Are CEO Salaries Too High?

It’s a perennial question, but one that still merits examination, given that one of the big complaints of the Occupy Wall Street movement has to do with the increasing wage disparity between the income-and-or-wealth of the top 1% vs the rest of us.

Economist Mike Moffat offered some new perspective on this yesterday, when he pointed out on twitter that “More NHLers earn 6 million+ a year than Canadian CEOs do.” And while sports commentators and fans sometimes roll their eyes at the astronomical salaries top athletes currently command, they’re not exactly taking to the streets in protest.

So why are people so outraged by executive compensation, but not by the salaries of sports figures?

There are two different questions to ask the question of “are CEOs paid too much.”

One is to ask whether CEO salaries are too high given what they contribute to the firms they manage. That’s a question that primarily concerns the shareholders and employees of a firm, who need to know whether their multi-million-dollar CEO is worth the money. Does hiring “Mr. A,” who insists on $6 million in pay, rather than hiring “Mr. B.”, who would work for a mere $3 million, bring more than an extra $3 million in offsetting revenue to the company? If so, then Mr. A is worth the money. If not, then he’s not. And my non-expert impression of the economic literature on this count is that evidence is mixed. Lots of CEOs aren’t worth the money. Lots are. The correlation, overall, is unclear.

The problem of how much to pay CEOs from this point of view, and what combination of kinds of payment to offer (cash, stock options, etc.), is hotly debated by top business scholars and economists. But it’s worth remembering that the money isn’t just all sitting there in a big pot, waiting to be distributed among the CEO, other workers, and shareholders. Each of those contribute some value to business. The hard question is how much.

The second way to look at CEO compensation is to ask whether CEO salaries are, in some sense, too high from a social point of view. That is, is it simply unconscionable that some people are paid that much? It is in this regard that Mike Moffat’s question about CEOs vs NHL players becomes interesting. Philosopher Robert Nozick famously raised this question of sports figures’ salaries over 30 years ago, as a way of investigating fundamental questions of justice. Modernizing Nozick’s example, we could look at a star player like the Pittsburgh Penguins’ Sidney Crosby, who was paid $9 million for the 2010-11 season. That’s a lot of money, in anyone’s eyes. But consider the process that results in that sum. Imagine how many fans Crosby has, and how many of them would each be willing to pay a dollar to see him play. It’s not hard to imagine 9 million fans, each happy — indeed, eager! — to hand over a dollar to see Crosby play. The net result is $9 million (taxable) in Crosby’s pocket, and no one else involved feels bad about it.

It’s not hard to translate Nozick’s example into business terms. Imagine a CEO who gets $9 million in total compensation. We’ll simplify and assume that’s all cash, which it never is. We’ll further simplify by looking only at the interests of employees (leaving out customers and shareholders). If the company is a fairly big one, and has 30,000 employees, then the Nozickean question is this: can we imagine each of those 30,000 employees voluntarily transferring $300 to their CEO for the value he adds to their lives? If that CEO leads the company to flourish — or, in tough economic times, even just to survive — then it’s at least plausible. And if so, then (says Nozick) there’s little grounds for complaint by employees, and even less grounds for complaint by anyone else. People might question the end result, but none can fault the fairness of the process that would have (or could have) resulted in it.

Now none of this amounts to saying that all is right in the world of CEO compensation. Many, many people inside the world of business will tell you that the situation is out of hand. And I agree. There have been outrageous abuses. The point here is just this: the fact that someone is highly paid isn’t automatically unfair. Sometimes it is unfair, and sometimes it isn’t. We need to look carefully, on a case-by-case basis, at what that individual contributes to the business they manage, and what that firm contributes to society.


See also: “Executive Compensation,” from the Concise Encyclopedia of Business Ethics.

11 comments so far

  1. Zhi Dai on

    Dear Professor Chris,

    I just read your blog and found it very interesting. I am very confused right now with this protest going on because I, myself, am a business management student. This is my last semester at Ryerson and I’ve been trying to make a plan with what I am going to do with my future. Apparently, my aspirations and goals are to obtain an MBA and hopefully become an executive in a well-known corporation. My second choice would be to take over my family’s business.

    My point here is that my mentality has changed after studying business. In fact, some professors even encourage students to be greedy since greed can lead to success. But I have been asking myself what the real meaning of success was? would making a lot of money make me a successful person?

    Even after asking these questions to myself, I am still inclined towards achieving my personal goals, which again is to work for a big corporation or take over my family’s business. Therefore, if I am aspiring to be that 1% of the population, does that mean that I have no right to support the protestors?

    By the way, I am in your Ethics Class at Ryerson University.

    • Chris MacDonald on

      Zhi:

      There’s a lot in that question! I’ll focus on your last question (though I’m happy to talk to you in person about the rest of it).
      There’s no reason not to support the protestors, if you believe in their cause and their methods. The fact that you aspire to being among the wealthy 1% doesn’t matter — lots of people who are wealthy are supporting the protest, and who you are (and your wealth) is separate from the quality of your arguments!

      CM.

  2. Charles Killin on

    Two things spring to mind when I read your article. First, you’ve got to consider the principle of risk and reward. Pro athletes risk career-ending injuries all the time—and they risk getting sent down to the minors if the don’t “produce.” CEOs don’t take the same kind of risks. They get millions whether they produce or not because of the golden parachutes in their contracts. I’d love to see a CEO get sent down to middle management for a rehab assignment.

    Second, whether the CEO leads the company to do well or not has little or nothing to do with how much the rank and file get paid. Most corporations don’t share profits among the employees. They use “industry norms” for rates of pay, which is interesting because all companies in that industry have a vested interest in keeping these norms as low as possible.

    • Chris MacDonald on

      Charles:

      Thanks for your comment. I agree with all of that, I think. Just to be clear, I don’t take any of that as contradicting anything in the blog entry above. The analogy between athletes and CEOs is not intended to show that they’re both worth millions of dollars per year. It’s just to show that there are processes that can result in great wealth that don’t involve any procedural injustice. And you’re right that the rank and file don’t get paid according to how well the company does (except at those companies where share ownership is common, as it was at Enron for example). But the rank and file do depend on having a good CEO to keep the company solvent, which determines whether they have a paycheque or not at all.

      Chris.

      • Charles Killin on

        Well, when you ask the question, “So why are people so outraged by executive compensation, but not by the salaries of sports figures? I think it’s because the talent of a sports figure is obvious, they’re taking real risks to play the sport, they must play it well or be demoted, and they usually come from ordinary families. A CEO’s talent is not obvious, they don’t take any risks to earn the money, they don’t necessarily have to do well to stay where they are, and many come from wealthy and powerful families.

      • Chris MacDonald on

        Charles:

        You’re right, I did ask that didn’t I? lol I guess the point is that, once you see the force of my main argument, you basically have to look at the sorts of more complex factors that you’re looking at, on a case-by-case basis. I think that generally — with exceptions — being a CEO does require significant talent, personal risk-taking, etc. I don’t believe that running a major corporation is something that just anyone can do. But even if you disagree with me, at least we’ve moved the discussion past the point of people simply asserting that a high salary must be unjust.

        Chris.

  3. Jerome Miskell on

    CEO’s do lead and ultimately answer for the success of a company, but are not necessary responsible for failure or success. In order to suceed, the policies they create have to be implemented by a talented and driven work force. In a company reorg that involves cutting jobs and salaries and results in a rising stock price the CEO does the easy job. A monkey can cuts jobs, budgets, and salaries. The remaining rank and file have to do all of the heavy lifting. The end result? Bonus for the CEO, lower salaries for the rifed employees.

    True, one can construct arguments for a fair process that results in a executive salary that bears little resemblance to their management and below counterparts, but the end result will still be unfair and damaging to the company. CEO’s do not work five times the number of hours, with five times the stress, and five times the responsibility of their presidents. Their presidents do not work ten times the hours, with ten times the stress, and ten times the responsibility of their vice-presidents, etc, etc, but this is the typical corporate salary structure. A gradually increasing gradient for the rank and file and then craziness at the executive level.

    Want to see our economy turn around? Limit all American executive pay based upon a company’s worth with the top compensation packages capped at $2,000,000.00 for the largest companies. Exceptions could be made, but only with a heavily punitive tax (say %75 on all earnings above the cap). US corporations would see an unprecedented influx of cash through compensation savings that could be used for investment, additional hiring, and higher dividends. Time to rif the CEO’s I say. Work harder for less. It’s the American way for the 99%. If they can make more money over seas, God bless them. I imagine we can still find talented individuals to apply for jobs that pays two million.

    • Chris MacDonald on

      Jerome:

      Thanks for your comment. A couple of points:
      1) Cutting is only easy if you’re talking about butchering, rather than surgery.
      2) Hours worked and stress levels are not viable measures of value. If a CEO improves productivity more than the next-best available candidate would (and if the difference is greater than his salary), then he’s got an argument for being worth what he’s paid.

  4. Andrew on

    I have to disagree on the athletes comparison. In my opinion sports actually has some of the most equal pay and here is why.

    Athletes in my opinion are the equivalent to skilled workers in any business. They are the ones producing the product. Each team also has a CEO/Owner which is the same as in other business.

    Athletes and CEO/Owners of teams income is largely in line with one another. Making the business profit to employee pay more evenly distributed.

    In normal business this is not the case. CEO’s receive a vastly larger piece of the profit pie…. even though some of the skilled labor in the company are, if not more valuable to the revenue, production and success of a company.

    • Chris MacDonald on

      Andrew:

      My point wasn’t about equality within an industry. It was about justifying or critiquing accumulation of large amounts of wealth, which is something athletes and CEOs definitely have in common.

  5. Jakub F. Jensen on

    I’m research salaries across different industries and proposals to a more just distribution. It’s too early to share the research but one approach you be to tie to the lowest and highest salaries, as e.g. http://theothermanifesto.org/ suggests:

    “In the free world which we envision, no one is allowed to earn more than one hundred times the global average minimum wage, nor to own more than one hundred times what the global average person owns. ”

    How would this be perceived here?


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