October 24th, 2020

A closer look at CEOs’ pay


By Lethbridge Herald Opinon on January 21, 2020.

Pay increase related to value of their skills

Vincent Geloso

SENIOR FELLOW, THE FRASER INSTITUTE

In debates about inequality, some people – including some economists – claim the salaries and compensation of chief executive officers aren’t linked to performance. Essentially, they don’t really earn their money.

This claim, repeated ad nauseam in recent years, is misleading to say the least.

As noted in my recent study published by the Fraser Institute, CEO pay has increased over the last decade but the increase is perfectly related to the value of CEO skills. Thanks to globalization, large firms face greater competition. Moreover, the accelerated pace of technological innovation means these firms regularly compete with new potential substitutes (e.g. cable television companies versus streaming services, hotel chains versus Airbnb). Consequently, small errors in management can create large costs. Therefore, to attract highly-skilled managers, companies are willing to pay more.

The economics, economic history and management literature confirms this. It shows that administration boards hire CEOs with considerably more technical skills than in the past. For example, in the 1930s less than 10 per cent of corporate executives had post-graduate masters and doctorates compared to 60 per cent today. Clearly, the demand for top management skills has increased substantially.

But this increased demand has not been matched by increasing supply.

Why?

Because some of these skills can’t be easily transferred from firm to firm (e.g. the skills needed to run a hotel chain differ from those needed to run an automobile manufacturer). This reality constrains the supply of elite management skills. Thus, as demand grows for these skills and supply lags, pay increases, just like in any other labour market.

What’s rarely mentioned in public debate about inequality, however, is that this dearth of supply comes with a downside for managers. If boards are willing to pay more to hire executives that will avoid costly mistakes, they’re also willing to spend more to track CEO performance and fire the CEO the instant it becomes clear that a hiring decision was unwise.

Some economists estimate that between 38 and 55 per cent of CEO turnover is “performance-induced” (the CEO is fired for disappointing results). This is why those who make it to the top don’t stay there long. For example, of the top 100 CEOs in Canada in 2007, only 32 remained in the top 100 five years later. Ten years later, that number dropped to 15.

Furthermore, some people exaggerate the extent of CEO pay relative to the pay of the average worker by using apples-to-oranges comparisons. For example, they compare the cash pay of all workers to the total compensation of the top 100 CEOs and arrive at a ratio of 197 to one. But a much more instructive apple-to-apple comparison – comparing the total compensation of the top 1,000 CEOs (the maximum number available in databases) with the workers in the firms managed by those same CEOs – dramatically shrinks the ratio of CEO-to-worker compensation by 81 per cent.

Finally, there’s an important nuance that few acknowledge when discussing CEO pay – the incentives of administration boards. Boards choose a CEO based on the ability to generate profits. Crucially, if political factors are relevant to generate profits, boards will choose candidates with political clout and acumen. If a firm’s profits are tied to government subsidies, trade barriers and regulations that prevent competitors from entering the market, political clout will be of paramount importance in the hiring process. Pay will be conditioned on political skills rather than market skills.

To critics, this type of arrangement, where CEOs are paid for their political standing, seems unfair and unbalanced. And in some cases, they may have a point. But they shouldn’t blame the CEOs, they should blame political meddling in the marketplace, which produces these perverse incentives among administration boards.

These facts and nuances should always inform debate about CEO pay in Canada and beyond.

Vincent Geloso is a senior fellow at the Fraser Institute and an assistant professor of economics at King’s University College at Western University Canada. Distributed by Troy Media.

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Fescue

As the Bard said: The Fraser Institute doth protest too much, methinks.

All these contortions to convince people that the CEO actually adds the value they take in wages, stock options, benefits, and the inevitable golden handshake.

“The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labor which it enables him to purchase or command. Labor, therefore, is the real measure of the exchangeable value of all commodities.”

This from the supreme deity of the F.I.: ‘Labour the is real measure of exchange’ – so, just how much labour does a CEO do? how much more does his education and skill-set add to this value, compared, say, to an equally well educated school teacher or nurse? how much more precarious is his or her (but mostly his) job compared to the average person working today?

Based on any of the criteria presented in this commentary, workers (who actually add value to commodities and services) should be paid much more.

Worse, this sort of apologetic only emboldens pseudo-CEOs in other industries outside of manufacturing. Take the embarrassing wages for the CEOs of our University and College, or many upper managers of the health regions and school superintendents, for example.

Seth Anthony

What a CEO is paid in the private sector is no ones business. Public sector CEOs and upper management are the only legitamate concern.

Fescue

Do you think massive and growing inequalities of wage and wealth can be deleterious to society? Destabilizing democracy, inciting class conflict, and the like?

Seth Anthony

Fescue, of course I do. However, that is irrelevant to what I posted.

Fescue

And paying CEOs astronomical salaries and benefits creates this wealth disparity.

Here is another one: It has been estimated that the top 10% of wealth holders in society are responsible for 50% of ghg emissions – through their personal, luxury consumption. Would bringing these people back down to earth not be an easy first step to reducing emissions worldwide (along with a lot of other types of pollution)?

Seth Anthony

You’re really going off on tangents today Fescue. Let’s first resolve what we were initially discussing:

Are you suggesting that PRIVATE companies should be forced to limit what they pay their employees? (CEOs and upper management included)

IMO

When public funds are utilised to bail out private companies, what a CEO is paid in the private sector becomes everyone’s business.

Think federal bail outs: Bombardier, GM. Think 1.6 billion dollar federal bail out to Alberta O&G, 2 billion for steel and aluminium companies, 1 billion for softwood lumber.

Think the Alberta government’s 4.7 billion dollar, so they say, corporate tax bail out. In reality, the total is closer to 6 billion (see SEDAR online).

This state of affairs should be everyone’s legitimate concern.

Seth Anthony

IMO, then those companies should then be considered public. As such, my point stands.

biff

seth – i feel it is worth looking into both placing a ceiling on income and a floor on how little (particularly for those that are the working poor). perhaps this might be a way to limit the consumerist disaster that is wrecking the planet.
points presented here by fes and imo are valid, given certain actions bring about reactions that too much affect (and undermine) the whole. i feel their take and yours are not so much apple and orange comparisons as you may be thinking.
as for the point of the article, there is no justifying the kind of remuneration too many ceos take home…how about that great guy running boeing, for an off the cuff example…but then again, there is no justifying the salaries of the likes of our city manager, alberta school superintendents, professional athletes/entertainers and so on. trying to make sense of it, to me, is too much like being banged on a funny bone: am i crying in or laughing at the pain of it all.

Seth Anthony

So Biff, if you owned a business, what would you do if I demanded to know what you pay your manager, and if I thought it was too high, then I would force you to pay your manager less? I’m thinking you would tell me to mind my own business…and rightfully so.

So no, Fescue’s and IMO’s points are not valid unless you and they are ok with violating human rights.

biff

seth – i appreciate the question. my point as stated is simply to examine whether placing a limit on individual income, and a floor, brings about notable and worthy net benefits for the whole. as such, if the upper limit is say 200k, then one’s earnings from all ventures is 200k – it will come out in the revenue canada wash (at least reported income will). if you wish to pay me 100k to clean tables, i can still earn another 100k through various other endeavours.
my feeling is that the gap between top and bottom needs to be closed, considerably…i’ll toss out a 10:1 ratio, just for a sake of reference. to that i add we need to regulate ourselves far more towards a needs based society, and be far less wants based. that there remain so many that cannot see the madness of it all, is kind of…maddening.