The real reason CEO compensation got out of hand.

The search for better economic policy.
May 11 2009 6:08 PM

Comparison Shopping

The real reason CEO compensation got out of hand.

CEO.
How did CEO compensation get so out of control?

Last fall, with headlines of million-dollar Wall Street bonuses appearing amid the worst economic crisis in a generation, I attended a lecture on corporate ethics by the CEO of one of America's most venerable corporations. This captain of American industry was critical of the compensation committees and formulas that generated these outsize payouts and felt that in his own case, he didn't deserve more than $10 million, regardless of what the committee came up with.

It is truly a statement of the times we live in that a self-imposed $10 million pay cap is a sign of modesty and virtue. Half a century ago, the median pay of top executives in U.S. companies was 30 times an average worker's salary; by 2005, the ratio was nearly 110. How did we get here?

The popular (and populist) perception is that of America's CEOs greedily rubbing their hands together as they approve their own paychecks, and there certainly has been some of that. Others argue that in most cases CEOs are richly compensated because they're so good at what they do.

Several recent studies stake out a middle ground, assuming that CEOs are neither villains nor business masterminds. These studies argue that the seemingly innocuous practice of benchmarking pay against other companies' CEOs may be to blame, because the list of comparable executives is often formed selectively to include highly paid peers and to omit lower-paid ones. Though this opportunistic selection of peers may result in only a small bump to CEO pay in any particular year, over time, the rising tide of peer pay may well account for much of the increase in corner-office salaries that we've seen in recent decades.

Advertisement

If bosses set the salaries of their workers, who decides what the bosses earn? In a modern corporation, the task of setting the CEO's pay falls to the board of directors, typically a subgroup of board members on its compensation committee. A CEO's pay is partly a reward for leading the company and partly an inducement to keep him from leaving for greener pastures.

How much is enough? It makes sense to see what competing firms—the ones that might try to lure your CEO away from his current job—are spending to reward and retain their leaders. That's where the peer-group comparison comes in. But who is the "right" peer? You probably want to pick someone running a company in the same industry, of similar size, of comparable profitability, and with similar experience (similar tenure at the firm and so on). Depending on your industry, however, there might still be dozens of CEOs who meet these criteria—how do you decide who makes your list of comparables?

Compensation committees use their discretion, and that has led to claims of abuse by committees with too-cozy (or just plain incestuous) relations with the CEO. (Compensation consultants, often brought in to help figure out the "right" pay, have also been accused of currying favor with executives in the hope of securing other, more lucrative business from the company.) To shed more light on what had been a less-than-transparent process, the Securities and Exchange Commission mandated in 2006 that companies had to make their peer lists public.

TODAY IN SLATE

The Juice

Ford’s Big Gamble

It’s completely transforming America’s best-selling vehicle.

Should the United States Grant Asylum to Victims of Domestic Violence?

The Apple Watch Will Make Everyone Around You Just a Little Worse Off

This Was the First Object Ever Designed

Don’t Expect Adrian Peterson to Go to Prison

In much of America, beating your kids is perfectly legal. 

Moneybox

How the Apple Watch Will Annoy Us

A glowing screen attached to someone else’s wrist is shinier than all but the blingiest jewels.

Music

A Little Bit Softer Now, a Little Bit Softer Now …

The sad, gradual decline of the fade-out in popular music.

Is Everyone Going to Declare Independence if Scotland Does It? 

I Tried to Write an Honest Profile of One of Bollywood’s Biggest Stars. It Didn’t Go Well.

Trending News Channel
Sept. 12 2014 11:26 AM Identical Twins Aren’t Really Identical
  News & Politics
Politics
Sept. 12 2014 7:24 PM Come and Take It Libertarians fight for people whose property was seized by the police.
  Business
Moneybox
Sept. 12 2014 5:54 PM Olive Garden Has Been Committing a Culinary Crime Against Humanity
  Life
Outward
Sept. 12 2014 3:32 PM Yes, Those Straight Guys Who Wed for Rugby Tickets Are Mocking Marriage. What’s New?
  Double X
The XX Factor
Sept. 12 2014 4:05 PM Life as an NFL Wife: “He's the Star. Keep Him Happy.”
  Slate Plus
Behind the Scenes
Sept. 12 2014 5:55 PM “Do You Know What Porn Is?” Conversations with Dahlia Lithwick’s 11-year-old son.
  Arts
Brow Beat
Sept. 14 2014 7:10 PM Watch Michael Winslow Perform Every Part of “Whole Lotta Love” With Just His Voice
  Technology
Future Tense
Sept. 12 2014 3:53 PM We Need to Pass Legislation on Artificial Intelligence Early and Often
  Health & Science
New Scientist
Sept. 14 2014 8:38 AM Scientific Misconduct Should Be a Crime It’s as bad as fraud or theft, only potentially more dangerous.
  Sports
Sports Nut
Sept. 12 2014 4:36 PM “There’s No Tolerance for That” Pete Carroll and Jim Harbaugh say they don’t abide domestic abuse. So why do the Seahawks and 49ers have a combined six players accused of violence against women?