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E-MailI was shocked (but encouraged) to read the New York Times yesterday. Instead of writing another article about how CEOs are massively overpaid, dishonest, or both, Andrew Sorkin and Eric Dash make a strong argument that U.S. CEOs are underpaid! According to the article, private equity firms are increasingly successful in luring talented public company executives to run private equity-funded firms. A big part of the reason is that private equity firms pay those executives more.
Consider what this exodus of talented public company executives to private equity-funded companies means. These executives can certainly get hired as CEOs of public companies. If they were so overpaid, they would not leave the public companies. The fact is that many of them are leaving to run private equity-funded companies.
This also suggests that CEOs do not control their boards and get the boards to overpay them. On the contrary, the fact that CEOs are leaving suggests that public company boards may not be paying their good CEOs enough. I am encouraged because it may finally have become apparent, even to the New York Times, that U.S. CEOs, boards, and corporate governance are subject to market forces. In addition to the fact that public-company CEOs can earn more as private-equity company CEOs, here are a few additional observations that suggest that the criticism of CEOs and boards may have gone too far.
First, the CEO job at large companies is less secure today than it has been in any time over the last 35 years. In a recent paper, Bernadette Minton and I show that CEO turnover at Fortune 500 companies has been running at over 16% per year since 1998. This compares to about 10% per year in the 1970s. In other words, a CEO can expect to have his or her job for six years today versus ten years back in the 1970s.
Second, CEO turnover at those large companies is strongly linked to the companies’ stock performance relative to the industry as well as the performance of the industry. Since 1998, that link has been stronger than in any other period since 1970. Said another way, boards do pay attention to a company’s stock performance and have been doing so for quite a while. Contrary to reports that they were unusual, the public dismissals of Hank McKinnell at Pfizer and Bob Nardelli at Home Depot turn out to be very typical of the last eight years. McKinnel and Nardelli each served for only six years or so and both presided over poor stock performance relative to their industries. Pfizer’s industry also performed poorly relative to the overall stock market.
Third, despite much that is written, realized CEO pay is strongly related to firm stock performance. In a recent paper, Josh Rauh and I sorted the firms in the ExecuComp database into ten groups based on realized compensation in 2004. We then looked at how the stocks of each group performed relative to their industry. According to the critics, we should not have found much of a correlation. In fact, we found a strong one. Realized compensation is highly related to performance. CEOs in the top decile of realized compensation saw their firms outperform their industries over the previous three years by more than 50%. CEOs in the bottom decile saw their firms underperform by more than 25%. As you go from the lowest-paid to the highest-paid executives, performance always increases.
Fourth, as Xavier Gabaix and Augustin Landier point out, CEO compensation should be tied to firm size. And firm size has increased markedly in the United States over the last thirty years.
It is a fact that top executives of public U.S. companiesare paid a lot today, and a lot more than they have been paid in the past. The high pay combined with questionable behavior by some CEOs and boards has led the press and some academics to conclude that average CEO pay is excessive, driven by dishonest, manipulative top executives and ineffective boards.
The discussion and evidence above calls that conclusion into question. One has to wonder how overpaid public company executives are when private equity investors (who do not have an incentive to overpay) will pay them more. And public company boards appear to have been more active in managing CEOs than they are given credit for.
5 Comments
Hi,
Thank you for the interesting post. It really puts things in a different perspective.
A minor point: when in the first paragraph you write “Instead of writing another article about how CEOs are massively underpaid, dishonest, or both…” you presumably mean to say “overpaid” – which would be the conventional wisdom reinforced by the New York Times.
Cheers,
A. Kvetch
It does say “overpaid”
Yes, I do think that CEOs are not overpaid, but I think one of the biggest issues is the golden parachute effect created failing CEOs in this time of turmoil. One of the biggest issues is that CEOs that have run their company into bankruptcy should not be paid to leave the company.
I think what may have brought the question up was when a company was performing poorly and the CEO was still locked in to make millions in bonuses and a million dollar parachute. In a down cycle economy, weak leaders companies perform poorly. Strong leaders take the poor leader’s business, and become to big to fail at some point, as government has long forgotten their role (no monopolies, etc.) in a free market, or perhaps they were influenced to let them be. That is another discussion…
I believe the right question may be, are employees underpaid?
If you look at sports coaches, they are on a contract. They can win or lose, and keep their jobs or get fired. No one really complains about the coaches salaries, because they are often less than the players- who by the way, are also on a contract. They can produce and get more, or fail and get cut. The money isn’t the issue, as it was in the contract.
Now, let’s come back to the question, but apply it in a similar light. If a CEO makes 10 million, and the players make from 1 to 50 million, and the business is profitable and winning, who are we to cry wolf? After all, they are all making what they are valued at, and they all agreed to work for that amount, right? Perhaps the key is contracted labor for all employees? Would that eliminate worker’s comp insurance and administration?
If we buy their product- sports or other business- at a price that supports those salaries, and the business model is sustainable, who cares? Why don’t we start the same business and make our millions too?
Regulation of salaries is the wrong approach, in my opinion. We need to break up the monopolies and allow small business the chance to make a comeback, as they will bring back better wages to the risk takers.
Plus, if we do regulate salaries, how about starting with the government? Some of them make much more in salary and benefits than the free market. Trust me- I have looked! On second thought, just stop salary regulation, as the thought of more money spent on people to regulate others makes me ill…plus my government employee friends will get mad at me, and I don’t want them to make less and lose their pensions…maybe they will hire me someday and I will understand. lol
Have these trends in high CEO pay been good for the economy???? When I look around me, I’m not sure. Maybe the shareholders need to strenthen the workforce. It may prove to be better for the bottom line than a streamlining CEO.