May 25, 2018
The reporting of pay ratios between CEOs and median workers has drawn considerable attention to the enormous gap. Most of this has taken a moral tone, noting that would take the typical worker hundreds of years, or in some cases, more than a thousand years to earn as much as the company’s CEO gets in a year. While there are certainly important moral questions here, it is also important to ask a simple economic question.
Are the highly paid CEOs actually producing returns for shareholders? This is not an expression of concern for shareholders, the question is whether CEOs are actually worth their pay to the company or whether they are effectively ripping off shareholders. The latter story is plausible because it is difficult for a diverse group of shareholders to carefully monitor and control the conduct of a company, just as it is difficult for citizens to make sure that their city or state government is not ripping them off by having patronage jobs or sweetheart deals with well-connected contractors.
The argument would be that the directors who most immediately monitor the CEOs have more allegiance to the CEOs and top management than the shareholders whom they ostensibly represent. This is a plausible story since directors who are renominated by their board win their elections more than 99 percent of the time. This means that directors would have little incentive to upset top management and their colleagues by asking annoying questions about whether CEOs get paid too much.
There is considerable research indicating that CEO pay does not reflect performance (measured as returns to shareholders), much of it summarized in Lucien Bebchuk and Jesse Fried’s book, Pay Without Performance. Jessica Schieder and I did a short piece that also supports this view, showing no drop in CEO pay at health insurers, after the Affordable Care Act ended tax deductibility for pay over $1 million.
This matters because it means that if rules of corporate governance were changed (these come from the government, not the market) to give shareholders more control over CEO pay, it is likely CEO pay would fall. This is not just a matter between rich CEOs and mostly rich shareholders. (Pension funds and middle-income people with 401(k)s also do own stock.)
Bloated CEO pay affects pay scales throughout the economy. If the CEO gets $30 million, the folks next in line likely get $10–15 million, and the third-tier executives may earn in the range of $1–2 million. Also, top executives in the non-profit sector also get bloated pay, often well over $1 million a year at universities and major charities.
By contrast, if CEOs were getting $2–$3 million a year, the next in line would likely be getting paychecks not much over $1 million, with the third tier settling for the high hundreds of thousands. And, the presidents of elite universities might also see paychecks in the high hundreds of thousands. And, if there was less pay for those at the top, there would be more pay for everyone else.
The point here is that this would not be a story of just saying we don’t like some people getting incredibly rich, while others get little (which may be the case), it would also be the story of getting the market to work better so that CEO pay reflects their actual performance, not their ability to take advantage of their insider position. There is no good argument for defending CEO pay that does not reflect performance unless you think it is a positive good that some people incredibly get rich while most workers get little benefit from the economy’s growth.
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