Why is ceo compensation so high

I think [CEOs] would still get out of bed in the morning and do a good job out of pride, because that's what they were trained to do. And it's still a lot of money! There is a wide range of theories about what will happen if inequality continues to expand at the current rate.

In a now-famous Politico article titled "The Pitchforks Are Coming… For Us Plutocrats," Nick Hanauer, a billionaire entrepreneur and self-identified "proud and unapologetic capitalist" says he worries that inequality is increasing at such a fast rate that the U. Before the revolution," Hanauer writes, predicting that pitchforks and guillotines are what is next if CEOs like him don't speak out against inequality.

And many have expressed disdain for billionaire entrepreneurs such as Jeff Bezos, Richard Branson and Elon Musk who have invested heavily in trips to space amid mounting inequality. Some even fear such billionaires will amass enough wealth to abandon the planet. Mishel continues, "The very first bill passed was the American Rescue Plan, which put us on a trajectory to have full employment by the end of We're expecting unemployment to be 3.

That's pretty good. He also references provisions in the reconciliation bill currently on the Hill that would create monetary penalties for companies that violate workers' union rights and a Biden executive order that asks the FTC to implement rules to limit or ban employers from forcing non-compete clauses on employees.

Now, if workers are able to assert themselves and do assert themselves, and reap results, that's going to make it harder for the CEOs to rake it in," says Mishel. And we will see inequality decline over the next five years. Skip Navigation. Since shareholders are a relatively privileged group themselves if not as privileged as CEOs , they could potentially wield power in this situation; policymakers should try to figure out how to enlist shareholders in the fight to restrain excess managerial pay.

What can be done about it: Policies should be passed that boost both the incentive for and the ability of shareholders to exercise greater control over excess CEO pay. Tax policy that penalizes corporations for excess CEO-to-worker pay ratios can boost incentives for shareholders to restrain excess pay. To boost the power of shareholders, fundamental changes to corporate governance have to be made. One key example of such a fundamental change would be to provide worker representation on corporate boards.

Finally, as a starting point, the Securities and Exchange Commission SEC should change the reporting requirements for corporations calculating their CEO-to-worker pay ratios to make them consistent over time and across firms; this will make these ratios far more useful to policymakers and the public. There are many facets to the rise in American income inequality over the last four decades, but a particularly salient one is the explosion of pay for top corporate executives.

While chief executive officers CEOs have always been well paid, the ratio of CEO pay to typical worker pay went from or to-1 in the s and s to or to-1 in recent years. This paper argues for the desirability of reining in CEO pay and discusses policy strategies that could be part of such an effort.

Its key findings are described below. Excessive CEO pay exacerbates inequality. This excessive CEO pay matters for inequality, not only because it means a large amount of money is going to a very small group of individuals, but also because it affects pay structures throughout the corporation and the economy as a whole. Many directors of well-funded nonprofit institutions or colleges and universities, for example, once worked in the corporate sector and have seen their pay rise as corporate director pay rises.

The explosion of pay for CEOs of large firms is not strongly associated with evidence that these CEOs have become far more productive in their ability to generate returns to shareholders.

Weak corporate governance is a large part of the problem. Research has demonstrated that CEOs are rewarded for luck and that weak corporate governance—boards of directors more concerned with hanging onto their own positions than with advocating for the best interests of shareholders—fails to restrain CEO pay by subjecting it to serious competition.

Shareholders are not well positioned to hold corporate boards accountable. Reforming corporate governance to empower shareholders to rein in CEO pay will require policy changes that overcome a host of bad incentives and agency problems that currently keep boards of directors from working on behalf of shareholders. Essentially, the market for good corporate governance is plagued by externalities—costs or benefits faced by actors not directly involved in the corporate governance decisions.

For example, because a large share of the benefits stemming from activist shareholders spending resources to try to discipline CEO pay will accrue not to the activists, but instead to the lazier group of shareholders who do not spend resources in this effort, the gains from activism are substantially muted. Similarly, the excess pay for CEOs at firms with particularly poor corporate governance puts upward pressure on pay for CEOs at firms whose shareholders do spend resources on good corporate governance, thereby reducing the payoff to these efforts.

Tax penalties or incentives may be helpful in restraining CEO pay, if complemented with corporate governance reforms. A number of proposals for reining in CEO pay through tax penalties or incentives have been introduced in recent years. These proposals have merit, but they would need to be complemented with corporate governance reforms to be effective in restraining CEO pay growth.

We first outline the problem of excessive CEO pay over four sections: The first section briefly outlines the history of CEO pay over the last four decades. The second section draws out the implications of excessive CEO pay for the overall wage structure. The third section discusses the corporate governance problem and explains how the current system effectively allows CEOs to have their pay determined by their friends. The fourth section puts excessive pay in the context of returns to shareholders.

This section draws largely on the work of Mishel and Schieder , who have clearly documented the explosive growth in pay for CEOs at the largest firms in the economy. Table 1 —reproduced from their report—shows growth in CEO pay measured two ways and growth in annual compensation for production and nonsupervisory workers.

Using their preferred measure of CEO pay, which calculates it based on stock options realized, Mishel and Schieder document a rise in the CEO-to-typical-worker pay ratio from to-1 in to to-1 in to to-1 in to to-1 in Because CEO pay is often pegged to the share value of companies, the bursting of the stock market bubble in led to the decline of the CEO-to-worker pay ratio to to-1 by The stock market decline brought on by the financial crisis depressed it further, to to Notes: Projected value for is based on the change in CEO pay as measured from June to June applied to the full-year value.

Projections for compensation based on options granted and options realized are calculated separately. Often, the stratospheric rise of CEO pay in recent decades is defended as simply another symptom of a technology-induced rise in the wage premium for skilled workers that allegedly occurred over the same time. This argument is not convincing. For one, evidence backing claims that technology-induced shocks to relative demand are driving wage inequality in the bottom 99 percent of the wage distribution has been shown to be quite weak.

In short, the rise in large-firm CEO pay in recent decades has been extraordinary and seems impossible to explain with generic forces that have affected the rest of the economy.

There really does seem to be something special and especially broken about the market for CEO pay. The issue of high CEO pay is not just a problem of the top executives at large companies getting paychecks in the tens of millions of dollars. Excessive pay at the top affects pay structures throughout an individual corporation and even throughout the economy. But pay of the next four highest-paid executives at these same firms totaled roughly this much on average as well.

This would free up a considerable amount of money that would most likely accrue to shareholders in the form of higher corporate profits. The high pay of CEOs in corporate America also affects pay structures elsewhere in the economy. As in the corporate sector, the high pay for a CEO at a nonprofit also affects the pay of other top officers. The high pay for those at the top comes to some extent at the expense of pay for those at the middle and bottom of the wage ladder.

High pay in the corporate sector also affects pay in government. While wages at the top of the government pay ladder are usually held down by statute, people are often hired on contracts by which their effective pay may be many times higher than the pay of top government employees. The story would be quite different if high-level public officials could only expect to earn twice or perhaps three times their pay in the corporate sector, as opposed to 10 times or more. For these reasons, we would be looking at a very different world in terms of income inequality, regulatory quality, and corruption if we could get CEO pay back down to the levels, relative to ordinary workers, that we saw in the s and s.

The economy and corporate America performed very well through most of this period when CEO pay was not so outsized. It would be difficult to argue that top executives lacked incentives and that talented people did not consider running a major corporation to be worth their time in those years. The main justification for why shareholders tolerate huge increases in CEO pay—money that comes directly out of their pockets—is that this higher pay is necessary to attract the CEOs who produce good returns for shareholders.

In that narrative, shareholders are getting a good deal even with these very high pay packages for CEOs. Before we turn to the evidence, it is important to be clear about what is at issue.

Corporations obviously need to have someone in charge although there is no reason it needs to be a single person. In that sense, it is trivially true that CEOs contribute an enormous amount of value to shareholders in the sense that corporations contribute value to shareholders and CEOs lead these corporations.

But the issue is not how valuable having a CEO is to shareholders relative to having the company operate aimlessly, the question is how valuable a specific CEO is relative to the other people who could fill the position.

If the people who are next in line, or who could be hired from other companies, are as capable as the current CEO, then the value of the CEO to the company is only as high as what they would have to pay to replace them. We certainly apply this logic to the pay of other jobs.

The reason they are so low paid is that other people can be found to do the job for a very low wage; further, institutions unions or robust minimum wages, for example that could keep low-wage workers from having to accept low pay in order to secure work have been eroded over time.

For these reasons, it makes no sense to credit any CEO with all of the profits the company delivers to shareholders. There is considerable evidence that the pay of CEOs is not closely related to the returns they provide to shareholders. For example, a study found that jumps in world oil prices led to large increases in the pay of CEOs at oil companies Bertrand and Mullainathan Presumably, the CEOs had nothing to do with the rise in world oil prices, so effectively they got large pay raises as a result of factors that were outside of their control.

The bulk of CEO pay usually comes in the form of company stock or, more typically, stock options. In principle, company boards of directors could construct contracts ensuring that CEOs would only be rewarded for stock returns that exceed the average returns of companies in a reference group.

While it is possible and even easy to structure compensation for CEOs in this way, these sorts of contracts are the exception.

There is evidence that boards often have almost no understanding of the pay packages they grant to CEOs. A recent paper found that corporate boards largely failed to recognize that the value of an option was rising hugely over the course of the s as share prices soared due to the tech stock bubble Shue and Townsend This analysis found that most boards continued to issue the same number or a greater number of options to CEOs, even as the value of these options hugely increased, apparently because they did not want to seem to be cutting the pay of their CEOs.

Certainly directors cannot effectively rein in CEO pay if they do not even know how much they are paying them. Quigley, Crossland, and Campbell looked at the impact of unexpected CEO deaths—such as in an airplane or car crash—on stock prices.

The reason for focusing on unexpected deaths is that it takes away the possibility that a death may have been anticipated and its impact already reflected in the stock price, as might be the case when a CEO dies after a long illness. In almost half of the cases examined since In fact, the market might be expected to overreact on the negative side to the unexpected death of a CEO, since there might be the expectation that the CEO actually was a major asset to the company even in cases where it is not true.

After all, why else would the shareholders have been paying them so much money? And yet there is little effect on share prices from these losses.

Marshall and Lee looked at long-term year returns to shareholders relative to total CEO pay at large corporations over the years — The study found a significant negative relationship, with high CEO compensation associated with worse returns to shareholders. The analysis divided CEO pay by quintiles and found that the total return to shareholders of companies with pay in the bottom quintile was more than 60 percent higher than the total return to shareholders of companies with CEO pay in the top quintile.

These findings are hard to reconcile with claims that the pay of CEOs reflects their ability to increase returns to shareholders.

These and other studies indicate that there is little relationship between CEO pay and returns to shareholders. This would mean that it is reasonable to believe that shareholders could get away with paying their current CEO considerably less money and still get a comparable performance in terms of returns or, alternatively, that they could hire another CEO who would do just as good a job for considerably lower pay. There is one aspect to this picture that is underappreciated. It is often taken for granted that, while wage growth for the vast majority of American workers has been weak for decades, returns to shareholders have been strong.

However, returns to shareholders have actually not been very good in recent decades. This compares to an average of more than 7 percent that prevailed between and The idea that shareholders and CEOs have jointly benefited from a governance structure that has allowed CEO pay to soar is simply not true.

Obviously, there is always a possibility that shareholders could have done even worse with an alternative structure that left them with lower-paid CEOs. The people most immediately in a position to rein in CEO pay are the boards of directors who approve CEO pay packages. Ostensibly, these directors are answerable to shareholders, who vote them in and can, in principle, remove them.

As a practical matter, directors are generally more responsive to top management including CEOs , who often play a large role in selecting members of the board. Furthermore, once a director is on the board, the incentive structure goes strongly against raising serious questions about CEO pay.

In his book The CEO Pay Machine , Steven Clifford, who has sat on a number of corporate boards, estimated that the amount of work involved was typically in the range of hours a year. In short, being a member of a corporate board is an extraordinarily lucrative job, which most directors would presumably like to keep.

Keeping these jobs turns out to be trivially easy, as it is almost impossible for directors to be voted out through a shareholder revolt. An analysis of director elections in by Investor Shareholder Services found that Even among the 61 who were defeated, 55 were still on the payroll many months later at the next proxy filing.

I t is fashionable today to bash Big Business. And there is one issue on which the many critics agree: CEO pay. But the more likely truth is CEO pay is largely caused by intense competition. While individual cases of overpayment definitely exist, in general, the determinants of CEO pay are not so mysterious and not so mired in corruption.

In fact, overall CEO compensation for the top companies rises pretty much in lockstep with the value of those companies on the stock market. The best model for understanding the growth of CEO pay, though, is that of limited CEO talent in a world where business opportunities for the top firms are growing rapidly.

They also need better public relations skills than their predecessors, as the costs of even a minor slipup can be significant. To lead in that system requires knowledge that is fairly mind-boggling. There is yet another trend: virtually all major American companies are becoming tech companies, one way or another. Similarly, it is hard to do a good job running the Walt Disney Company just by picking good movie scripts and courting stars; you also need to build a firm capable of creating significant CGI products for animated movies at the highest levels of technical sophistication and with many frontier innovations along the way.

On top of all of this, major CEOs still have to do the job they have always done—which includes motivating employees, serving as an internal role model, helping to define and extend a corporate culture, understanding the internal accounting, and presenting budgets and business plans to the board.

By most measures, corporate governance has become a lot tighter and more rigorous since the s. Yet it is principally during this period of stronger governance that CEO pay has been high and rising.