Here’s Why CEO Pay Is Even Crazier Than It Seems

Commentary about business and finance.
July 1 2013 3:18 PM

Outsource the CEO

The latest figures tell us that American executives make more than foreigners, media titans make more than oilmen, and none of it makes much sense.

CBS chief executive officer Les Moonves arrives at the premiere of CBS Film's "Extraordinary Measures" at Grauman's Chinese Theatre in Hollywood, California, January 19, 2010.
CBS CEO Les Moonves in 2010

Photo by Danny Moloshok/Reuters

It’s not exactly news that CEOs of big companies get paid a lot of money. And everyone knows that the pay gap between the big executives and the average Joe has been growing. The surprise revealed in a great new database of executive compensation—compiled by Equilar on behalf of the New York Times and covering U.S. firms with more than $1 billion in revenue—is the striking lack of method to the madness: America’s CEOs are paid a lot largely because other American CEOs are also paid a lot.

Philippe Dauman of Viacom, for example, is a very rich man—which is what you’d assume about the CEO of a major media firm, with the 100th highest amount of revenue of any publicly traded American company. Dauman brought in $33.4 million in salary, bonuses, perks, stock, and options in 2012. Nice work if you can get it. But then again, there’s Leslie Moonves of CBS. He’s also a very rich man. Given Dauman’s wealth, that’s exactly what you’d expect of the CEO of another large American media company. What you might not expect is that, even though Moonves’ firm is just two spots ahead of Dauman’s on the revenue rank order, Moonves made nearly twice what Dauman did last year: $60.3 million.

Lurking between Moonves and Dauman on the executive pay list is Disney’s Robert Iger, who brought in $37.1 million in 2012. Disney, which is more than twice as big as CBS or Viacom, had $42.3 billion in 2012 revenue, and its stock did better than the other companies in 2012, too.

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So is Iger underpaid? Or perhaps Moonves is overpaid? Nobody knows.

It would be wrong to say that compensation for America’s chief executives is handed out randomly, but there’s certainly no clear link to corporate performance, and even the link to corporate size is surprisingly vague. But there are patterns. Despite the seemingly scattershot nature of the pay packages for Dauman, Moonves, and Iger, the one thing they have in common is that they’re all very well-paid—not just compared to the average American, but compared to the average CEO. And that’s the case throughout the media industry, where executive pay is high compared to what you see in other sectors.

This reflects the fact that nobody really knows how to judge a CEO’s worth. Since the executive is hired by a board of directors that’s theoretically accountable to a company’s shareholders, it seems like CEO pay should have something to do with stock price. But nobody wants a CEO to focus exclusively on short-term stock issues and ignore the firm’s long-term strategic position. And even if you do focus on share prices, what’s the relevant issue? Absolute return? Returns relative to the market as a whole? Returns relative to the sector? Tim Cook’s compensation at Apple was recently restructured to emphasize Apple’s share price relative to the S&P 500, which in some ways hitches him less to how well Apple fares against its competition than to how investors view the technology sector as a whole. There’s enough ambiguity that you could argue a given case in many different ways.

In practice, norms tend to dominate. Media CEOs are very highly paid because so are other media CEOs. Nationality matters, too. On the one hand, it might seem strange that John Watson of oil giant Chevron was paid “only” $22.3 million in 2012—less than the CEOs of CBS or Viacom, even though his company is much bigger than either. On the other hand, compare Watson to the CEO of the similarly sized French oil giant Total S.A.: poor Christophe de Margerie earned a mere $3 million in 2011 (the most recent year for which numbers are available). That same year, Watson brought home $18.1 million.  The reason for this is both mysterious and epically clear—American chief executives are systematically better paid than CEOs from continental Europe or Japan. CEOs of U.K., Canadian, and other Anglophone firms tend to earn at close to American levels.

These kind of local differences matter so much because, as Ray Fisman has explained for Slate, executive compensation decisions are typically made by peer group comparisons. Media CEOs are compared to other media CEOs and oil executives to other oilmen.

American executives argue—conveniently enough—that their compensation should be compared to what other American executives are paid. This argument has tended to be persuasive to American boards, which—conveniently enough—are made up primarily of American corporate executives. And big American investment management firms—also led by American corporate executives—likewise think this makes sense. Which is all quite nice, but if you tried convincing one of these very same executives that he shouldn’t replace an American factory worker with a cheaper Chinese one, he would laugh you out of the room.

Apologists for this arrangement, such as the University of Chicago’s Steven Kaplan, argue that pay for U.S. CEOs has merely risen in line with pay for other kinds of very highly compensated individuals. Others dispute this math, but one might also dispute its relevance. It is true to some extent that America’s unusually well-paid CEOs are matched by an unusually large and aggressive financial sector and an unusually lucrative legal profession. Compared to the United States, continental Europe and Japan rely much less on lawsuits and much more on preventative regulation. They’re also much less gung-ho about the nonbank financial institutions—hedge funds and private equity shops—that provide for a very large share of the non-CEO element of the superrich.

But the thought that American executives need to be paid more than German ones because America also has more superrich hedge-fund managers does not provide me with enormous comfort. At best, this argument would prove that we should add skyrocketing CEO pay to the list of social ills exacerbated by an inadequately regulated American banking system. Meanwhile, nobody is going to be crying for the poor oil executives, but the huge and seemingly nonsensical gaps between CEOs of one company and another should give us pause. Executives are compensated lavishly but arbitrarily, and there’s no end in sight to the upward trajectory.

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