This past Sunday afternoon I was discussing economic issues with an Uncle of mine. One issue we discussed is why CEO's of companies make so much money while Americans are paying huge amounts of money for gas and other goods. He believes we are being ripped off, and that CEO's are greedy. Please allow me to discuss the fallacy of this argument in a two-part series. I will first put their pay in perspective and talk about costs. In the next blog I will explain opportunity cost and other reasons for the high pay of executives and in short explain why many failing executives are paid high compensations to leave the company.
First some perspective. In 2004 the top ten corporate executives earned on average $59 million each. The top ten celebrities earned an average of $119 million each. Yet many in the media criticize corporate executives more than they criticize sports, movie, and media stars. Given the billions of dollars at stake in a company it should not be surprising that they make $59 million. Many would argue that they are paid at the expense of stockholders and consumers. That prices are rising to pay for their huge compensations. However if a CEO saves a company $100 million in a year and is compensated $59 million then the company is still better off $41 million and thus saving stockholders and consumers extra expenses. Sounds like a good trade off to me.
Wages, rents, capital, and investments are all "costs" to a corporation, thus the pay of their CEO is a cost to the company and that company will do whatever it can to pay as little as possible to the boss running their company. Remember CEO's pay is usually decided by a board of directors, or those with the most stock in the company. Why would they pay him more than he or she is worth? I would think they would not. So when you buy a product such as Gas and you hear that the CEO of that company is making millions and you think it is at your expense, you might want to ask yourself how much money that CEO is saving you in company losses.
Part 2 will discuss more economic analysis and point out the less obvious costs that are associated in paying CEO's these large sums of money. This will include opportunity costs, incentive costs, and the compensations of failing CEO's just to get rid of them.
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10 comments:
This is clearly double-talk and rationalization -- You still have not clarified or defined WHY a CEO of a company should be rewarded for keeping the working class of a company living at poverty level. The salaries a CEO makes in comparison to the workers within a company is OBSCENE and you are using rationalizations to try and justify it. BUNK, pure BUNK, and anyone with a high school education knows it is wrong and should wonder how such a greedy creep sleeps at night in their one-of-four mansions while the workers of the company struggle not to lose their ONE meager home!
It is ok for one to have the opinion that a CEO should not be paid so much when hard working people who do not live as lavish as he might are making far less. Of course most workers are not living at the poverty level either. Still only some 5% of people are losing their homes even now and most of them should never have gotten a home to begin with. Most working class people are making their home payments on time. The Capitalist system we have today has brought millions and billions throughout history across the world out of poverty. My point in in explaing why in a free market CEO's are paid so much. Their supply is low and their demand in a company in which they will make billions of dollars worth of decisions (many of which effect those hard working-class people) is very high. Thus they are paid high salaries.
Further it is greedy and creepy to be the kind of person who can't sleep at night because they think (as you evidently do) that they possess the amount of knowledge to rightly judge how much people should be paid. Again CEO's usually do not set their salaries, stockholders and company boards do. And they have far more information than me, you, or anyone else does. So I have found it smart to believe that they know far more about what THEIR CEO should be paid than I do.
And lastly my main point is that government should not regulate their salaries due to the fact that government regulation has unintended consequences. Such as the current housing crisis that yes government regulation caused. I would not want government to ruin a company because they did not want that company to pay a CEO a few million dollars more than you or the public thinks they should be paid, thus that company lose out on the CEO they wanted that they felt was best for their company, and thus had to hire a lesser CEO that made a couple bad decisions that cost those working class people some 3,000 jobs which causes them to really live at the poverty level.
The problem with the atheletes ceo's comparison is two fold. First the athelete has a very short earning period - 3-5 years. While CEO's tend to be in their 50's. Secondly the athelete is totally responsible for whether he gets a hit or strikes out. The CEO can only ask other people to make a better car. There are loads of stats on ball players, but how do you measure a CEO. I don't make 20 mil a year yet I know whats wrong with detroit. Their cars have lower quailty than the Honda's. Most CEO's are ex-accountants and they just look at figures. Look at the total picture - I need a car with comforatble seats- so my back does not hurt. I need a car that is reliable so I don't miss work and lose my job.
Most CEO's of big companies like that uaually do not last a very long time. THey work their way up to that point at smaller companies and by working extremely long hours that they would not be willing to do if the reward is not worth it by the time they are 50 years old as you pointed out.
My point is really proven by your comment. We buy cars based on quality and what we like. CEO's have to put people throughout their company that can get in touch with those feelings and make decisions based on that. He might not be making those micro decisions himself but that CEO puts people in position to make those decision.
Having said that... the free market allows this to take place. WE buy more foreign cars today because we the people have made the decision to buy from them. While our local auto industry is now being considered for a bailout. Government officials want to make decisions on CEO pay and what businesses needs to be bailed out, and what businesses should not be... I'd rather the market of 300,000,000 people decide... Not Barack Obama, John McCain or any other President or politician..
Did you read Thomas Sowell? It would only be correct if you quoted him and not use the information as if it is yours: it's a little something called: plagiarism.
Lot's of Red Herrings too.
Oh I read almost everything I can find from Sowell as well as Walter Williams, Kudlow, and others. I have a minor in economics but read many books on it outside of college.
Thus it is true that much of what I say are ideas that come from Sowell but any quote I use I would definately cite. Much of what I have learned come from him but much of what I have learned come from Professor Hutchinson at UTC, and Professor Pratt at UTC, and many other places even places that I do not know. All Capitalist use Adam Smith but we don't reference him unless it is a direct quote.
I have referenced Williams and Sowell in the past and get a lot of information from them but plagiarism? No... Their smarter than I am so I do write a lot on what they write about because I find it interesting. But how many of us actually do write truly 100% original stuff? Not many of us.
Besides please comment on what is wrong with the blog? Do you hate freedom and the right of a company to pay their CEO whatever they want to pay their CEO?
Jess, Most of what you said I agree with. What is difficult to for the general population to understand is that although the best CEO talent brings a premium price then why do companies hire people that fail them and then have to pay them to leave. The unfortunate truth is that the good ole boy syndrome is still alive and well in corporate America. The boards of directors of these failing companies need to be replaced, fined or otherwise penalized for making such poor choices in hiring their CEOs.
I truly understand the concern. And I agree that it sucks that CEO's who make bad decisions and are forced out are paid high pensions or money to leave. That happens in sports a lot too.
Unfortunately economics is not about perfect worlds. It is about the maximun net benefit which is reached with costs and benefits put together. Unfortunately sometimes CEO's fail to their own blame and sometimes it is not their fault. But to get some of these highly qualified CEO's one company must guarantee them a certain package with a clause requiring the pay even if the CEO failed. The market is so tight (low supply and high demand) in this field that contracts have to cover a CEO who fails at times because so many do in fact fail even when they are not at fault but still lose their job. If a company stands on principle that a failing CEO should get nothing that company may never be able to hire that great CEO they want because the other companies do guarantee him/her that guaranteed pay. It is unfortunate but I see no way around that.
Also if you read my other blogs on CEO pay you will see that CEO's are paid to make good decisions. Sometimes those decisions during a struggling economy might mean the company losing 300 million dollars in that year as compared to 600 million that could have been lost without good decisions. The CEO saved that company 300 million and should be conpensated. When it is reported in the news and there is pressure from stockholders and the public to get rid of that leader it could look like they are getting paid to leave. When if fact they saved that company from maybe going bankrupt but only individuals close to the situation would know this information. Just a thought this happens sometimes.
The point is who is in best positoin to make those decisions? Government? Me? You? NO, those large stockholders and boards set up to make these decisions. Let them do their job. They have high interests in getting the best CEO and making as much money as possible.
How the CEO came to make 10 times as much money as the other employees
It was a warm spring morning in Oakwood Forest, and entrepreneurship was in air. Bear and Fox decided that today would be a good day to start a company.
Bear hired ten squirrels for his company and made one of them CEO. He paid both the worker squirrels and the CEO squirrel one acorn per day. Fox did the same thing, hiring ten squirrels (nine workers and one CEO) and paying each of them one acorn per day.
Business was split equally between the Bear's company and Fox's company.
Business continued as usual, until one day Fox had a brilliant idea. He decided to pay the CEO squirrel 10 acorns per day. The CEO squirrel didn't do any more work than he used to. He just got fat. But the other squirrels started working like crazy! They came to work early, ate lunch on the job, and worked late into the night. Some of them slept at the office. Others stopped going on vacation. All of their squirrel spouses grew quite upset and most of the squirrels working at Fox's company had sad squirrel divorces. All to have a better chance of being picked as the next CEO. But business was booming and Fox's company, with its highly productive worker squirrels, drove Bear's company out of business.
This is called "Tournament Theory" and it explains why CEOs (and Partners, upper management, etc.) are paid so much more than average employees.
Moral: pick your own acorns.
The only issue is of course the CEO does much more than the regular workers. Most CEOs spend over 15 hours a week working and that is not called the constant 24 hours a day being on call for anything. But yes that is a great example of the motivation that is created by income.
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