The SEC’s New CEO Pay Rule Is Useless and Dishonest

 

To match Special Report SEC/INVESTIGATIONSA party line, three Democrats vs. two Republicans vote of SEC commissioners has finalized a rule that will require companies to disclose the ratio of the compensation of their CEOs to the median compensation of their employees. This rule is required under the 2010 Dodd-Frank financial regulation law.

Like most progressive policies, this sounds good on its face to most people. “No more fat cats! No more too big to fail!” chants the collective liberal media and political establishment. But, again like most progressive policies, it’s not quite so simple.

People naturally grumble at the idea of some CEO making millions and millions of dollars each year while some employees at their given company are making minimum wage. This makes the idea behind the SEC’s new ratio rule politically popular and an easy sell. The problem is that proper perspective isn’t applied to the issue of CEO compensation. Let’s address a few key points that explain why CEOs are compensated so handsomely in many cases.

First, the number of people qualified to fill a CEO position of a major corporation is very low. CEOs shoulder huge burdens. Some can be held responsible for the missteps of their most junior employees. The buck stops at their desk on virtually every issue, whether they have any direct ties to it or not. When companies shake up their practices, the first person to go is often the CEO, not low-level employees. Company boards do this to signal to their shareholders and customers that they are serious about change. Basically, a lot of pressure rests atop a CEO. This requires a person with the knowledge and energy to observe and manage a company’s affairs soup-to-nuts. Most people tend to only focus on one or two sectors in their jobs or careers. CEOs must be well versed on customer service, logistics, advertising, financial management, real estate, legal and regulatory compliance, etc. Put all this together, and it’s easy to realize that someone capable of juggling all of these things while simultaneously driving the company without crashing it into a ditch is an impressive person — indeed a rare person.

Think about anything that is rare: gold, antiques, water in the desert, real estate in Manhattan, etc. Scarcity drives prices higher. Employee compensation is a price. The scarcer our effective leaders are, the higher CEO pay will become. Further, companies fail every day. From giant corporations to small businesses, companies are willing to pay a premium to ensure they don’t become just another part of the statistics on business failures. A CEO with extensive business knowledge and experience, as well as the gumption to actually make tough decisions without hesitation can prove to be invaluable. Don’t think one person can make a difference for a business? Try watching the popular shows Shark Tank or The Profit. This may be anecdotal evidence, but there is a long history of singular individuals who have meant life or death for some of the world’s most recognizable companies. In short, what we have here is a basic function of the laws of supply and demand. There is a short supply of these kinds of truly talented and remarkable leaders and an enormous demand for their services. In this situation, we should fully expect prices to be astronomical.

Yet in what perspective are these prices for the services of qualified CEOs astronomical? To a minimum wage worker, certainly a $10 million salary is an unfathomable fortune. But what about to a multi-billion dollar company that is losing $50 million a year? If a CEO comes in and within next year the company not only eliminates its losses but also begins to profit to the tune of $50 million, then is that $10 million really all that much money? The company has swung a total of $100 million for the price of $10 million. That is a 10:1 return on investment. Any rational person would love to find such lucrative returns in their own finances. This example is perhaps too generous to the CEOs in terms of the compensation versus the return. The CEO of Walmart reportedly made $26 million in 2014. While this is a lot more than the $10 million in our example, Walmart also posted a profit of roughly $16.4 billion that year. That’s up two percent from the year before, which means Walmart’s profits grew by about $322 million. Thus, that two percent growth in profits is enough to cover the CEO’s salary more than 12 times over. So while $10 million or $26 million may seem like some sort of criminally high salary, just remember that it is often a small price for companies to pay in order to ensure stability, as well as the livelihoods of the hundreds, thousands, or even millions of their employees.

Finally, the main issue with the SEC’s rule is that it does not apply the aforementioned perspective to the issue. All that this rule does is throw out big numbers without proper context, sure only to inspire more of the already extant and misplaced consternation that exists regarding executive compensation. In this way, it is deeply deceptive if not outright dishonest. There is little to any “there” there when it comes to issue. Excessive compensation is a problem that the market already solves. Shareholders and board members have absolutely no incentive to overpay on anything, much less a CEO. Progressives tell us that these people are greedy capitalists who will do anything to save a buck but then we’re also supposed to believe they like to waste money compensating their executives. Which is it? Companies that don’t spend their money wisely sooner or later go out of business.

In short, the government isn’t serving any useful purpose by implementing this rule and advertising its findings to millions of hardworking people who otherwise do not study the relevant economics. There are real economic problems out there, most of which trace roots back to the government and laws like Dodd-Frank, but instead the government is wasting its energy directing the very real ire of people towards boogeymen CEOs and their salaries. Meanwhile, no one seems to care that an NFL quarterback just signed a contract equivalent to $22 million a year; all probably because good quarterbacks are hard to find. The government treated him with a trip to the White House two years ago, along with all his other millionaire teammates.

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  1. Guruforhire Member
    Guruforhire
    @Guruforhire

    Employees get paid relative to the product, CEO’s get paid based upon the scale of teh organization.

    Its really kind of ridiculous to think about ratios relative to small teenie tiny markets.

    • #1
  2. Pelayo Inactive
    Pelayo
    @Pelayo

    I believe in letting the free market determine CEO compensation.  I also agree that the SEC has no business getting involved with this. Having said that, I don’t agree with your rationale regarding CEO valuation nor do I believe that current CEO salaries are justified in many cases.

    First of all, a CEO cannot accomplish anything without a talented team around him or her.  Imagine Tom Brady playing QB behind a horrible Offensive Line.  He would get sacked and accomplish nothing.  I think you are giving the CEO too much credit for the company’s success although the CEO obviously sets the strategy and guides the company.  Execution is equally important and is overlooked.

    The bigger problem I have is justifying huge CEO compensation in companies that are struggling.  If a CEO deserves $20 million when the company is succeeding then the CEO should take a huge pay cut when the company takes a downturn.  The reality is that even when a CEO is fired, he/she gets a Golden Parachute.

    I also dislike the hypocrisy I see in companies where front-line employees are given tiny annual raises (or none at all) despite strong earnings and big bonuses for C-level employees.  Even worse in my mind are CEOs who look for any excuse to move jobs offshore.  Funny how companies never try to cut cost by hiring Executives from third-world countries.

    • #2
  3. PHCheese Inactive
    PHCheese
    @PHCheese

    Jealousy and envy are the most powerful human urge outside of sex. Democratcs play to that base instinct.Pelayo one of the primary responsibilities of aCEO is to bring good people into the company so as to enhance the value to the shareholders. Also if you believe in free markets Golden Parachutes are almost always negotiated in advance of hiring or at new contract time. Also as far as raises for employees,no one is forced to work for a corporation. some of the greatest companies have been launched by disgruntled employees.

    • #3
  4. Manfred Arcane Inactive
    Manfred Arcane
    @ManfredArcane

    Patrick Hedger:”Shareholders and board members have absolutely no incentive to overpay on anything, much less a CEO.”

    This is what the average person isn’t quite sure of.  If the members of the board and candidates for the CEO job are all chummy, all run in the same social circles, they might each be scratching each others back.  Can you make credible your claim here?  I don’t mean giving me a theory of how efficient markets are, because the whole issue is whether CEOs are being selected in a competitive market.  Is it really supply and demand that determines CEO compensation?  Are there really a restricted supply of candidates for being CEO?  In the company I belong to, I get the sense that the CEO is strongly aided by members of his executive staff – so that it isn’t clear to me that he couldn’t trade places with one of them and the company works pretty much as before.

    If you can make this case, you win the argument – but for some reason no one yet has been very persuasive, or this issue would have died away a long time ago.

    • #4
  5. david foster Member
    david foster
    @DavidFoster

    Why not also require the income of entertainers (movies, tv, music, sports) to be disclosed as a ratio to the median income of their viewers/audiences?

    Also, the salaries of university presidents (including in-kind benefits such as the mansions and the chauffeurs) relative to the median income of graduates who have been out for 15 years.

    • #5
  6. Manfred Arcane Inactive
    Manfred Arcane
    @ManfredArcane

    david foster:Why not also require the income of entertainers (movies, tv, music, sports) to be disclosed as a ratio to the median income of their viewers/audiences?

    Also, the salaries of university presidents (including in-kind benefits such as the mansions and the chauffeurs) relative to the median income of graduates who have been out for 15 years.

    Right-on, right-on, right-on!

    • #6
  7. Godzilla Member
    Godzilla
    @Godzilla

    With many American companies the CEO is in bed with the board of directors. It is often the case that those who should be concerned only for the welfare of the share holders are often more beholding to those who run the company. If you want true CEO pay reform, put the board and management more at arms length.

    • #7
  8. Big Green Inactive
    Big Green
    @BigGreen

    This law are regulation of whatever one wants to call it is completely pointless.  It is not complicated at all and the explanation is simple.  The job of the SEC is to ensure that publicly traded companies’ disclosures provide investors with information in a nature, quantity and detail so that investors can make appropriately informed decisions (I actually disagree with much of its mandate, but the law is the law…).  Investors in general couldn’t give one hoot about the theoretical ratio of CEO to median employee compensation.  I have sat through a large number of presentations/discussions, the purpose of which is whether to buy or sell a company….I have never heard someone inquire about this ratio…not once.  It is entirely irrelevant to the vast, vast majority of investors.

    • #8
  9. Big Green Inactive
    Big Green
    @BigGreen

    Godzilla:With many American companies the CEO is in bed with the board of directors. It is often the case that those who should be concerned only for the welfare of the share holders are often more beholding to those who run the company. If you want true CEO pay reform, put the board and management more at arms length.

    This is not really true.  Some instances?  Yes.  In the vast majority?  No.  In the cases where it is, activist investors generally get involved.

    That said, since you seem to think this is a systemic problem and one way to solve it is to “put the board and management more at arms length”, perhaps you could offer a suggestion or two on how to accomplish this?

    • #9
  10. Johnny Dubya Inactive
    Johnny Dubya
    @JohnnyDubya

    One thing about executive compensation that irks progressives and even some conservatives is that CEOs are sometimes handsomely paid despite poor corporate performance. It looks bad when a chief executive is given an enormous bonus after his or her company posted a huge loss. In my career, I have occasionally seen incompetence from highly-paid CEOs who had the right look and demeanor but poor leadership skills.

    However, such matters should be of concern only to the company’s employees, leaders, and shareholders. If there is a mismatch between executive compensation and corporate performance, that is a problem for them to work out.

    There is no logical reason why the ratio of highest pay to lowest pay in an organization should be a matter for government regulation. (And you know that disclosure is only the first step toward legislating caps.)

    The sports analogy is a good one. Where’s the outrage over the compensation gap between star players and lowly equipment managers?

    • #10
  11. Johnny Dubya Inactive
    Johnny Dubya
    @JohnnyDubya

    Furthermore…

    The government constantly touts college education on the basis of the income disparity between college graduates and non-graduates. It becomes a mixed message when our leaders seem to be saying, “Get an education so you can make more – but not TOO much more.”

    • #11
  12. Jordan Wiegand Inactive
    Jordan Wiegand
    @Jordan

    Johnny Dubya: The sports analogy is a good one. Where’s the outrage over the compensation gap between star players and lowly equipment managers?

    Or for that matter, middling players and great players.

    In the NFL, for instance, the highest paid players in a position are paid anywhere from 10 to 100 times what the lowest paid players are.

    And they do the same job.

    It’s not even that they’re 10-100 times better either, they can command that value by doing only slightly better than their less paid, but also highly skilled professional ball players.  I mean, they’re all pros.  They’re all great players by any absolute standard. But by being just a hair better than their fellow pros, they command a higher salary by a few orders of magnitude.

    • #12
  13. Manfred Arcane Inactive
    Manfred Arcane
    @ManfredArcane

    Jordan Wiegand: And they do the same job. It’s not even that they’re 10-100 times better either, they can command that value by doing only slightly better than their less paid, but also highly skilled professional ball players.  I mean, they’re all pros.  They’re all great players by any absolute standard. But by being just a hair better than their fellow pros, they command a higher salary by a few orders of magnitude.

    Err, no, don’t think that’s right at all.  There is a big economic no-no here.

    The whole point of this thread and other threads like this on Ricochet is to reiterate a fundamental economic truth (of which the left seems blissfully unawares), namely that only the market place can quantify value (at least of the kind that goes into setting salaries).  The owners who pay these salaries to the various players have determined the demand curve for each skill level, that, along with the supply curve for same, sets prices.  You are applying some separate standard when you claim that all ball players do the ‘same’ job, one that team owners totally reject for determining salary levels.

    • #13
  14. JimGoneWild Coolidge
    JimGoneWild
    @JimGoneWild

    Good post. Thanks.

    • #14

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