Lack of justification for high executive pay


in Economics, Politics

The most convincing proof of the failure of corporate governance and of the absence of a rational productivity justification for extremely high executive pay is that when we collect data about individual firms (which we can do for publicly owned corporations in all the rich countries), it is very difficult to explain the observed variations in terms of firm performance. If we look at various performance indicators, such as sales growth, profits, and so on, we can break down the observed variance as a sum of other variances: variance due to causes external to the firm (such as the general state of the economy, raw material price shocks, variations in the exchange rate, average performance of other firms in the same sector, etc.) plus other “nonexternal” variances. Only the latter can be significantly affected by the decisions of the firm’s managers. If executive pay were determined by marginal productivity, one would expect its variance to have little to do with external variances and to depend solely or primarily on nonexternal variances. In fact, we observe just the opposite: it is when sales and profits increase for external reasons that executive pay rises most rapidly. This is particularly clear in the case of US corporations: Bertrand and Mullainhatan refer to this phenomenon as “pay for luck.”

Piketty, Thomas (Translated by Arthur Goldhammer). Capital in the Twenty-First Century. 2014. p. 334-5 (hardcover)

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