Executive pay

2007-01-25

in Daily updates, Economics, Politics, Rants

This week’s Economist features a survey on executive pay that basically argues that, while there have been excesses, executive pay is generally awarded in a fair and legal way. The crux of the matter, as presented, is that executives earn less in pay than they add to the value of the company. More specifically, they add more than the most qualified person willing to work for less could.

At one point, the article holds up Robert Nardelli from Home Depot as an example. When he left the company, he got a severance package of $200 million. Even if his performance did earn more than that from the company, I think a case can be made that it is fundamentally unjust for one human being to have that much money. It enormously outstrips the needs a person could possibly have, and it is awarded in a world where millions domestically and billions around the world live in poverty. While emotionally satisfying, that argument may be fallacious: poverty alleviation is not the alternative usage for this money, and there isn’t a fixed amount of the money in the world to be distributed to one thing or another. It is at least logically possible that the economic contributions of chief executives do generate societal benefits.

Is the marginal value versus marginal cost perspective really the right way to evaluate executive pay? The degree to which the public tends to view such people as little better than venomous snakes suggests that the idea clashes with general moral intuitions. (Personally, I don’t think that venomous snakes belong in the category of things to which moral judgments can be applied; they are like large falling stones.) Of course, that doesn’t advance argument very far on the matter of what could or should be done about it. As discussed before, the problem is not that inequality is inherently morally problematic, but rather that it seems impossible that the differences between one human being and another could justify such excessive differences in payment. Furthermore, the reasons for which any such differences might exist are largely the product of chance.

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{ 18 comments… read them below or add one }

Ben January 25, 2007 at 5:16 pm

The question is who or what is unjust about the situation. Here I think Cohen is right – it’s unjust of these people to demand so much, when they could work for less. (Though possibly it depends what else they think will be done with the money – it might be right to demand £200m provided you then give most of it to the poor/charity)

Tristan Laing January 25, 2007 at 6:14 pm

Milan, this is a small problem, whose awnser doesn’t exist aside from the large one. The large problem is – is legal structure that coorperations operate inside of just? Is it just for a coorperation to be beholden to its shareholders above the public good? Etc, etc, I believe if these fundamental problems were solved, we would not have these problems to contend with.

The notion that inequality itself is not morally problematic is false – the Millian sphere does not exist. One person’s being well off makes everyone else less well off because its scientifically (and also, people have just known this for a long time) proven that people evaluate their happiness relative to others. Thus, it’s not that Rawls is wrong, it’s that you need to add another value into the equation – inequality can’t be justified on absolute terms (i.e. it’s justified because it makes the least well off 1$ richer), but needs to be justified on terms which reflect the fact that people feel worse off because of the inequality, full stop.

Considering this, the fact that some executives make 200 million dollar severance packages, makes everyone in society depressed. It’s difficult to quantify the social cost of these severance packages because different people obviously experience the phenomenon to different extents (i.e. those who feel the salaries are fundamentally unjust because they are too large will feel even more worse off than those who think they are just, but still see their own saleries as tiny in comparison).

Liberalism tried to develop an ethical system that would justify the status quo, but again and again its failed. I think this is simply because ethical systems based on people’s moral intuitions (and their codification into moral laws) appear close to the status quo, because for the most part people generally agree with the society they live in (after all, they were raised in it). However, capitalism in current forms produces contradictions between it’s ideals and its realities that makes inequality a problem, and makes the happiness of others important. However, capitalism doesn’t actually have any resources to deal with inequality (it survives off the structure of inequality – without desperately poor countries we could simply not have become so rich). So, we have courses and papers that you read (and the Economist) that try to contain the problems using only the moral intuitions that are containable within the sytem (such as in this case, the notion that one’s pay can be ethically determined from the amount to which one benefits a company). This is a fine intuition – except that it holds no water when it stands besides the company’s externalities which it does not pay for, like Environmental damage in special economic zones, like the perpetuation of misery and poverty, like union crushing etc.. etc… To compensate a person for their positive contribution is hypocritical if one does not also compensate parties for negative contributions.

Anon @ Wadh January 25, 2007 at 7:51 pm

What you are saying here is that inequality is a problem in itself when:

a) It is excessive

b) It is not very obviously earned

You are probably right to say that this is more about peoples’ emotions than about logical or moral argument.

Anon @ Wadh January 25, 2007 at 7:56 pm

Tristan,

At one point, letting women have senior jobs in government probably made a lot of people depressed. Does that mean we should have banned it?

Tristan Laing January 25, 2007 at 11:44 pm

Anon,

No, what I’m saying is that inequality is itself a moral problem because the millian sphere, in which you can do anything you want as long as you don’t hurt others, is a lie – because the things that you do that don’t seem to affect others, actually do.

I don’t think it’s an invalid point to raise against women’s equality, that it may have a psychological cost on a large portion of the population. However, in this cause that value is outweighed obviously by the value of gender equality which is something the state has a right to paternally enforce, mostly because it has paternally enforced the opposite for the previous 2000 years.

Anon @ Wadh January 26, 2007 at 12:56 am

No good Tristan. What about some tiny minority group that the majority really loves to beat up on? Say, the Roma in Europe.

There, the utility of racist enjoyment far exceeds the disutility of being discriminated against.

Tristan Laing January 26, 2007 at 4:30 am

Utility isn’t the be all and end all of morality, but it also isn’t something to be ignored.

Milan January 26, 2007 at 6:38 am

inequality is itself a moral problem because the millian sphere, in which you can do anything you want as long as you don’t hurt others, is a lie – because the things that you do that don’t seem to affect others, actually do.

Isn’t this self-contradictory? When you say that the reality of harm to others makes inequality a violation of the harm principle, you are arguing that it is problematic in its consequences, not inherently. The project, then, is the standard economic one of internalizing third party effects.

Utility isn’t the be all and end all of morality, but it also isn’t something to be ignored.

On the utility issue, I think it is entirely possible for people to have preferences that should not be satisfied, no matter how happy it would make them. How you formulate that, exactly, is tricky.

The protection of the unpopular may well be a democratic virtue, if not a necessity.

Ben January 26, 2007 at 10:05 am

Various things I do may have some indirect effect on others, but that doesn’t violate the harm principle. Two men walking hand in hand down Cornmarket St may upset homophobes, but that is not a relevant or legitimate harm (if harm at all). The fact company directors and footballers ‘earn’ obscene salaries may upset those who compare themselves to such figures, but that’s irrelevant. They shouldn’t be doing so – that’s the kind of attitude that earns egalitarianism the ‘politics of envy’ tag…

. August 16, 2010 at 11:48 am

Regulating pay

This house believes that bosses’ pay is none of the government’s business.

Mark Calabria
Director of Financial Regulation Studies, Cato Institute

Eliminating government guarantees should be the preferred approach, rather than creating intrusive regulatory schemes that seek to control moral hazard, especially when those regulatory schemes have at best a mixed record, if not one of outright failure.

Wayne Guay
Yageo Professor of Accounting, Wharton School, University of Pennsylvania

Disclosures about pay, and more importantly executive incentive structures, are of great interest in understanding how a firm is governed, and lack of transparency in this regard undermines the public’s confidence in the integrity of corporate America.

Tristan August 17, 2010 at 1:08 am

I’m on vacation – do you think I’m going to debate this?

. August 23, 2010 at 3:31 pm

“Nonetheless, the story has intensified a necessary debate about how to avoid rewarding bad leadership. The financial crisis revealed that top bankers were fabulously remunerated for doing what turned out to be a lousy job. Some pocketed immense bonuses when they falsely appeared to be doing well, and then kept much of the loot when their firms collapsed. Other industries sometimes pay handsomely for failure, too (see table). It is not only business-bashing politicians who find this upsetting. “If I was running things,” growled Warren Buffett, an investor, in January, “if a bank had to go to the government for help, the CEO and his wife would forfeit all their net worth.”

That might satisfy the public’s appetite for executive blood. But it is highly unlikely to happen. “Boards of directors feel embarrassed about removing the chief executive and it is not their money, so they tend to be generous,” says Nell Minow of the Corporate Library, a corporate-governance research firm. Failed bosses are seldom fired. Instead, they are usually allowed to resign or retire with dignity, and usually with money thrown at them. This culture of sympathy will be hard to break, not least since most board members are current or former bosses and may feel that “There, but for the grace of God, go I.”

More importantly, ruining bad bosses is a bad idea. Who would want to take a job that came with a serious risk of financial destruction? Whoever did take it would surely manage in a way that minimised the risk of catastrophic failure. That sounds peachy until you remember that capitalism depends on risk-taking. Penalise failure too harshly and “you risk creating bureaucrats,” says Ira Kay of Pay Governance, an executive-pay consultancy.”

. September 6, 2010 at 12:36 pm

“Such facts are inevitably followed by the impossible-to-answer question, do they deserve it? While the corporate world has certainly gotten more complex over the last 50 years, it’s hard to make the case that CEOs themselves have gotten any smarter, or that investors are doing a better job of judging a CEO’s success. Compensation levels are all too often driven by short-term thinking. The CEOs of the 50 firms that laid off the most workers since the onset of the economic crisis took home 42 percent more pay in 2009 than their peers did—largely because cutting workers boosts short-term profits and appeals to Wall Street. Yet a growing body of academic research suggests that downsizing doesn’t always lead to increased profitability over the longer haul, or even lower costs. There are many reasons for this, ranging from the fact that companies going into layoff mode often lose their best workers to competitors, to the toll taken on R&D spending, which is what produces the revenue and growth potential of the future.

While one can argue the merits of layoffs on a company-by-company basis, what’s striking is that the executives who are the most willing to ax workers also seem to be the least likely to tighten their own belts. Management guru Peter Drucker once noted that after CEO-to-worker pay ratios went above 25–1, major moral questions started to be raised. It will be hard to make employees believe that “we’re all in this together” when it becomes clear in public documents that company leaders have largely insulated themselves from any financial risk.

The larger issue of growing inequity in the Western world is a tough one to tackle; the forces of globalization that have led to stagnating wages aren’t going to disappear. But executive pay could be made fairer and more transparent. For starters, corporate America might take a page out of the European playbook. In countries like Germany, which boasts many of the world’s most competitive and productive companies, worker representatives often sit on corporate boards, providing a check against bloated pay packages.”

oleh September 6, 2010 at 12:54 pm

Occasionally in the newspapers I will read of CEO’s of some companies receiving compensation in extraordinary amounts – say over $100 million dollars. I wonder possibly use that amount in any natural way.

I expect it is a form of competitiveness where the CEO sees it as a measure of the stature of that CEO as against other CEO’s.

Perhaps they could follow the example of some of the world’s wealthiest people (such as Bill and Melinda Gates and Warren Buffet) and commit to contributing at least half to worthwhile causes.

Milan September 11, 2010 at 12:22 pm

Doesn’t it seem logical that either CEOs deserve their pay or they do not? Suggesting that they have an obligation to give some to charity suggests they never deserved it in the first place. That being said, I agree that voluntary giving is laudable, at least when compared with not doing so.

Tristan September 12, 2010 at 9:54 am

“Doesn’t it seem logical that either CEOs deserve their pay or they do not?”

Non contradiction applies only when the attribute is applied to the subject “in the same way”. So it’s quite possible that, in a sense, CEOs deserve their pay, while in another sense, they do not. They difficult thing is to understand these different senses.

. September 26, 2010 at 7:12 pm

“Mr Pfeffer starts by rubbishing the notion that the world is just—that the best way to win power is to be good at your job. The relationship between rewards and competence is loose at best. Bob Nardelli was a disastrous CEO of Home Depot. But he was paid nearly a quarter of a billion dollars to leave and quickly moved to the top slot at Chrysler, which then went bankrupt. Mr Pfeffer points out that CEOs who presided over three years of poor earnings and led their firms into bankruptcy only faced a 50% chance of losing their jobs (and perfectly successful senior managers are routinely cleaned out when new CEOs take over). There are plenty of things that matter more than competence, such as the ability to project drive and self-confidence.

The best way to increase your chances of reaching the top is to choose the right department to join. The most powerful departments are the ones that have produced the current big-wigs (R&D in Germany, finance in America), and the ones that pay the most. But the trick is to find the department that is on the rise. Robert McNamara and his fellow whizz kids flourished in post-war America because they realised that power was shifting to finance. Zia Yusuf zoomed up the ranks of SAP, a German software company, because he offered something that the engineering-dominated company lacked: expertise in corporate strategy. Men with pay-TV backgrounds have risen in media companies like News Corporation and Time Warner—rightly so, given the importance of cable and satellite TV to those businesses. “

. March 13, 2012 at 7:26 pm

Former NYT CEO paid $23.7M exit package; company netted $3M over the past 4 years

Outgoing New York Times CEO Janet Robinson received an exit package worth $23.7 million after presiding over an eight year tenure that saw the company’s share price fall by 80 percent. The company’s net earnings over the past four years were $3 million. In addition to her exit package, Robinson earned a $1 million annual salary.

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