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Why CEOs Actually Deserve Their Gazillion-Dollar Salaries

5 minute read
Cowen is Holbert L. Harris Chair of Economics at George Mason University and the author most recently of [tempo-ecommerce src="https://www.amazon.com/dp/1250110548" title="Big Business: A Love Letter to an American Anti-Hero" context="body"].

It is fashionable today to bash Big Business. And there is one issue on which the many critics agree: CEO pay. We hear that CEOs are paid too much (or too much relative to workers), or that they rig others’ pay, or that their pay is insufficiently related to positive outcomes. But the more likely truth is CEO pay is largely caused by intense competition.

It is true that CEO pay has gone up—top ones may make 300 times the pay of typical workers on average, and since the mid-1970s, CEO pay for large publicly traded American corporations has, by varying estimates, gone up by about 500%. The typical CEO of a top American corporation—from the 350 largest such companies—now makes about $18.9 million a year.

While individual cases of overpayment definitely exist, in general, the determinants of CEO pay are not so mysterious and not so mired in corruption. In fact, overall CEO compensation for the top companies rises pretty much in lockstep with the value of those companies on the stock market.

The best model for understanding the growth of CEO pay, though, is that of limited CEO talent in a world where business opportunities for the top firms are growing rapidly. The efforts of America’s highest-earning 1% have been one of the more dynamic elements of the global economy. It’s not popular to say, but one reason their pay has gone up so much is that CEOs really have upped their game relative to many other workers in the U.S. economy.

Today’s CEO, at least for major American firms, must have many more skills than simply being able to “run the company.” CEOs must have a good sense of financial markets and maybe even how the company should trade in them. They also need better public relations skills than their predecessors, as the costs of even a minor slipup can be significant. Then there’s the fact that large American companies are much more globalized than ever before, with supply chains spread across a larger number of countries. To lead in that system requires knowledge that is fairly mind-boggling.

There is yet another trend: virtually all major American companies are becoming tech companies, one way or another. An agribusiness company, for instance, may focus on R&D in highly IT-intensive areas such as genome sequencing. Similarly, it is hard to do a good job running the Walt Disney Company just by picking good movie scripts and courting stars; you also need to build a firm capable of creating significant CGI products for animated movies at the highest levels of technical sophistication and with many frontier innovations along the way.

On top of all of this, major CEOs still have to do the job they have always done—which includes motivating employees, serving as an internal role model, helping to define and extend a corporate culture, understanding the internal accounting, and presenting budgets and business plans to the board. Good CEOs are some of the world’s most potent creators and have some of the very deepest skills of understanding.

The common idea that high CEO pay is mainly about ripping people off doesn’t explain history very well. By most measures, corporate governance has become a lot tighter and more rigorous since the 1970s. Yet it is principally during this period of stronger governance that CEO pay has been high and rising. That suggests it is in the broader corporate interest to recruit top candidates for increasingly tough jobs.

Furthermore, the highest CEO salaries are paid to outside candidates, not to the cozy insider picks, another sign that high CEO pay is not some kind of depredation at the expense of the rest of the company. And the stock market reacts positively when companies tie CEO pay to, say, stock prices, a sign that those practices build up corporate value not just for the CEO.

There is also reason to question criticisms of CEO pay that focus much more on issues of economic inequality. In general, within business firms, returns to higher-tier workers have not risen relative to the pay of the lower-tier workers—except for the few at the very top. Changing pay scales within firms are not major drivers of income inequality.

In fact, the main driver has been the blossoming of superstar firms that sell an innovative product and have global reach, as well as productivity shifts that benefit those companies especially. These firms include Google, Facebook, Boeing and Verizon. Typically, everyone in these companies—from senior managers to personal assistants—is paid more than workers at their more traditional counterparts. But that reality makes for a less juicy narrative than stories of CEOs taking money from their workers.

The overall value of superstar firms is yet another reason a first-rate CEO can be so very, very valuable. Building such an operation helps those firms raise wages for just about everyone. So the real question, looking forward, is what we might do to get more of those companies, so that more people’s pay can go up.

Adapted from Big Business: A Love Letter to an American Anti-Hero by Tyler Cowen. Copyright © 2019 by the author and reprinted with permission of St. Martin’s Press, LLC.

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