Since the start of this crisis, we’ve been regaled with stories of CEOs receiving lavish bonuses. Well-paid executives have been vilified as reckless and greedy. L.A. Times columnist Patt Morrison captured the mood when she declared: “I want blood.”
But this is nothing new.
Long before the current crisis, Warren Buffet, John McCain, President Obama, and many other critics condemned (supposedly) outrageous executive pay. “We have a [moral] deficit when CEOs are making more in ten minutes than some workers make in ten months,” Obama said during the presidential campaign.
With today’s government entanglement in business affairs, many Americans are open to attempts by Washington to slash CEO pay. Apparently hoping to exploit that opportunity, the chairman of the House Financial Services Committee, Barney Frank, recently floated the idea of extending the TARP executive pay caps to every financial institution, and potentially to all U.S. companies.
It’s understandable that taxpayers think they should have some say in how bailed out businesses are run, which is one reason why Washington should have never bailed-out those companies in the first place. But why have the critics been so intent on dictating to shareholders of private companies how much they can pay their CEOs?
It’s not because the supposed victims, shareholders, have been demanding it. A few ideologically motivated activists aside, most shareholders in the years leading up to the crisis weren’t complaining about CEO pay packages. Virtually every time they had a chance to vote on a “say on pay” resolution, which would have given them a non-binding vote on CEO compensation, shareholders rejected the measure. Even if they had been given a say, there is no reason to expect they would have put the brakes on high pay. In Britain, for instance, shareholders had a government-mandated right to vote on management compensation, yet CEO pay still rose unabated.
So what has the critics all riled up?
They allege that, despite appearances, executives were not really being paid for performance. Pointing to CEOs who raked in huge bonuses while their companies tanked, the critics say that executive pay was driven not by supply and demand, but by an old boys’ network that placed mutual back-scratching above shareholder welfare. As Obama put it last year, “What accounts for the change in CEO pay is not any market imperative. It’s cultural. At a time when average workers are experiencing little or no income growth, many of America’s CEOs have lost any sense of shame about grabbing whatever their . . . corporate boards will allow.”
It was a compelling tale, but this account of rising pay just doesn’t square with the facts. To name a few: (1) the rise in CEO pay was in line with that of other elite positions, such as professional athletes; (2) the rise in pay continued even as fewer CEOs chaired their board of directors; (3) the companies that paid CEOs the most generally had stock returns much greater than other companies in their industries, while companies that paid their CEOs the least underperformed in their industries.
The critics of CEO pay ignore all of this. They take it as obvious that executives making millions are overpaid. “It turns out that these shareholders, who are wonderfully thoughtful and collectively incisive, become quite stupid when it comes to paying the boss, the guy who works for them,” Barney Frank has said. But what kind of compensation package will attract, retain, and motivate the best CEO is a complicated question. Companies have to weigh thousands of facts and make many subtle judgments in order to assess what a CEO is worth.
What should be the mix between base salary and incentive pay? What kind of incentives should be offered; stock options, restricted stock options, stock appreciation rights? How should those incentives be structured; over what time frame and using which metrics? And what about a severance plan? What kind of plan will be necessary to attract the best candidate? And so forth and so on.
The mere fact that people make their living as executive-pay consultants illustrates how challenging the task is. Central planners like Frank cavalierly dismiss this and declare that they can somehow divine that lower pay for executives will not hinder a company.
Of course, a free market doesn’t eliminate mistakes. A company can hire an incompetent CEO, or structure a pay package that rewards executives for short-term profits at the expense of the company’s long-term welfare. But a company suffers from its mistakes: shareholders earn less, managers need to be fired, and competitors gain market share.
There is, however, something that can short-circuit this corrective process and help keep highly paid incompetents in business: government coercion.
Take the Williams Act, which restricts stock accumulation for the purpose of a takeover, for example. In a truly free market, if poor management is causing a company’s stock to tank, shareholders or outsiders are incentivized to buy enough shares to fire the CEO and improve company performance. But the Williams Act, among other regulations, makes ousting poor management more difficult.
And while the critics have tried to scapegoat “overpaid executives” for our current financial turmoil, the actual cause was, as past editions of Fusion have indicated, coercive government regulations and interventions. Far from vindicating the denunciations of “stupid” shareholders and “inept” CEOs, the recent economic downturn shows what happens when the government interferes with economic decision-making through policies such as the “affordable housing” crusade and the Fed’s artificially low interest rates.
If the critics’ goal were really to promote pay for performance, they would advocate an end to all such regulations and let the free market work.
But that’s not what they advocate. Instead, they call for more regulatory schemes, such as government-mandated “say on pay,” massive tax hikes on the rich, and even outright caps on executive compensation. They do not want pay to be determined by the market, reflect performance, or reward achievement — they just want it to be lower. Frank stated the point clearly when he threatened that if “say on pay” legislation doesn’t sufficiently reduce CEO compensation, “then we will do something more.” Another critic, discussing former Home Depot CEO Robert Nardelli, confessed that “it’s hard to believe that those leading the charge against his pay package . . . weren’t upset mainly by the fact that Nardelli had a $200 million pay package in the first place — no matter how he had performed.”
The critics want to bring down CEO pay, not because it is economically unjustifiable, but because they view it as morally unjustifiable. Prominent opponent of high CEO pay, Robert Reich, for instance, penned a Wall Street Journal column titled “CEOs Deserve Their Pay,” where he defended CEO pay from an economic standpoint, but denied that it was justified ethically. Insisting that wealth rightfully belongs to “society” rather than the individuals who create it, the critics maintain that “society” and not private owners should set salary levels. Many critics go so far as to regard all differences in income as morally unjust and the vast disparity between CEOs and their lowest-paid employees as morally obscene.
But it’s the attack on CEO pay that’s obscene.
Far from relying on nefarious backroom deals, successful CEOs earn their pay by creating vast amounts of wealth. Jack Welch, for instance, helped raise GE’s market value from $14 billion to $410 billion. Steve Jobs’s leadership famously turned a struggling Apple into an industry leader. Only a handful of people develop the virtues — vision, drive, knowledge, and ability — to successfully run a multibillion-dollar company. They deserve extraordinary compensation for their extraordinary achievements.
In smearing America’s great wealth creators as villains and attributing their high pay to greed and corruption rather than productive achievement, the critics want us to overlook the virtues that make CEOs successful. In demanding lower executive pay, despite the wishes of shareholders, the critics aim to deprive CEOs of their just desserts. In denouncing CEO pay for the sole reason that it’s higher than the pay of those who haven’t achieved so much, the critics seek to punish CEOs because they are successful.
Ultimately, how to pay CEOs is a question that only shareholders have a right to decide. But in today’s anti-business climate, it’s vital that we recognize the moral right of successful CEOs to huge rewards.
They earn them.