In response to yesterday’s column on CEO pay, a lot of people wanted to engage in a debate over whether or not chief executives are “overpaid.” I think this is a not-very-helpful way of looking at the issue. But if you want to think about it, a good starting place is that it’s easy to see why a rational shareholder would want to invest huge sums of money in CEO compensation. Take CBS, which I write about in the column. They had almost $15 billion in revenue in 2011. So the value to the company of a CEO who can boost revenue 1 percent higher than a replacement-level CEO would to the company is about $150 million. So if you have a 50 percent confidence level that CEO Leslie Moonves is 1 percent better for the company than a replacement-level CEO, then you’d be justified in paying him as much as $75 million a year—making him “underpaid” with 2012 compensation of around $60 million.
Neat, huh? And indeed if you look at what private equity companies do, they normally pay the CEOs of the companies they buy quite a lot. A private equity firm typically has a pretty well-defined medium-term objective in terms of dividend payouts and an eventual exit, and they rationally spend a lot of money on ensuring the existence of a management team that’s both very competent and very committed to the PE firm’s goals.
For reasons that aren’t quite clear to me, liberals who would normally consider themselves critics of pure market arrangements have gotten themselves very emotionally invested in insisting that high CEO pay represents a non-market phenomenon. But I think the correct observation to make is simply: Who cares? The interesting policy question is whether large increases in the level of tax these guys pay would cause skilled managers to go Galt en masse and devastate the economy. The fact that oil companies manage to get away with being stingy compared to media companies, and that German firms get away with being stingy compared to American ones all suggests to me that the answer is “no.” Pay packages are driven by peer group comparisons and locally salient norms, and so as long as everyone else is paying high taxes too it’s all fine.
I think some people feel that it will make CEOs look bad if they can expose the fact that their high salaries aren’t “really” won on an open market but instead just reflect poor corporate governance and exploitation of shoddy boards of directors. But even if that’s true, that would simply prove that in an open market investors place almost no value on sound corporate governance (which I think is correct—corporate governance is lame). This is an interesting fact about the operation of financial markets in the early-21st-century United States, but all that goes to show is there’s a potential tax revenue windfall for the United States. Presumably after a few years of super-high taxation of super-sized compensation packages, firms will stop handing out so much money and think of some other way to reward CEOs (really nice desks, executive washrooms made of diamonds, I dunno) but it’ll be a fun ride while it lasts.