Why CEO Salaries are so High
Important facts about CEO salaries tend to be ignored by the news media. The back-story, the realities of CEO compensation, are far more complex than what can fit into a 30-second series of sound-bites on the evening news, and the complexities are often overlooked in even the more in-depth written stories.
Yet these points are a key to understanding why it is that CEOs make the money they do. Nobody understands this perhaps better than Thomas Sowell, who has taught economics at institutions such as Cornell, UCLA and Amherst. He is currently a scholar-in-residence at the Hoover Institution, Stanford University.
Sowell provides provides a thoughtful context for CEO salaries.
“Among the bountiful supply of fallacies about income and wealth are the following:
1. Except for the rich, the incomes of Americans have stagnated for years.
2. The American middle class is growing smaller.
3. Over the years, the poor have been getting poorer.
4. Corporate executives are overpaid, at the expense of both stockholders and consumers (pg. 124).”“The high pay of corporate executives in general, and of chief executive officers in particular, has attracted much popular, media, and political attention – much more so than the similar or higher pay of professional athletes, movie stars, media celebrities, and others in very high income brackets. While the top ten corporate executives earned an average of $59 million each in 2004, the top 10 celebrities earned an average of $119 million each that same year – twice as much. Yet it is rare – almost unheard of – to hear criticisms of the incomes of sports, movie, or media stars, much less hear heated denunciations of them for ‘greed.’*
“One of the most popular – and most fallacious – explanations of the very high salaries of corporate executives is ‘greed.’ But when your salary depends on what other people are willing to pay you, you can be the greediest person on earth and that will not raise your pay by a dime” (pg. 141).
So why is it that corporate CEOs make so much money? Sowell says that the simple answer is the basic principle of supply and demand. Further, there’s a sound economic reason for high CEO compensation packages, namely the impact CEOs have on high-stakes corporate decisions.
“Given the billions of dollars at stake in corporate decisions, $59 million a year can be a bargain for someone who can reduce mistakes by 10 percent and thereby save the corporation $100 million…. For example, the director of the company that publishes the Washington Post assessed the recommendations of one member of his board of directors this way: ‘Mr. Buffet’s recommendations to management have been worth – no question – billions’” (pp. 142-143).
It should now be obvious why corporate leaders receive what are dubbed golden parachutes upon termination. Simply, if CEO decision making is faulty and is in fact costing the company money, a “lucrative” severance package may in fact be a cost-saving investment for the company. Again, Sowell explains:
“…Putting an end to a relationship may be just as valuable, or even more valuable, than the initial beginning of the relationship once seemed. As with the original hiring decision, neither stockholders nor consumers nor other employees are worse off for the payment of a large severance package, if that cuts losses that would have been bigger if the failed CEO stayed on” (pp. 144-155).
At the least, the next time a story airs that mentions leadership salaries in contexts deemed negative, it is likely that only a sliver of the picture is being revealed. To adequately understand the myths and realities of CEO compensation requires truer objectivity and a more thorough understanding of corporate trends beyond what headlines and charged storylines procure.
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*Activist filmmaker Michael Moore, who frequently attacks corporations in his films, said on Larry King Live in November:
“… [W]e’ve allowed a few people at the top to get filthy rich…. The Ford chairman is making something like $22 million a year and his company lost $2 billion last year. The G.M. chairman is making $15 million a year. His company lost $39 billion last year. And he’s rewarded with a $15 million payout. I mean this is — this is just absolutely insane….”
Moore himself is said to be worth more than $50 million.
Melanie
1 year ago
OK, I agree that Michael Moore’s comments were disingenuous. But to claim that greed isn’t a factor in corporate compensation schemes and to say that this is a simple issue of supply and demand is to ignore the underlying problem: unbridled capitalism itself. In the words of genius economic professor Willem Houwink: “Capitalism is extraordinarily cruel.”
I say this as someone who believes in entrepreneurship and capitalism — but not in the unrestrained form that led to the global economic meltdown, or that keeps the majority of Mexicans in poverty, for example.
The claim that criticism of celebrities’ salaries is “almost unheard of” makes me discount Sowell’s other remarks. What ivory tower is he living in?
OSMAN DENIZTEKIN
8 months ago
So what Mr. Sowell’s account boils down to is: Damned if you do (keep the failing CEO in place) and damned if you don’t (and fire him with a hefty compensation package as good riddance alimony.) Either way it’s the stakeholders’ money (or even taxpayers’ money, when the corporation needs to be bailed out thanks to the same CEO and cohorts) that is paid in return for failure. As for celebrities’ compensation, Mr. Sowell is just spining the facts: If Michael Jordan or M.Moore earned tens of millions a year, it was because the former’s team (Chicago Bulls) got 6 NBA titles in 8 years; and the latter’s documentaries had very good box office returns. Do you think either of them could have earned as much if they hadn’t? It amazes me how sometimes the best educated people can overlook the simplest facts and come up with such uneducated arguments!