August 06, 2015
This is the question that Neil Irwin raised in a discussion of efforts to reduce inequality by constraining C.E.O. pay. Irwin comments that Walmart CEO Douglas McMillion:
“makes more than $19 million a year (including unvested stock grants) to run Walmart, a company with 2.2 million employees and half a trillion dollars in revenue. That’s a lot of money, no doubt. But 26 Major League Baseball players make more than that. It is a safe bet that the future of the United States economy depends more heavily on how well Mr. McMillon does his job than how well Albert Pujols does his, even if Los Angeles Angels fans might disagree.”
Asking whether the work of a CEO or a great athlete is more important to the country actually misrepresents the issues involved in the determination of CEO pay. We can grant the ensuring that Walmart is well-run is more important, but that is really beside the point. The question is how much to we have to pay to get someone to do a good job running Walmart.
If the New England Patriots did not have Tom Brady, there are few, if any, other people who could do a comparable job as quarterback. This means that they would either have to pay the Tom Brady substitute a comparable salary or get by with a quarterback who would not be nearly as effective in scoring points for the team. (We’re ignoring the deflation problem here.)
By contrast, it is not clear that if Mr. McMillion left Walmart that the company could not find a comparably talented person to run the company. In this case, Walmart need only pay Mr. McMillion the amount that would be needed to attract another comparably talented person.
The example of firefighters can be seen as presenting a similar situation. Firefighters do incredibly important work, often at great personal danger. Certainly pulling people out of burning buildings has to be seen as more important than winning a football game. However firefighters do not receive multimillion dollar salaries because there are other people who are prepared to do this work at a relatively modest salary. This means that if any individual firefighter were to insist on a multimillion dollar paycheck, they could be replaced by someone who could do a comparable job at a far lower salary.
The argument on CEO pay is that the corporate governance system in the United States does not lead to the same sort of market pressures. Board members have little incentive to pressure CEOs to take pay cuts even when it is quite likely that they could get equally comparable replacements at a much lower wage.
Board members can count on six figure paychecks for attending a small number of meetings every year, even if they allow the CEO to be paid far more than is necessary. The fact that well-run and highly profitable companies in Europe and Asia typically pay their CEO’s far less than companies in the United States suggests that it is not necessary to have such exorbitant CEO pay to attract competent managers.
Note: Brady’s first name has been corrected to be “Tom” rather than Jim. Thanks to those who called my attention to this one.
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