The Dangers of Regulating Exectutive Pay

Though there's no such thing as a guarantee of future profits when hiring top management, one can try the following thought experiment as though there was such a guarantee:

If, you as a company's board member, knew for certain that by hiring a certain CEO the company would increase the bottom-line by $25 million [before the cost of his or her salary, of course] a year, what would be a rational amount to spend for that certain CEO's services. The answer, of course, is any amount up to one dollar less than 25 million because up to that point, the company is still making more of a profit, right? Yes, even in this hypothetical scenario it is far more complicated than that because the salary of the CEO will change the bottom-line numbers but the priniple behind the thought experiment remains be solid.

Makes sense!! How much of the political thrust on CEO compensation is driven by envy?

Always keep in mind that true wealth is control over the disposition of assets and has nothing to do with who owns the deed to the asset. If I control the use of your car (who, when and where), I effectively own it except that you have to pay the taxes and beg me to use it. If we allow bureaucrats and politicians to set CEO pay, we will have the bureaucrats/politicians as the true owners/controllers of the firms and get results based upon their levels of competence (usually not very high), not the CEO's.

Don do you have a link to the uncut version? What they took out might be as interesting as what they left in.

It's not a big stretch from regulating executive pay to regulating everyone's pay.

Here is a simple plan for regulating pay that should be acceptable to right and left.

The SEC should pass a regulation requiring that all publicly traded companies allow their shareholders to vote on the following (binding) resolution each year.

"The total compensation of both the CEO and the CFO shall not exceed $1 million in the coming fiscal year."

Those who dislike government meddling in business have little to complain of here since the government isn't telling any business how to set salaries. The government is just requiring that business owners be allowed to vote on a specific option.

What would happen of such a regulation were in place? Senior executives would complain long and loudly. Many large shareholders --- especially pension funds --- would gladly vote for lower compensation. Many mutual funds would feel pressured to do so. My guess is that the resolution would pass at many companies.

There would then be significant (downward) pressure on executive salaries across the board. If you're the CEO/CFO of a big company, there are very few employees who you think should be paid more than you are. Of course, this won't allow you to pay people (much) less than they could get elsewhere, but the number of people for whose services the "market" is willing to pay more than $1 million per year is small. The very best baseball players, rock stars, entrepreneurs and Wall Street traders would still make millions, but only because any attempt to lower their pay would cause them to go elsewhere with their talents.

Some would say that this plan won't work since the companies whose shareholders agree to pay more than $1 million per year (whether they be public or private companies) will snap up all the "best" executive talent. Maybe. But, our ability to measure executive talent is so limited that it would be hard for any company to easily identify a CEO candidate who is significantly better than many other candidates for the job.

There is a sense in which such a scheme, if implemented, would amount to implicit collusion among the employers of senior executives. Perhaps. But collusion in the service of class warfare is no vice.

The SEC should pass a regulation requiring that all publicly traded companies allow their shareholders to vote on the following (binding) resolution each year.

This requirement would be undue meddling in corporate governance.

On the other hand, ordering electoral procedures of all sorts on corporate employees wishing to bargain collectively is essential to the democratic order.

What is the philosophical difference between the minimum wage and Obama's apparent dream of setting the maximum wage? To me, it seems to be two sides of the same coin. Both represent wrong-headed gov't intervention into the labor market by those with more heart than brains (I'm giving them the benefit of the doubt and not assuming they are simply power-craving busibodies who want to tell the rest of us what to do just b/c they can).

How many of us could oversee organizations employing thousands or even hundreds of thousands of employees? How many of us have the judgment necessary for deciding when to expand a product line, close a factory, or relocate a headquarters? How many of us have the people skills required to ensure that teams of workers perform together productively, day after day?

The honest answer is "not many."

Honest or deferential?

If we chose fortune 500 CEOs by lot among graduates of reputable universities with a B average or better and paid them a quarter million dollars a year, I suppose little would change. Competition for the positions would still be fierce, because a quarter million is still a very enviable salary, and the perks of being a Fortune 500 CEO far exceed the salary.

Some of these CEOs would preside over multi-billion dollar profits and some would preside over losses, because profits of this magnitude are characteristic of a Fortune 500 company.

No test we could perform a priori could distinguish the CEOs presiding over the largest profits from the others, but people would nonetheless say that the CEOs presiding over large profits are "more valuable". This observation is an instance of post hoc ergo propter hoc.

I believe so, because I accept a Hayekian theory of spontaneous order in a market economy, and I therefore believe that effective central planning is impossible. That's why I follow this site. A few CEOs don't decide which productive organizations succeed in the market in a given season. Millions of free consumers decide.

I don't only believe that central authorities in a planning apparatus are not smart enough to plan large-scale economic organization. I believe they cannot be smart enough. Large-scale economic organization can exist in a market economic. It just can't be "planned" in the conventional sense.

Similarly, many people believe that Presidents of the United States presiding over the nation during times of relative economic prosperity must be responsible for the prosperity somehow. Muirgeo is a good example. These people talk about their favorite presidents this way, just as Don talks about corporate presidents in the nominally "private" sector this way.

Some "libertarians" seem to believe that practically omniscient central planners are impossible only in the socialist state sector. In the nominally "private" sector of a corporative state, expecting these miraculous wise men to add incredible value to resources through their unparalleled foresight and boundless intellect is completely reasonable.

Large-scale economic organization can exist in a market economy.

A few days ago, I heard Obama pontificate on his awesome responsibility as Commander in Chief. Notably, he said, "Only one man is the President." He spoke the words, so I relate the emphasis in his voice, but the emphasis is his, not mine.

As a libertarian, other words came spontaneously to my mind. "The President is only one man." I think that sums it up.

In the scenario above, one thing would change. Fewer CEOs would appropriate fortunes from corporate bottom lines and then go on to found new corporations with the loot, even competing corporations. For this reason, I oppose limits of the kind Obama favors. I instead favor a progressive consumption tax.

I also oppose enforcement of any contractual provision prohibiting this behavior by a CEO. Corporations may write any terms they like into any contract they like. I just don't want states enforcing these particular terms.

How about regulating civil service? Maybe term limits?

I could go along with that. At least, I'd eliminate benefits unavailable in the private sector, particularly in the civil service pension programs.

Can we learn something here from the NFL? The NFL has a salary cap so that no one team can have a monopoly on all the talent and theoretically make the NFL more competitive. I can assume we all want competition in the NFL and Market????

Do companies that pay the most for their top executives monopolize the executive talent and therefore create a less competitive market?


Maybe, the government is in favor of markets and competition and against monopolies and therefore knows what it is doing to regulate executive pay, as per the NFL example; however, it chooses words such as "greed" to appease the voters?


I doubt it too, but anything is possible.


Go Patriots!

Do companies that pay the most for their top executives monopolize the executive talent and therefore create a less competitive market?

No. The companies that pay the most for their executive talent are the ones that believe a theory of "executive talent" that somehow correlates this metric, however vaguely measured, with the future performance of the companies.

In reality, large companies generating large profits have thousands of factors of production, even tens or hundreds of thousands. The CEO is only one of these factors and not a particularly critical one. In fact, the larger the company and the larger its profits, the less critical a particular CEO is to the company's success.

Similarly, large, national economies cannot be centrally planned. Particular statesmen are not simply inept at economic planning. That's not the theory accept. Central planning for optimal utility is fundamentally impossible, because a large, national economy is a chaotic, dynamic system.

Maximizing utility within a nation (or the profitability of a large corporation) requires satisfying millions of free consumer-producer-investors simultaneously, and central authorities just can't do that. If they could, I'd be a socialist.

Where is the statistical evidence that high CEO salaries correlate with future corporate profitability? Measuring this correlation is trivial. I only need to know CEO salaries and corporate profitability five years later. The relevant data presumably are public, for publicly traded companies at least. Where is the measurement?

"

thought experiment as though there was such a guarantee:

If, you as a company's board

"

Although thought experiments are terribly unscientific, nevertheless they remind me of Albert Einstein thus make me feel so important.

Here is another thought experiment:

If most of what CEO does are things similar to President Johnson's taking all the silver out of our coins, thus CEO is increasing profits for himself and other shareholders but decreasing the wealth within the pockets of the plebeians. He gets paid to take the real lobster out of our can of soup? He gets paid to rob us? That old weirdrdrdo?

Gimme a break

!

Αμάτι Nώνυμος

Patience.

Surfisto: The kind of competition we want in sports is very different from the kind of competition we want to see in business. In sports, we want to see evenly matched teams or players competing against each other for the sake of the excitement. It would be boring to watch Michael Jordan playing against Danny Divitto, except maybe for the comedy value. It certainly would not be exciting because the outcome is certain. But in business, we want businesses to excell, no matter the quality of their competitors. Wallmart is going to beat a mom and pop operation every time for most goods, unless the mom and pop store specializes in a way that takes them out of competition with Wallmart. Who cares if this isn't exciting? Taking Wallmart down to a level where the mom and pop store would deprive us of the low prices made possible by Wallmart's economies of scale and business structure. What we want from competition is the low prices, and anything you do to increase competition defeats this purpose.

That second last sentance should be "Taking Wallmart down to a level where the mom and pop store could compete would deprive us of the low prices made possible by Wallmart's economies of scale and business structure."

Martin Brock: I think your first paragraph possibly strengthens my agrument.

"No. The companies that pay the most for their executive talent are the ones that believe a theory of "executive talent" that somehow correlates this metric, however vaguely measured, with the future performance of the companies."

Using another sports analogy, The Yankees typically have a much higher payroll than any other team in baseball. The teams that pay the most for their talent believe a theory of "talent" that somehow correlates this metric with the future performance of the team. (wins)

So if the Yankees monopolize the talent they create less competition. Many would argure the NFL is far more competitive than MLB because of the salary cap.

So if executive pay is regulated, top talent would go to different firms, possibly medicore or poor firms (that possibly otherwise would have failed) and raise their value creating a more competitive market.

SaulOhio: Point taken. The competition that we want to see is different.

Incentives obviously matter, if one company is offering more of an incentive ($$$, although there are other incentives) they will attract top executive talent. You also have a good point "But in business, we want businesses to excell, no matter the quality of their competitors." The best thing a company can do for the good of the world is to be as profitable as possible.

I guess I am torn by your last sentence;

"What we want from competition is the low prices, and anything you do to increase competition defeats this purpose."

Should we spread executive talent out more or keep the best executives at the best companies? Would increasing competition in this sense hinder lower prices, I am not sure?

"Should we spread executive talent out more or keep the best executives at the best companies? Would increasing competition in this sense hinder lower prices, I am not sure?"

Who decides who is the best executive? The government implementing its own competition and production plan, or the people directly involved, such as the stockholders and boardmembers?

Maybe certain industried NEED better executives, because they do not at the moment supply consumer needs all that well. Or maybe a certain company needs the better executives in order to make the best use of its resources. I say lets not make the decisions based on politics or some standard for competition that is out of context with the reasons why we want competition. Let the market decide.

>>If most of what CEO does are things similar to President Johnson's taking all the silver out of our coins, thus CEO is increasing profits for himself and other shareholders but decreasing the wealth within the pockets of the plebeians. <<

shoot,

You could post this drivel for a fourth time and it does not explain one thing: how does the demand for the company's goods or services continue if your world view is correct? It was a thought experiment, so please start thinking!

Surfisto,

How much does Bill Belicheck and the Patriots front office make relative to their peer group?

How wealthy is owner Bob Kraft relative to the other NFL owners?

So if the Yankees monopolize the talent they create less competition.

That's true only if the Yankees can predict a greater likelihood of future victory by paying more for "talent" it measures today. Similarly, price discrimination in life insurance is a profitable business model only if an insurer can distinguish one person from another based upon the likelihood of their death in the future.

Many would argure the NFL is far more competitive than MLB because of the salary cap.

People argue nonsense, mostly. I don't know about the NFL pay cap. I'd need to study the question in detail, and even if I did, cutting through my own nonsense can be challenging.

So if executive pay is regulated, top talent would go to different firms, possibly medicore or poor firms (that possibly otherwise would have failed) and raise their value creating a more competitive market.

Frankly, I doubt that top talent makes a lot of difference in this scenario. Again, I suppose you could pick CEOs of Fortune 500 companies by lot from minimally qualified applicants, and nothing much would change. Baseball players are different, because they don't try to direct the fortune of a complex, dynamic, chaotic, economic organization involving hundreds of thousands of people spread across a vast territory by issuing vague decrees from the top of a Manhattan skyscraper.

Once you realize that Fortune 500 CEOs are statesmen in a corporative state, you don't make meaningless distinctions between them and other statesmen presuming to calculate the incalculable.

(my writing here is a little sloppy, sorry abt that; i'm just doing this extemporaneously, if it was a pro job, i'd polish. not worth it for a quickie comment; not a short comment, i admit, but still a "quickie" :P )

agree on general principles, but 2 corollaries:

1. NO corporations should receive GOV'T/TAXPAYER FUNDED BAILOUTS, EVER!

basic principles of free enterprise dictate that companies should be allowed to fail (or succeed). bailing them out makes the companies into, at best, gov't make-work projects, at worst, corporate welfare bums.

(it's notable how the philosophies of the majority of people running large corporations change (or "evolve"), as suits their own best interests; i.e.: "FREE ENTERPRISE! get gov't off our backs!" & "damned welfare bums!"/becomes/"help 'US'!" & "give 'us' $")

if u wanna ride the rollercoaster, up comes with down, & u stay on it 2 the end :P

put it another way, using a popular conservative approach:

OWN YOUR ACTIONS, & TAKE RESPONSIBILITY FOR THEM

if they are spending MY MONEY; damned straight i want a say as to how much of it is going to line their pockets! (especially after they have bungled themselves into a financial mess in the first place!)

if it's the company's own $, then fine, it's btwn them & the shareholders. if it becomes criminal, that's what the justice system is for.

2. the current system; the way corporations are structured at present, is giving too much power to the boards & the executives, & too little power to the shareholders, who actually OWN THE COMPANY. this results in egregious abuses, such as the escalation of the pay system for senior execs to ABSURD levels.

most of these people ARE REPLACABLE, a lot of them are dime-a-dozen.

racking up big paychecks is part of the game; & the overwhelming majority of the senior-exec community is perfectly willing to play this game; it's in their own self-interest to do so, there are also obvious issues of ego...

under the current system. senior executive take-home pay has become EXTREMELY UNRELIABLE as an indicator of the actual value of the employee (at present, by the measure of "results", i think it is fair to say that the "market" for senior exec pay is a grossly-inflated bubble).

more importantly: in the current system, there is very little control in the corporate structure to limit this behavior: THESE IS NO MECHANISM THAT SERVES AS AN OBJECTIVE MEASURE; NOBODY TO SAY "NO".

THERE IS ALSO NO REAL "PUNISHMENT" FOR FAILURE

the system of determining worth/vale of senior exec level employees, & paying them accordingly needs to be based on ACTUAL VALUE of the employess,

& it needs to have mechanisms to both REWARD (success) & PUNISH (failure).

right now, the main punishment is a failure of the corporation, which hurts the shareholders & "normal" employees FAR MORE than the senior execs.

in a typical bankruptcy/restructuring it is the senior executives, presumably the people most directly responsible for the company's failure, who are hurt the least; they usually still get their take-home pay, often retain employment in the restructured company, & if they are "let go", it is almost always on extremely generous terms (especially for someone who has mis-managed a corporation into financial ruin!).

if salaries were structured on free-market principles (as the should be), most of the big paychecks would lose a decimal place, or two.

if salaries were structured along any kind of reasonable merit-based-system, the same would apply.

bottom line:

AS LONG AS NO GOV'T/TAXPAYER MONEY IS INVOLVED, fine, free market: let the corporations work it out between their various internal stakeholders, within the bounds of the law. (criminal behaviour is one of the categories of activity which a free market needs to be protected against, or it simply becomes anarchy; no rules = anarchy.)

BUT

THE CURRENT SYSTEM OF DETERMINING SENIOR EXEC PAY IS DEEPLY FLAWED.

it should be fixed more by changes in the basic rules by which companies operate, & by adjusting the balance of power between senior execs, board, & shareholders (also the rest of the employees/unions/etc.).

it will NOT be fixed by simple-minded regulatory payscale structures, imposed by the gov't, which fail to properly measure the merit/worth of the employees, & reward (or punish!) them accordingly. the pay scales in use in most gov't bureaucracies are splendid examples of the failures & shortcomings of such an approach.

copyedit of my previous post:

* agree on general principles, but 2 key points (i want to emphasize):

follow-up

i note that a number of the previous comments, in one way or another effectively concede the point that current senior exec payscale is a playground, where the rules are being made by the senior execs, in agreeable partnership with their boards.

shareholders ARE being left out, unless they control a large enough stake to significantly affect shareholder votes; in which case they become part of the club, & usually have close ties to the board & senior executive.

the pay limit vote plan is an interesting idea, on general principles, but it's FAR TOO NARROW!

letting shareholders have more control over the pay for senior execs & boardmembers is a good idea.

BUT

locking it in as a one ballot-measure vote, with the $ number arbitrarily set @ $1,000,000.00 (or any number value set arbitrarily), & ONLY affecting the CEO & CFO cripples the usefulness of the concept, at best; at worst, it distorts it into a potentially harmful approach.

i'd like to see more shareholder control of things such as senior-level employee pay, but the measures have to be more in-depth, thought out, & specific to the circumstances.

the voting issues would also need to be very clearly defined, & easy to understand, with all the relevant information available, accessable, & objectively compiled.

easier said than done; but something does need to change there.

a share/stock company IS A DEMOCRACY; you just have to pay for your voting rights, & you buy them one share at a time...

re: Martin Brock's comment; was that meant ironically?

re: obama criticism in general; all well & good, but:

WHERE THE HELL WERE YOU PEOPLE FOR THE LAST 8 YEARS OF GEORGE BUSH JR.!? :p

as a last word from me, in this thread;

...there's a lovely line, from somewhere-or-the-other, about how, even in a corporation where promotions are "by merit":

a successful employee will tend to get promoted up the corporate ladder, progressively going through all the jobs that they are actually good at...

it's when an employee gets to a job/level where they're not very good (but not quite bad enough to get fired and/or demoted), that they tend to settle in...

think of it as a ranking system based on "buoyancy"

...or, kind of like playing your way up through the levels in a video game; if you're young enough for that analogy to have meaning.

clarification:

re: re: Martin Brock's comment; was that meant ironically?

i meant his first comment:

____

The SEC should pass a regulation requiring that all publicly traded companies allow their shareholders to vote on the following (binding) resolution each year.

This requirement would be undue meddling in corporate governance.

On the other hand, ordering electoral procedures of all sorts on corporate employees wishing to bargain collectively is essential to the democratic order.

Posted by: Martin Brock | Jun 27, 2009 4:56:37 PM

____

(just noticed MB's name comes up more than once; personallu; i prefer boards where the commentor's name is above, or to the left of their comment. i find placing the names below the comments to be counter-intuitive; aka: i'm not used to it XD)

... was that meant ironically?

Yes. I really don't want Congress dictating details of elections among corporate shareholders, but I also don't want Congress dictating these details among workers who want to bargain collectively, effectively to incorporate. I don't see much difference in the two dictates, but I do see gross hypocrisy among politicians in this area.

Like I said, my panacea for the CEO pay problem, such as it is, is a progressive consumption tax and the non-enforcement of non-compete agreements.

I really don't care what a CEO, in cooperation with the board, manages to game out of a large corporation. If he reinvests a hundred million bucks of the corporation's profit outside of its bureaucratic constraints, his investment might be more useful.

Smaller investors in a large corporation might suffer a loss of shareholder value through this gaming, but that doesn't bother me so much. Corporations are not rent collectors for shareholders in my way of thinking. They're organizations of productive means for use. Shareholder value is a means to this end, not the end itself.