Addressing Liberal Gripes with CEO Pay, Part II

Author: Vale

Maximum Wage sml

Almost every week a new article comes out about income inequality. The usual villain chosen by the authors is the role of the CEO. It's never the politician, the actor, or athlete, not that it would somehow make their argument any more coherent.

They claim that CEO pay is unjustified, and lament the fact that CEO pay has grown so much more than entry level pay over the last several decades. They, of course, cannot articulate reasons why CEOs are overpaid and instead use a circular argument revolving back to the growth in compensation among the two groups. Clearly these journalists and blog writers don't have a clue what responsibilities a CEO has. But I never understood why there is so much utter whining about the independent decisions of  a  company making its own money and then paying its own employees with that money in mutual agreement on the amount. 

  • Growth Differences

Usually the authors start citing statistics that CEO pay has increased X times while the entry level worker's pay has only increased Y times (with X being much greater than Y). Where's the relevance? Factors that may have affected the growth of CEO pay over those decades include higher educational requirements, larger companies, more employees under management, higher company profit, new laws they are subject to (such as Sarbanes-Oxley), more products, globalized firms, mergers and entirely new industries. Factors that may have affected the decline of entry level pay: more competitors from illegal immigration, dying industries that require no skills and can use foreign labor or automation. So the pay for unskilled workers has stagnated over the last two decades, but CEO pay has grown several times over that same period? So what? Why should we expect CEO pay to follow the path of the lowest skilled workers when our economy is increasingly requiring workers with a higher skill set? If ATMs are replacing bank tellers then demand for those jobs will decrease, which means the average pay for those same jobs will follow suit. But the founder of the ATM company is going to sell a lot of machines and be paid handsomely. Except that this example applies more generally as the lowest skilled jobs are being driven out of existence and being replaced with fewer high skilled jobs. The problem lies with the low skilled worker and only they can make the choices to be more valuable in the economy.

  • Not Really Comparable

And how does the top talent compare with the lowest talent anyway? It's like comparing the speed of a Bugatti Veyron with a Kia Rio. There is absolutely no relation between the two except both being automobiles. The Veyron is a $1 million state-of-the-art machine with a 1000 HP engine and body made out of carbon fiber, while the Rio is a bare-boned entry level car priced for the masses. Similarly, our generic CEO went to Harvard, has an MBA, has 25 years of experience in the industry, is 57 years old while the our generic entry level employee is still in high school, has no experience and is 16 years old. While the CEO role is highly specialized, requires a particular educational and experience level, and the magnitude of the decisions reverberates throughout the entire company and can make or break the company's future, the entry level worker's job can be replaced with trained chimps. And somehow there is supposed to be a pay relation between them?

  • Biased Sample

Another  issue I have with CEO pay complaint is that they are looking at a very small biased sample. Usually the media uses the average pay for the top 500 largest companies, which is about $10 million per year. Of that sample, the distribution is skewed even further because only 170 CEOs (34%) make that or more. So the complaint really centers on a biased subset of data consisting of 170 people in the country and comparing it with the entry level job that, by definition, anyone on the planet could do. While we are making outrageous comparisons, why don't we just go ahead and juxtapose the pay for the #1 CEO and the lowest earning human on the planet? Or why don't we get more realistic and view all CEOs in the country of all company sizes and find that the average compensation is actually about $170,000? Well that wouldn't have the same media cache.

  • Why No Maximum Wage?

Of course there are arguments to cap CEO pay. Why? The way the populists look at it is that if the CEO is getting more, then he or she is taking it from everyone else. They apparently think that if they slice off a million dollars from the CEO's compensation, then that will filter down into everyone else's paycheck. But it doesn't work that way. The CEO pay has nothing to do with your pay unless that company is paying out completely all of its revenue (like a 'non-profit' does). It's not like pouring a CEO a glass of water into another cup and giving whatever is left over to the rest of the employees. CEO pay is a drop in the bucket of firm revenue, and total employee compensation is usually about a third of revenues. Most established firms leave some money as profit to invest back into the business (known as "retained earnings*"). So it is a grasping assumption that paying someone else less leads to more pay for you.

  • Closing

The closing fact is that CEOs are rare. You aren't. That's why they make so much more than you.

And I will leave you with this thought: Why is it that when these populists finally find a very profitable industry that pays its employees very well, shares the highest amount of revenue with employees and shareholders of all industries, do they then attack that industry, throw fits, call them "greedy," and protest? That industry is finance.

* On a related point, some companies earn so much that they start accumulating billion dollar stock piles. Populists usually attack these too as "hoarding wealth". Apple could pay out 1.3 million dollars to every employee in the company. Does that mean they should just because they can? Would that action benefit future business developments or the shareholders who own the business? Would anyone just give money away for the sake of it? The key point they are missing is that established companies aren't spending 100% of their revenues on compensation. Just because someone else is getting paid more, does not mean that another person is getting paid less and reducing someone else's pay increases the pay for others!

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