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executive pay
Dec. 2nd, 2009 11:56 amAn article in last week's New York magazine discusses the dispute over pay and "bonuses" for upper executives at AIG and other bailed-out giant financial companies. The executives in question, when asked/ordered to give up the majority of those bonuses, have at least two valid points. First, the amounts they're supposed to be getting were specified in their job offers, so if the company doesn't pay them it's in breach of contract, just as if my employer decided on a whim not to give me my paycheck this month. Second, many of them weren't around to make the bad decisions that led to the collapse; they're just here to clean up the mess, so why should they be penalized?
The third point, however, I find more interesting and troublesome: the company needs to pay these salaries in order to attract really good managers. (The experience of the past few years shows how successful that strategy has been... but never mind that.) In fact, the company (and all its shareholders) does have a vested interest in paying its executives competitively, so the best managers don't walk off and go to a competing firm.
So that's one vested interest. But by itself, it doesn't determine salary levels: if the prevailing salary for CEO's were $100,000 rather than $10,000,000, and my company were paying the prevailing salary, we'd still be able to get a good CEO, but for a hundredth the price (and much less political price).
So who sets executive pay? Boards of directors. Most of whom are themselves upper executives, or retired upper executives, at other financial firms, whose friends and relatives tend to also be upper executives at financial firms. As directors (and probably major shareholders) of this company, of course, they have a vested interest in the company being successful, and therefore in it paying competitive executive salaries. But they also have a vested interest in the company (and all the other companies) paying high executive salaries, because the "prevailing" salaries directly affect what they themselves get paid.
Who has a vested interest in prevailing executive salaries being low? Shareholders (and employees), because executive salaries are a (small but significant) drain on the company's profitability. But they have no power over salaries except at their own company, and lowering salaries at their own company is (arguably) unilateral disarmament. So everyone with any actual power over executive salaries at Company X wants to raise them, for one reason or another; the result, not surprisingly, is an unchecked inflationary spiral, with top executives paid hundreds of times as much as their average employee.
My graduate school had a lot of student-run co-ops and collectives: a bookstore co-op, a food co-op, a restaurant co-op, a clerical-supplies co-op, etc. Some of these (like the bookstore) were in direct competition with more traditional businesses, like The University Bookstore or the fast-food franchises in the University Center. I recall somebody in the Administration complaining about the "lack of accountability" in the co-ops, because their members set their own salaries. It struck me that this was a much more "accountable" situation than the "traditional" for-profit businesses. At a co-op, no one employee was paid much more than another; if they all set their salaries too high, the co-op would go bankrupt and they would all lose their jobs. At the Bookstore, the manager could set his own salary high and those of his clerks low so the store wouldn't go bankrupt, and this situation could go on for years.
But if the bookstore co-op had been competing for "top managerial talent" with The University Bookstore, it would have lost. There's no incentive for any company to be the first one to pay its top executives "only" ten times, rather than a hundred times, what its average employee makes, and every incentive in the other direction.
How could one solve this problem?
The third point, however, I find more interesting and troublesome: the company needs to pay these salaries in order to attract really good managers. (The experience of the past few years shows how successful that strategy has been... but never mind that.) In fact, the company (and all its shareholders) does have a vested interest in paying its executives competitively, so the best managers don't walk off and go to a competing firm.
So that's one vested interest. But by itself, it doesn't determine salary levels: if the prevailing salary for CEO's were $100,000 rather than $10,000,000, and my company were paying the prevailing salary, we'd still be able to get a good CEO, but for a hundredth the price (and much less political price).
So who sets executive pay? Boards of directors. Most of whom are themselves upper executives, or retired upper executives, at other financial firms, whose friends and relatives tend to also be upper executives at financial firms. As directors (and probably major shareholders) of this company, of course, they have a vested interest in the company being successful, and therefore in it paying competitive executive salaries. But they also have a vested interest in the company (and all the other companies) paying high executive salaries, because the "prevailing" salaries directly affect what they themselves get paid.
Who has a vested interest in prevailing executive salaries being low? Shareholders (and employees), because executive salaries are a (small but significant) drain on the company's profitability. But they have no power over salaries except at their own company, and lowering salaries at their own company is (arguably) unilateral disarmament. So everyone with any actual power over executive salaries at Company X wants to raise them, for one reason or another; the result, not surprisingly, is an unchecked inflationary spiral, with top executives paid hundreds of times as much as their average employee.
My graduate school had a lot of student-run co-ops and collectives: a bookstore co-op, a food co-op, a restaurant co-op, a clerical-supplies co-op, etc. Some of these (like the bookstore) were in direct competition with more traditional businesses, like The University Bookstore or the fast-food franchises in the University Center. I recall somebody in the Administration complaining about the "lack of accountability" in the co-ops, because their members set their own salaries. It struck me that this was a much more "accountable" situation than the "traditional" for-profit businesses. At a co-op, no one employee was paid much more than another; if they all set their salaries too high, the co-op would go bankrupt and they would all lose their jobs. At the Bookstore, the manager could set his own salary high and those of his clerks low so the store wouldn't go bankrupt, and this situation could go on for years.
But if the bookstore co-op had been competing for "top managerial talent" with The University Bookstore, it would have lost. There's no incentive for any company to be the first one to pay its top executives "only" ten times, rather than a hundred times, what its average employee makes, and every incentive in the other direction.
How could one solve this problem?
