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Apple's Tim Cook will receive $378 million in his first year on the job Photograph by ImagineChina/AP Photo
To the C-Suite Go the Spoils
Chief executive officers are not the only highly paid people in America. It’s just their misfortune that, thanks to disclosure rules, they’re among the most visible. This proxy season coincides with an electoral cycle in which income inequality has become a populist issue for candidates in both parties, which means CEO paychecks will be scrutinized as never before. And what can’t evade discovery is that, even among the very rich, CEOs have been consistently overpaid.
By overpaid, I don’t mean merely highly paid. We live in a capitalist country, and talent is entitled to fetch its price. But to take just one shining example, Larry Ellison, CEO of Oracle, has gorged himself on more than $60 million in stock options every year since 2008. Even if Ellison did groundbreaking work and was a juggernaut of management brilliance, abusive would not be too strong a word.
Fixing CEO pay—making it more reflective of what executives are truly worth—would go a long way toward restoring America’s faith in business, and in equal treatment. How, is the $60 million question.
One myth should be cleared at the outset. In 2008, the CEOs who run companies in the Standard & Poor’s 500-stock index earned, in total, less than 1 percent of what everyone who’s a 1 percenter earned. So it’s unfair to blame CEOs alone for fostering inequality. Defenders of the system cite such data to advance a larger claim. Pay for public company CEOs has risen, they say, for the same reasons it has for movie stars, real estate moguls, and private entrepreneurs: Globalization and technology has created a wider market. Even President Obama, no friend of the very rich, acknowledged in December that “over the last few decades, huge advances in technology have allowed businesses to do more with less, and made it easier for them to set up shop and hire workers anywhere in the world.” Read thoughtfully, that implies that 1 percenters are taking home more because, in an economic sense, they’re earning it.
“The system has worked,” says Steven Kaplan, a professor at Chicago Booth School of Business. From 2000 to 2010, compensation for the median CEO in the S&P 500 rose from $5 million to just over $8 million. (Those figures represent actual dollars received; when calculated by the value of options at the time of grants, pay over the period began and ended at $8 million.) Kaplan asserts that CEOs are “paid for performance.” In a literal sense this is true; CEOs did earn more when their companies succeeded. But they earned so much, as well, for ordinary and unquantifiable performance as to undermine the intended effect. Apple’s new CEO, Tim Cook, may turn out to be every bit as good as Steve Jobs, or he may not. Apple’s board did not wait to find out. Cook got—for his very first year as CEO—a package worth $378 million.
The real explanation for sky-high pay lies in the “agency” problem. Agents exploit their role as intermediaries. They thrive in imperfect markets in which pay scales do not respond quickly, if at all, to results. Hedge fund managers who deliver mediocre returns get rich thanks to their role as agents. Mortgage traders employed by banks got huge bonuses in the fat years but ducked responsibility for losses; they got a free ride on their employers’ capital.
So do some CEOs—though certainly not all. (Steve Ballmer of Microsoft, for example, gets no options and total compensation of $1.4 million.) But all CEOs compete in a warped marketplace. How often does the head of Company X leave for Company Y? How often does a corporation sack its head? It happens more than it used to, but the market remains inflexible, and firings are rarely for reasons of expense. Consider that Philippe Dauman, the chief executive of Viacom, speared $84 million in 2010, and that Eugene Isenberg of Nabors Industries was awarded $100 million last year for agreeing to relinquish his job. These may be anomalies, but it’s hard to imagine them happening in any rational marketplace. The agency problem in the corner office is as old as public ownership, though it was most famously brought to light in the 1980s by Harvard Business School professor Michael Jensen, who observed that CEOs, unlike private entrepreneurs, owned little stock and had scant stake in the common corporate purpose. In a 1989 Harvard Business Review article, “Eclipse of the Public Corporation,” Jensen suggested that public shareholders had become passé. Of course, there was nowhere near enough private capital to replace the mass of public investors. For the public companies that remained un-eclipsed, Jensen reckoned, the next best thing would be to shower stock options on the executives, endowing them with the same incentives as their peers at private firms.
©2011 Bloomberg L.P. All Rights Reserved.
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