Final 2006 Thoughts on CEO Pay

The Hoover Institute’s Thomas Sowell is an economist who usually makes a lot of sense. And in his latest blog, he touches upon some uncomfortable truths about the media’s obsessive objections to high executive pay. He first points out data which show that 99% of people “can’t understand” how any executive can make $50 million in total compensation. Sowell’s response is: So what? He asks: “Do you understand how your automobile's transmission works? Could you repair it if something went wrong? Do you understand how aspirin stops headaches? How to make yogurt?” If we accept these gaps in our knowledge, says Sowell, why would we be troubled by not understanding complex economic processes which yield huge compensations for working executives? Sowell, in fact, goes further, arguing that the politically correct solution to this knowledge gap--more government oversight-- is economically unjustifiable. He notes that the typical solution is “that politicians should impose policies based on your ignorance of what is going on. Can you imagine anything more dangerous than allowing politicians to decide how much money each of us can earn?” And he correctly notes that when politicians replace free markets in determining pay, there is an inevitable rise in government corruption, bureaucracy, and intrusion, not to mention the ever-growing definition of who is “rich” and ought to be taxed heavily—all in the name of socially engineered “justice” which has had a terrible historical track record in other countries. All true. And yet, I think Sowell is missing something important. Another economist, Irwin Stelzer of the Hudson Institute, points out that the reason that the political atmosphere vis-à-vis “fair” pay has moved leftward is that “voters feel that the middle class, or the average worker, has not shared in the economic growth of recent years. Wages have not risen as fast as profits, and the recent spate of multi-million dollar Wall Street bonuses has caused many workers to figure that some financial high flyers make as much in an hour as they make in a year…..(And then) throw in tales of rigged corporate compensation through pervasive backdating of options.” Stelzer is right, and it doesn’t even have to be rigged. To quote the Wall St. Journal, even legitimate stock options have become simply “an additional form of pay slathered on top of already generous packages.” That leads me to one other factor. In my November 3 blog “Grotesque Thoughts About Grotesque Pay”, I noted the persistently lousy correlation between executive pay and corporate performance. When people read about CEO’s raking in millions while their companies lose billions, those peoples’ perceptions about executive pay sour, even if they—to use Sowell’s words-- “don’t understand” complex economic theory. Never underestimate the voice of the marketplace. Managers, consumers, investors and just plain citizens often form opinions without fully understanding all their underlying dynamics. That’s life, that’s democracy, that’s capitalism. Messy and unruly, but effective. When it comes to CEOs’ pay, I believe the good ones deserve every penny of their millions, the bad ones ought to be ashamed of their obscene contracts (and shamed publicly), and the rest of us shouldn’t be afraid of analyzing, commenting, and evaluating on the subject. With that in mind, as 2006 comes to an end, I hope you’ve had a great Channuka and Christmas, and I hope that your compensation will rise in 2007.