How did executive pay get so high? |

How did executive pay get so high?

Alan Braunholtz

Locally, I’m hearing a few comments about high CEO pay and how “it’s wrong.” I guess people are reacting to the perceived unfairness of it all.

Fairness is an inherent trait of many animals. Experiments with monkeys reveal that they will throw a fit (and their treat) if another monkey gets a better reward for the same task or worst of all, a reward for no work. Any one with dogs knows that try to sneak one dog a treat and the other will indignantly snuffle up on its canine justice patrol.

“It’s not fair” is pretty much the theme tune of childhood, and while annoying it’s a good sign. Wanting one’s just rewards is a big motivator to reach your potential. With kids, though, it’s directed most vociferously at their siblings.

Fairness is a very relative thing and you compare yourself to your peers.

CEO pay is a complex issue and CEOs I’m sure compare themselves to other CEOs. Across the board (and with the help of it) CEO pay is going through the roof. Why?

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The basic reason is the spread of the “winner takes all” economy in which small differences in performance result in huge differences in reward. Athletics is the most obvious example of this. Win a gold medal and you’re rich. Come in fourth and I hope you competed for your own enjoyment and growth. With TVs and CDs, everyone around the world enjoys the top talents. Fifty years ago you went to a local field or concert hall to see performers not quite as gifted as the best. The new technology (and free agency for sports) has removed restrictions on the market power of the very best.

The same is happening in other fields. With the global economy we can buy the best computer in the world, not the one that happens to be made near us. We will also know which one is top rated in its category, thanks to the global information boom.

Companies are larger and compete on a global scale more than ever before and there is greater demand for the people who run them well. Businesses used to hire almost exclusively from within (a restriction on movement of labor). Now they hire not only from rivals, but also unrelated industries. The result, a free agency bidding war for the perceived top performers.

The top executive in the U.S. now earns 400 times the wage of his/her typical hourly employee, up from a ratio of 35 to 1 in 1973.

Free market economists see this as just reward for their unique “human capital” (education, training, insights, education, etc). Critics point to the executive world as a rich man’s club, all sitting on each other’s boards, paying each other outrageous sums while keeping the normal world of competition and social inhibitions out of sight behind wood paneled doors.

Both are probably right. Steve Jobs looks to be worth every cent at Apple Computers. A lot of people still have jobs because of Steve and I’m sure other executives are doing equally well.

The behavior of American Airlines last April bolsters the rich man’s club argument. While negotiating employee pay cuts of 16-23 percent, eliminating 7,000 jobs, reduced benefits on the strength of battling bankruptcy and an “all for one, one for all” executive pay cut, the board secretly approved large bonuses and a $41 million special executive retirement plan to be paid even if American went bankrupt.

It’s hard not to be cynical when executive pay keeps rising at over 10 percent a year even in years when corporate performance declines significantly. When stocks go up, they take all the credit. When they go down, then it’s the market’s fault.

Executive pay in other countries is rising but doesn’t come close to our 400 to 1 ratio. Britain averages 25 to 1 and Japan 10 to 1, and their executives work as hard as anyone. It’ll be interesting to see how the global free market addresses this imbalance. Will companies start importing under priced executives from abroad?

Rising CEO pay will be a fact of life in our global economy and I believe it’ll keep rising as the companies, markets and stakes get higher. I’m more concerned at the perception of backroom deals helping out an entrenched elite rather than rewarding performance.

Britain passed a law requiring that corporations disclose executive pay packagers and put them to a shareholder vote. Another idea to make companies more careful with large salaries is a Bill HR 2691 by Democrat Martin Sabo. Currently, these huge salaries are termed a “reasonable business” expense and deducted from corporate income tax. Sabo’s Income Equity Act redefines “reasonable” as up to 25 times the lowest paid worker. Above that and your executive pay comes from the corporate funds without a taxpayer subsidy, so they’d better be worth it.

If your complaints about high executive pay are less to do with value for money and more to do with “it’s not fair,” then think of the poor in Africa. If you’re worried about the harmful effects of gross income inequity on our society and economy (poverty, sickness, crime, an uneducated resentful work force, etc.) then remember we’re living in the world of economic trickle down theory. So all will be well, eventually.

Alan Braunholtz of Vail writes a weekly column for the Daily.

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