19 February 2009

The Executive Compensation Bubble

A buddy of mine yesterday said that the $500,000 pay cap for CEOs was still too high. Obama has tapped into the national outrage at executive pay by capping CEO pay in companies that receive aid from the government. In 1985, CEOs made 40X what the average worker did; by 2005, they made 450X. To my amateur's eye, this looks like a bubble.

There are at least two problems with Obama's CEO pay cap. One is that is only addresses the problem of excessive executive pay in companies that receive aid from the government. The other is that it leaves the definition of this pay cap to the government.

I own lots of companies. Probably you do too. Or, more accurately, we own shares in companies. If you actually owned a company outright and chose not to run it yourself, you would hire a company manager and agree to some salary to pay him or her - just as you would for all the other employees. And you would probably pay him or her more than other employees. But I'm guessing that you wouldn't just say, "hey, why don't I give you, say, $12 million a year?"

It seems to me that the real solution to excessive CEO pay is to have the people who own the companies determine the pay. This might not have been possible in the pre-Internet days, but today it should be relatively simple to give shareholders say in executive pay.

The result would be lower overall pay, I'm sure. But more importantly, it would allow variation. $500,000 is simply not enough in some instances and too much in others. Better, it would put the determination of pay into the hands of owners, not government officials.

I don't think that executive pay is the result of market dynamics. I think it is now the result of executives who know how to avoid market dynamics. By putting in place mechanisms that would allow us shareholders to "negotiate" with CEOs, we'd see market forces correct the bubble in executive pay. At that point, it is unlikely that we'd need DC to define a cap on CEO pay any more than we'd need it to define a cap on janitor's pay.

3 comments:

Dave said...

Ah, that damned market again. It does work if both/all sides have roughly equal power and it doesn't work when it's rigged. I have a feeling that your solution, while attractive, won't work. The players will find a way to game it; and, the rest of us "owners" won't have the time or the ability to fight them.

ThomasLB said...

The cap applies only to salary. They can get as much stock as they want.

And since they're getting the stock at pre-bailout value and selling it at post-bailout value, I imagine they'll make quite a nice little profit for themselves.

The wealthy take care of their own. I'm sure they'll be fine.

Ron Davison said...

Dave,
I wish I could fault your logic so I'll just say that I hope you're wrong.

Thomas,
It is true that these CEOs can still make a fair bit of money. Funny how that works.