's Hierarchy
3)Political- power is how things get done. So who has power? How is it exercised? This is where things get a little fuzzy and complicated. And nobody likes talking about it because it's kinda sordid; it's definitely taboo to acknowledge.
4)Symbolic- Culture, myths, appearances. This is where things get really fuzzy.

Tyro nailed the symbolic analysis. It's the easiest way to justify high CEO salaries.

Structurally: they make no sense at all. At a minimum they reduce profits and squander a large sum of money that could be directly reinvested.

Human Resources: no one needs that much money. And I daresay most of the purchase-able wants can be bought for less than the top CEOs make. The diminishing levels of satisfaction associated with cash at that level plays into the fact that there's now a cottage industry that provides 'meaningful experiences' for the obscenely rich. Also: giving even a fraction of that money to the peons would cause a much bigger boost in satisfaction and quality of life. High salaries can be justified here by noting that top candidates may expect to be paid top dollar. They may deserve it if they can deliver.

Politically: it's possible to justify the high salaries here. CEOs have quite a bit of power, so they can wield it to get that lucre. Board members may also want to curry favor with the CEO.

Posted by: Andrew | Jul 19, 2007 2:28:24 AM

TigerHawk, 80% of takeovers destroy shareholder value. They happen because there are perverse incentives involved - primarily, massive commissions for banks which act as advisors, which gives them an incentive to promote even stupid takeover plans. The last thing we need is easier takeovers.

Posted by: ajay | Jul 19, 2007 5:14:17 AM

Ezra, I like your point about how salary/options get "ratcheted up" and don't ever (or rarely) go down, but I don't think you have to invoke status to explain this. Rather, consider that people simply get used to what they have and don't want to lose it. A worsening in your condition really does count for something, we humans are very loss averse (see prospect theory).

Posted by: mk | Jul 19, 2007 12:10:48 PM

was wondering if any of you have connections with the SalaryBase.com folks. Would be rather interesring to see the CEO packages trend

Posted by: shelly | Jul 19, 2007 12:36:14 PM

Well, I have to believe the points here about psychology and groupthink are correct because there's no rational business case to be made for obscene CEO pay increases. Rational business people on compensation committees would tie pay to market capitalization, with bonuses attached to other performance-based metrics and deliverables. Anything else is will eventually prove unsustainable.

Posted by: Rick | Jul 19, 2007 2:02:24 PM

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