That CEOs are overpaid is something, as Leonard Cohen would say, “everybody knows”; including the directors and shareholders who ultimately decide their pay. Yet firms are unwilling to do anything about it, because to do so would damage internal relations, undermine status and run against the norms of the system.
Across , four-fifths of people believe business leaders in their countries are overpaid and/or that salaries .
In Britain, the head of the Institute of Directors said the “”. Several global business leaders have criticised “”. Paul Anderson, then retiring chief executive officer (CEO) of BHP Billiton, saw “” of CEOs.
An Australian survey showed a majority of directors considered CEOs were overpaid – yet boards of directors set CEO pay. In-depth interviews with non-executive directors brought out comments like “I don’t think any individual is worth that much.”
The retiring global CEO of Royal Dutch Shell “If I had been paid 50% more, I would not have done it better. If I had been paid 50% less, then I would not have done it worse.”
This disaffection is founded in reality. From the mid 1980s, real executive salaries grew substantially faster than average real wages.
Yet that difference in growth rates has not always existed. In , and , series on executive pay and average earnings tracked each other fairly closely through the 1970s and early 1980s; but from the mid-1980s they diverged. CEO pay helps explain the of national income, which in turn is only evident since the early 1980s.
Yet evidence shows the link between CEO pay and performance is often either or - though there is some evidence of a weak, positive link, but this may be only in , such as boom times.
The issue that bothers the public most, though, is not CEOs being out of line with shareholders (interested in performance) but CEOs being out of line with society. Even if a link existed between CEO pay and performance, this should not in itself create the recent pay divergence. There has in economic performance necessary to explain it.
Size and asymmetry
The first is . Large firms have greater power. Executives of larger corporations command more resources and have greater opportunities for “value skimming”, with “proximity to large flows of revenue and fees”; so high executive pay reflects “”.
The second key element is the unbalanced (“asymmetric”) nature of “bargaining”. Rather than having opposing identities to executives, the members of boards or committees setting CEO pay are from the same social milieu with broadly similar interests, precluding .
As in all markets, supply and demand are relevant. But in labour markets for executives and directors, social norms are a critical institution. These norms can be summarised by seven behavioural rules.
Status
First, the status of a corporation depends in part on the , and hence pay, of its CEO. As Warren Buffett , “No company wants to be in the bottom quartile as far as CEO pay goes”. Firms like to have “” CEOs, and “celebrity” status may , even though shareholder returns after a CEO reaches “” status.
Networks
The ability of CEOs to extract rents - “the that firms or individuals obtain due to their positional advantages”, is influenced by their social capital or networks. So CEO compensation includes a “”, boosted by “golfing in the same exclusive club, sharing directors who understand the local pay norm and displaying luxury mansions”.
Women typically are , and this helps explain the gender amongst executive directors and CEOs.
Comparisons
CEO pay is heavily influenced by comparisons. This is known as relative pay deprivation (or, as Buffett says, “envy is bigger than greed”). Executives they are and hence deserve to be paid above average. Many firms try to pay above average, almost no-one wants to pay below average.
Observers talk of the , the (after a mythical place where every child is above average) or even the . When business lobbyists claimed that caused a surge in pay growth, they conceded the relevance of relative pay deprivation. There is statistical evidence of it in Australia.
Institutions
Institutions emerge to help this asymmetric pattern bargaining. Leapfrogging happens with or without disclosure rules. Private institutions take advantage of relative pay deprivation concerns. Pay surveys, a , create for CEO pay. Remuneration consultants have in the last three decades. They “are only seen to be ”. Remuneration committees on boards provide the appearance of independent review, setting “” while “ratcheting” pay.
Incentives
The incentive structure of executive pay adjusts over time. It does this to minimise the risk that pay falls to match performance, to justify high growth and to deflect shareholder concerns.
There has been a major in of CEO pay towards greater use of incentive pay. If this was just about aligning pay and performance, base pay would reduce as incentive pay increased, and total CEO pay on average would change little. Instead the growth of incentives has been central to the growth of total CEO pay.
The , and its , has principally occurred through . Incentives give the appearance of tying pay to performance and can mask its level as “only relatively few individuals with technical insight are able to understand what an executive is being paid”.
However, CEOs resist pay reductions. If incentive formulas would cut remuneration, then a restructuring of CEO packages (eg to increase the base or revise incentives) . So a of CEO pay packages found many amendments leading to higher pay, but no amendments if packages paid above expectations.
Segmentation
Different norms shape pay in , though references will be made to other segments to . The general factors inflating US executive pay tend to be at work in Australia, but that does not mean Australian and US CEO pay are determined in a single global labour market. While beneficiaries have long used international comparisons as a justification for high growth, recruitment of Australian CEOs from overseas .
varies less between industrialised countries than does . The 20 highest paid US CEOs received , but on average ran smaller businesses by turnover. Cross-national differences in CEO pay are “”, including differences in (including amongst economic elites) and (though everywhere, inequality is ).
Contested
The ability of CEOs to ratchet pay upwards is contested. CEO power to shape pay is constrained by several factors. These include: shareholder activists (including superannuation funds); actual or threatened legislation to impose limits on CEO excess; and popular resistance. These wax and wane.
After world war two, an “” would “limit executive paychecks”. But from the 1980s, financialisation and the move towards market liberalism shifted, and the , setting new benchmarks for others to follow. The growing “” gave CEOs motivation to aim even higher.
A few years ago corporate Australia was engaged in “”. The subsequent “ forced to ”“ that was seen as "a genuine tightening”.
So it’s not quite the case that “nothing hapens”. But it only “happens” for a while, until the fuss dies down.
A more extensive version of this, with full references, is published in the .
As a university employee, David Peetz has undertaken research over many years with occasional financial support from the Australian Research Council, governments from both sides of politics, employers and unions for specific projects. Those funded projects do not concern the subject matter of this article.
