What’s Causing Big CEO Pay Increases?

Blog, Workplace, Ben Eisen

I just finished reading a report published by the Canadian Centre for Policy Alternatives (CCPA) describing growth in the compensation for the highest paid CEOs in Canada in recent years. The author clearly think very high levels of CEO pay are a problem. He also hints that high rates of CEO pay are the result of unfair mutual back-scratching when he writes that everyone involved in decision-making on salaries is “in the club” and part of the same “community of interest” even if there is not a direct conflict of interest.

Others who are worried about executive compensation have made very similar points. Linda McQuaig, a Toronto Star/Calgary Beacon columnist (and, full disclosure, a personal friend) makes a similar point when she writes that CEOs have pushed up their own salaries through “their control of corporate boards.” The idea here is that since the board members are often corporate executives themselves, they benefit by giving another CEO a higher salary because this will raise the standard for executive pay, which will help them get a bigger raise when their turn to negotiate comes around.

My concern is that these and other pieces I’ve been reading by prominent inequality hawks don’t seem to examine potential benign explanations for the growth in CEO pay. For example, an article in The American,  a publication of the American Enterprise Institute, recently highlighted research suggesting that in the United States the growth in CEO pay has been driven primarily by growth in the market capitalization of major companies. In other words, the biggest American companies have gotten bigger and more valuable in recent years. As companies get more valuable, the dollar value of good decisions by CEOs goes up, a fact that would enable the best executives to command higher pay.  The following quotation from The American summarizes the point:

According to Gabaix and Landier’s model, the talent differences among CEOs are generally minor. For example, if a given firm substituted the most talented CEO for the 250th most talented CEO, its market capitalization would only increase by 0.016 percent. But for a $500 billion company like ExxonMobil, 0.016 percent is equivalent to some $80 million. In other words, as companies get bigger, a talented CEO can have a greater impact. Therefore, large companies bid up prices across the board for the small number of men and women deemed capable of managing them. The reason CEO pay in other countries (such as Germany) tends to be lower is that the “big” companies abroad are generally smaller than the big companies in America.

The research presented in this article makes a convincing case that the explanations for growth in CEO salaries in the United States in recent years have generally been benign- with higher average market capitalization levels for large companies being the primary explanation. It is entirely possible (though by no means certain) that similar forces are driving the growth in CEO pay in Canada.

What troubles me is that I do not see the phrase “market capitalization” anywhere in the CCPA piece. Shouldn’t an examination of the growth in CEO salaries include a discussion of whether or not the companies they manage are getting bigger- which would make executive talent more valuable? In fact, I never see any mention of higher market capitalization as a possible explanation for higher CEO pay in the work of any of the major inequality hawks.  We shouldn’t just assume that what we’re seeing in terms of higher CEO pay is the result of destructive  back-scratching- we should also examine benign explanations for higher executive pay  to try to figure out what’s going on and whether or not a policy response is really necessary to prevent economic rent extraction through the manipulation of corporate boards.