Why CEO Pay Is Rising

Atleast part of the reason is a dwindling supply:

In tech circles, the C-suite at a publicly traded company is no longer the be-all and end-all. Just look at the troubles Yahoo! (YHOO) and Hewlett-Packard (HPQ) have recently had finding new leaders. HP canned former SAP (SAP) Chief Executive Officer Léo Apotheker after just 11 months—then faced a barrage of criticism for replacing him with HP director and former EBay (EBAY) CEO Meg Whitman without bothering to look beyond its own boardroom.

Industry consolidation has created a small number of very large technology companies such as HP, Cisco (CSCO), and Microsoft (MSFT). They’ve stumbled in recent years as disruptive developments like the mobile revolution and the dash to the cloud shake the entire sector. As the job of leading these companies gets tougher, there are fewer talented leaders with the skills—and inclination—to do it. Rather than wait for high-profile CEOs such as Cisco’s John Chambers, Microsoft’s Steve Ballmer, and Research In Motion’s (RIMM) Mike Lazaridis and Jim Balsillie to step down, many potential replacements have decamped for more exciting, and potentially more lucrative, gigs at startups or as investors. “This is the first time in tech history that you have this many companies with CEOs approaching 60 that don’t have any obvious successors,” says John Thompson, vice-chairman of recruiting firm Heidrick & Struggles (HSII).

Full story here.

19 Responses to “Why CEO Pay Is Rising”


  • I think there’s a core concept you neglect when you consider CEO compensation.

    The concept you do consider is this. What value does person A bring to the company contrasted what person B might bring? If person A brings more value we have to spend more to lure him.

    Here’s another concept. I’m a manager. I want to surround myself with and promote people that make my job more secure and more lucrative. Value to the company is one thing, but here’s another important thing. Is person A my friend or is person B my friend? And if I can see to it that I scratch his back by giving him more money, then he’ll scratch mine if he finds himself in a position where he can later down the road. How do we provide back scratching to each other? Reduce compensation for the ordinary workers so more can be provided to management.

    How can this be accomplished? The ordinary worker wants as much money as possible. But what I want to do is weaken his bargaining position. Just like in war if I can isolate workers from each other it strengthens my bargaining position. So naturally we weaken the union. Play one worker off of another. This makes it possible to divert more money to management and less to workers. I bring in friends, pay them tons relative to ordinary workers. This provides me with insulation and the likelihood of more further compensation.

    This plays a huge role, and it’s a role you seem oblivious to. This is what I see all around me wherever I work. The promoted are not necessarily the competent. They might be, but they might not be. But they are always, without exception, either friendly to or beholden to the people that make decisions about who is hired. Value to the company long term is secondary. Those that hire seek their own self interest first. That produces the exorbitant CEO compensation independent of value to the company.

    This literally creates a culture of deceit. People lie to their superiors. People flatter their superiors. People pretend that they are deserving when they really believe they aren’t.

    In a company where workers have a real say in the operations, in who is hired and fired, in how much compensation is delivered, these problems are corrected. CEO compensation falls. Worker compensation increases.

  • You are right, I don’t pay much attention to that role. Why? For two reasons: data does not back it up and second, it ignores competition.

    All that would happen for that glass house to come crashing down is for one person to create a company that DOES take into account productivity. Then that company would dominate all others and eventually control the market. You don’t see that happen, so safe to say that view does not represent reality accurately.

  • HP, several prominent libertarian bloggers disagree with you including Alex Tabarrok here and Arnold Kling here. I basically agree with Kling, especially on point 4.

    One force that pushes back against CEO’s with friendly boards is the stock owners. If CEO’s take too much of the surplus, the stock owners can sell the stock and buy in a company that they expect will better manage the money. It’s not a perfect solution, but I don’t think that there is a perfect solution.

  • HP –

    …You don’t see that happen…

    Wrong. It happens all the time.

    Twenty years or so ago I worked for a failing company called WordPerfect. The highly paid CEO of that dying company was a man by the name of Eric Shmidt. Feel free to Google “Eric Schmidt.”

    You appear to naively believe that highly paid executives are deterred from unproductive, though personally profitable practices, because their company would be damaged. What you fail to understand is that the fate of these executives in today’s business world is only very loosely linked to the success of their company. If the executive makes millions and the company dies, that’s not really such a bad outcome for these guys. In fact, they may soon move on to something even more lucrative.

    See “Eric Schmidt.”

  • I agree that there are failing CEO’s, I didn’t say that didn’t happen. In fact, the original quote above implies as such: “HP canned former SAP (SAP) Chief Executive Officer Léo Apotheker after just 11 months…” Probably because he wasn’t a very good CEO.

    What I meant to say was that you don’t see ‘one person creating a company that DOES take into account productivity, then that company dominating all others and eventually controlling the market.’ So this tells me there is SOME level of focus on productivity. Atleast enough to keep competitors at bay.

  • Here is another way to think about it:

    Imagine what would happen if all of the coaches of the NBA were racist? All of them REFUSED to employ any black basketball players. In such a scenario, what do you think would happen with the FIRST team that broke this rule and indeed, focused exclusively on talent – regardless of race?

    In such a scenario, I would predict two things: 1. The non-racist team would win many many games, probably ALL of them. 2. The non-racist team would become filthy rich.

    Are there really no greedy CEO’s out there to capitalize on this market failure that Jon speaks of? I doubt it.

  • Then that company would dominate all others and eventually control the market. You don’t see that happen, so safe to say that view does not represent reality accurately.

    There are a lot of places where the US is losing ground. Take GM as an example. They were on top of the world around 1970 or so. Is that true any more? What they did is pay CEO’s handsomely. Those CEO’s insulated themselves. And they weren’t punished by the stockholders because by ignoring infrastructure they could show excellent short term profits. Meaning dividend payouts to investors. They rode this policy for 40 years all the way to collapse and bail out.

    In other words, their behavior wasn’t in the interest of the long term success of the company. It was in the interest of protecting themselves. Placating shareholders with profits and dividends. Surround themselves with the right people that insulate them. Ride that strategy to the ruin of the company. CEO pay rose. The company was not getting better.

    Check this Krugman article and also the article related to Apple within it (maybe you sent that to me earlier, I read it and it’s quite interesting). There is a lot of ground being lost.

    http://www.nytimes.com/2012/01/27/opinion/krugman-jobs-jobs-and-cars.html?partner=rssnyt&emc=rss

    Meanwhile China is pursuing a different strategy. And having enormous success. Notice the key point. Apple isn’t in China just because it’s cheap. They are there because the infrastructure is in place that allows them to be successful. Industrial policy was key to that success.

  • Just one more example. Take Romney and Bain Capital. The strategy is take over a solvent company, slash benefits and wages, show a good quarterly profit statement, which was enough to trick banks into issuing large loans, then take the loans and use them to pay out dividends (also write yourself a big check). Now that you’ve steered the company straight towards the waterfall jump out of the boat. Thousands lose their jobs, but so what? Bain Capital investors are very happy and so is Romney. He got paid a lot. But it didn’t help the company.

    By the way, that kind of action would likely be blocked in China. In China regulators often stop stock trades if they think it is harmful to the national interest. You want to saddle a company with debt and you are pretending it’s good for the company? Fine. But you’re riding that boat over the falls with the rest. That has a way of preventing Romney’s short term approach which is so much to the benefit of investors but so harmful to the people that rely on their jobs and (at the time) solvent company to make a living.

  • Jon, it’s easy to find examples of companies where, ex post, the CEO looks like he was overpaid. The quote was supporting the position that in the tech industry it is difficult to find talent that is capable of managing companies, and that this drives up the salary of CEO’s. I think that is very plausible.

    Also, if you are going to use China to support your position, realize that it cuts both ways. They have a GDP/capita that is 1/10 that of the US, they have an terrible pollution. We have done better than China. Better capital markets is one part of what we have done better than China.

  • In your basketball analogy you continue to miss the point by focusing on the team/company. But what if the coach doesn’t really care that much about the team? Or more to the point, what if the coach were paid hundreds of millions of dollars for one season of play? If his racist team fails, (and we all agree that it will) he either retires comfortably or moves on to another team to make hundreds of millions more.

  • HP’s claim is that companies don’t follow the practices I described because if they were we’d see such companies being displaced and ceding control to others. How do you rebut that except by examples ex post facto?

    According to Gapminder GDP/capita in China is 1/5 of the US. In 1970 it was 1/34. Probably it’s true that we achieved what we did by 1970 due to better capital markets. What made them better prior to 1970? And did it change after 1970 in a way that made it better in China than here? Because you don’t want to just look at who is rich and who isn’t. I think you want to look at what was being implemented while the growth rate in one was leading the growth rate in the other. The US was leading prior to 1970 and China has been leading since and they have been leading by a wide margin.

  • According to the world bank US GDP/capita is $47,184 while for China it is $4,393. Either way, a factor of 5 or 10 is a huge difference. And the Chinese started to grow after adapting freer markets. In my opinion, what we can learn from the Chinese about growth is summarized here.

    I, and many others disagree with HP’s comments that companies that overpay CEO’s would be arbitraged out of existence. The question of whether a particular company has overpaid its CEO is difficult (impossible?) to answer. I would expect some companies to fail simply due to bad luck or unforeseen circumstances regardless of whether or not the CEO was the best man for the job, just by random chance. The fact that a particular highly paid CEO failed is not evidence for or against.

  • LaurenceB,

    Again, I agree. I am not arguing against the possibilities of bad CEO’s. Indeed, I agree completely with your analogy: a bad CEO would definitely be detrimental to a company! That is precisely why companies try their best – and by that I mean pay ALOT – to attract the best CEO’s.

    My point is with the overall system. Jon is making an overall market failure argument. He is saying the lack of focus on productivity is a widespread phenomenon. His claim is that this is generally the case with all companies, not just one or two here or there on the corners.

    My rebuttal is that that hypothesis is easy to test. If it were indeed a widespread phenomenon, then you would expect a company that DOES focus on productivity above all else to eventually dominate all others (you would expect this in the USA – no need to go to China). It’s like the non-racist coach analogy above. Once that coach came into the picture, all other teams would be pushed aside.

    The fact that you don’t see that happen proves Jon’s theory is wrong. It doesn’t represent reality.

    Jon,

    I’d blame GM’s failure on unions. When you have a unionized workforce it’s much more difficult to compete with talented Chinese. Indeed, the fact that GM fell from power is a stronger argument against your world view than you give it credit for: you would expect your scenario of the world to be limited by the presence of unions. Yet GM continues to be one of the biggest examples of company failing. Makes sense to me.

    Darf,

    Maybe I wrote my post wrong, but I did NOT mean to imply that companies that overpay their CEO’s will fail. My point is much simpler: the reduction in supply of competent CEO’s has driven up the price of CEO’s.

  • HP, when you say “that company would dominate all others and eventually control the market” it sounds like you’re overstating you case. And when you say that “the data does not back it up”, I think that is true, but doesn’t tell the whole story. When Tyler Cowen discussed the issue of CEO pay he mentioned that the best estimates were that CEO’s only captured a small fraction of the gains that they brought to the company, but others were quick to point out that the research wasn’t looking at the relevant margin. The second choice for CEO may have done nearly as well with a much smaller salary. In my opinion, the data is not likely to be nearly as informative as your prior beliefs. The correct level of Executive compensation is not going to be settled by research.

  • I’m not objecting to your 10x figure but I just wanted you to know my source as I contrasted 1970 to today. The key is to evaluate the policies that existed during the growth periods, not just point out that one nation is richer than another. What were they doing during the period for which they became rich?

    China did adopt freer markets, which I agree is much better for them. I’m advocating some management of an economy via the government, but not central planning.

    Companies do fail due to bad luck. But take the Bain Capital example. There was no bad luck there. They wrecked companies by design. Romney didn’t fail. He made tons of money for the investors. He was paid well to do what he did, and he succeeded. Creating a long term solvent company wasn’t even a goal. The goal was a return on investment. A company that could have made people a lot of money over a long haul and likewise employed a lot of people for a long time instead was turned into a company that made a quick short term profit which was parlayed into large loans. Loans were paid to investors in the form of dividends as well as compensation for the CEO. The company, now saddled with excessive debt, is now bankrupted and the workers sent to the unemployment lines.

    In a sense Romney was worth his exorbatent salary. For the investors. Not for the employees, but he wasn’t installed to help them. China is of the opinion that creating conditions that incentivize this behavior is good for the few individual investors and CEO but bad for Chinese people as a whole, so they block it. You can say it’s tough to evaluate if this is part of the reason for their success, and I understand the point. But notice that the #2 growing economy is India and they do the same thing.

    I don’t know that Sumner is right about China. It’s not exactly the same in Haiti, but they likewise moved from agriculture (especially rice and pig farming, which they were pretty good at) and now do more assembly. They’ve actually fallen even further behind the US in terms of the GDP multiple then they were 40 years ago.

  • It’s good to look at conditions when countries start to get rich, but keep in mind that China is still poor. GDP/capita in China is what the US had around 1900. I just don’t think we are going to agree on the relevance of the Chinese example on the US economy.

    The Bain Capital example, for me illustrates the difficulty of thinking economically. Yes, many of those companies were taken apart, and obviously Romney and his investors benefited, and the people that lost their jobs suffered at least a temporary setback. But what isn’t seen is the people that get jobs due to the capitol stock being freed and the customers that benefit from the companies being run more efficiently. That doesn’t mean that Romney deserved more money, but there are good reasons to think that a regulatory agencies will not do it better.

  • Darf,

    We generally agree. I also believe that CEO pay, the marginal value produced by a CEO, etc is complicated and not subject to easy worldviews about the causes and affects. What I was trying to rebut, and specifically with my “the data does not back it up” argument, was Jon’s claim. Which had more to do with the belief in widespread management colluding than CEO pay.

  • I read the article. Sorry it took me so long, I’ve been super busy. With that said, I must say that I am not impressed at all. Typical leftist views with strong economic ignorance. Which is fine, in most cases, but what makes it worse is the lack of understanding of what the critics actually believe. That makes it a difficult read.

    Here is one of the many mistakes. The author writes:

    The second false premise is even more far-fetched than the first. It is more insinuation than cogent argument, since there is no plausible mechanism that could possibly explain how the members of the UAW are directly responsible for investment, design and marketing decisions made by higher ups. As everyone knows, workers don’t make those decisions: they do what they’re told.

    Sure, the workers didn’t make the decision themselves but to stay competitive in a non-unionized industry, unionized autoworkers had to make big cars, with big profit margins, to compete. If they tried to compete in the small car, small margin, arena, they would get trumped on by the other non-union automakers.

    Megan McArdle explains here:

    Management has made a lot of mistakes. But making big cars wasn’t one of them. That’s because they couldn’t profitably make small cars in the United States. And the reason they couldn’t is that their labor costs were too high. All in, Detroit was paying about $30 more an hour than other companies to make cars. At that kind of differential, you have to concentrate on large cars with big profit margins, not economy cars where consumers fight to save $15 on the headlight bezels.

    The full article is worth the read here.

    And of course, the author ignores the fact that other automakers, while they may be heavily unionized in their home country, much of the manufacturing is done in the United States, in right to work states. I could go on and on, but you get the idea.

    Bottomline: Let’s apply your simplistic “Scientific Approach” and ask “What auto companies are clearly doing the worse in the United States?”. Then ask, “What auto companies are the most heavily unionized?”. Since the answer to each points to the same companies, my “scientific” calculation, based on observation, is that unions harm companies.

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