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A 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.