Blogs & Comment

Are CEO salaries unfairly high?

The debate over CEO pay revolves around performance and social need, and there are no pat answers despite what critics say.

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/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?

The question “Are CEOs paid too much?” is actually two questions.

One has to do with 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 if 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 ground for complaint by employees, and even less 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.