One could almost believe in the above arguments, if one made a small concession – ignoring the facts.
I am not disputing that some people are more productive than others and that they need to be paid more – sometimes a lot more (although they should not be too smug about it – see Thing 3). The real question is whether the current degree of difference is justified.
Now, accurately totting up executive pay is very difficult. To begin with, the disclosure of executive pay is not very good in many countries. When we look at compensation as a whole, rather than just salaries, we need to include stock options. Stock options give the recipient the right to buy a certain number of the company’s stocks in the future, so they do not have an exact value in the present and their value needs to be estimated. Depending on the methodology used for the estimation, the valuation can vary a lot.
As mentioned earlier, bearing these caveats in mind, the ratio of CEO compensation to average worker compensation in the US used to be in the region of 30 to 40 to 1 in the 1960s and 70s. This ratio has grown at a rapid rate since the early 1980s, reaching around 100 to 1 in the early 1990s and rising to 300–400 to 1 by the 2000s.
Contrast this to the changes in what the American workers get. According to the Economic Policy Institute (EPI), the Washington-based centre-left think-tank, the average hourly wage for the US workers in 2007 dollars (that is, adjusted for inflation) rose from $18.90 in 1973 to $21.34 in 2006. That is a 13 per cent increase in thirty-three years, which is around 0.4 per cent growth per year.[1] The picture is even bleaker when we look at overall compensation (wages plus benefits) and not just wages. Even if we look at only the recovery periods (given that worker compensation falls during recessions), median worker compensation rose at the rate of 0.2 per cent per year during 1983–9, at the rate of 0.1 per cent per year between 1992 and 2000 and did not grow at all during 2002–7.[2]
In other words, worker pay in the US has been virtually stagnant since the mid 1970s. Of course, this is not to say that Americans have not seen any rise in living standards since the 1970s. Family income, as opposed to individual worker compensation, has risen, but that is only because more and more families have both partners working.
Now, if we believed in the free-market logic that people are paid according to their contribution, the increase in the relative compensation of the CEOs from 30–40 times that of average worker compensation (which has not changed very much) to 300–400 times must mean that the American CEOs have become ten times more productive (in relative terms) than they were in the 1960s and 70s. Is this true?
The average quality of US managers may have been rising due to better education and training, but is it really plausible that they are ten times better than their equivalents were one generation ago? Even looking back at only the last twenty years, during which time I have been teaching in Cambridge, I sincerely doubt whether the American students we get (who are potential CEO material) are three to four times better today than when I started teaching in the early 1990s. But that should be the case, if American CEO pay had risen in relative terms purely because of the rising quality of the CEOs: during this period, the average CEO compensation in the US rose from 100 times the average worker compensation to 300–400 times.
A common explanation of this recent steep rise in relative pay is that companies have become bigger and therefore the difference that the CEO can make has become bigger. According to a popular example used by Professor Robert H. Frank of Cornell University in his widely cited New York Timescolumn, if a company has $10 billion earnings, a few better decisions made by a better CEO can easily increase the company’s earnings by $30 million.[3] So, the implicit message goes, what is an extra $5 million for the CEO, when she has given an extra $30 million to the company?
There is some logic to this argument, but if the growing size of the company is the main explanation for CEO pay inflation, why did it suddenly take off in the 1980s, when US company size has been growing all the time?
Also, the same argument should apply to the workers as well, at least to some extent. Modern corporations work on the basis of complex divisions of labour and cooperation, so the view that what the CEO does is the only thing that matters for company performance is highly misleading (see Things 3 and 15). As companies grow bigger, the potential for workers benefiting or damaging the company grows bigger as well and therefore it becomes more and more important to hire better workers. If that were not the case, why do companies bother with human resources departments?
Moreover, if the increasing importance of top managerial decisions is the main reason for CEO salary inflation, why are CEOs in Japan and Europe running similarly large companies paid only a fraction of what the American CEOs are paid? According to the EPI, as of 2005, Swiss and German CEOs were paid respectively 64 per cent and 55 per cent of what their American counterparts received. The Swedish and the Dutch were paid only around 44 per cent and 40 per cent of the American CEOs’ pay; Japanese CEOs only a paltry 25 per cent. The average CEO pay for thirteen rich countries other than the US was only 44 per cent of the US level.[4]
The above figures actually vastly understate the international differences in CEO remuneration as they do not include stock options, which tend to be much higher in the US than in other countries. Other data from the EPI suggest that, in the US, CEO pay including stock options could be easily three to four times, and possibly five to six times, that of their pay excluding stock options, although it is difficult to know exactly the magnitude involved. This means that, if we include stock options, the Japanese CEO compensation (with only a small stock option component, if at all) could be as low as 5 per cent, instead of 25 per cent, that of US CEO compensation.
Now, if the American CEOs are worth anything between twice (compared to the Swiss CEOs, excluding stock options) and twenty times (compared to the Japanese CEOs, including stock options), their counterparts abroad, how come the companies they run have been losing out to their Japanese and European rivals in many industries?
You may suggest that the Japanese and European CEOs can work at much lower absolute pay than the American CEOs because their countries’ general wage levels are lower. However, wages in Japan and the European countries are basically at the same level as those in the US. The average worker pay in the thirteen countries studied by the EPI was 85 per cent of the US worker pay in 2005. The Japanese workers get paid 91per cent the American wages, but their CEOs get paid only 25 per cent of what the American CEOs get (excluding stock options). The Swiss workers and the German workers get higherwages than the US workers (130 per cent and 106 per cent of the US wage, respectively), while their CEOs get paid only 55 per cent and 64 per cent of the US salaries (once again, excluding share options, which are much higher in the US).[5]
Thus seen, US managers are over-priced. The American workers get paid only 15 per cent or so more than their counterparts in competitor nations, while the American CEOs are paid at least twice (compared to the Swiss managers, excluding stock options) and possibly up to twenty times (compared to the Japanese managers, including stock options) that of what their counterparts in comparable countries are paid. Despite this, the American CEOs are running companies that are no better, and frequently worse, than their Japanese or European competitors.
1
L. Mishel, J. Bernstein and H. Shierholz,
4
Mishel et al., op. cit., table 3.A2. The thirteen countries are Australia, Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, New Zealand, Spain, Sweden, Switzerland and the UK.