orgtheory.net

are CEOs overpaid?

Teppo

Apparently CEOs are not overpaid; that is, once you take into account company size, market cap, talent, etc.  Here’s a summary on a recent study published in the Quarterly Journal of Economics:

As Gabaix and Landier write in a new Quarterly Journal of Economics article, the sixfold increase in American CEO pay from 1980 to 2003 is almost wholly explained by the roughly sixfold increase in market capitalization of big U.S. companies over the same period. (Asset values have increased sixfold because both corporate earnings and the price-to-earnings ratio investors are willing to tolerate have increased by factors of 2.5.) The trend lines of market capitalization and executive payouts rose and dipped in near-perfect tandem. 

According to Gabaix and Landier’s model, the talent differences among CEOs are generally minor. For example, if a given firm substituted the most talented CEO for the 250th most talented CEO, its market capitalization would only increase by 0.016 percent. But for a $500 billion company like ExxonMobil, 0.016 percent is equivalent to some $80 million. In other words, as companies get bigger, a talented CEO can have a greater impact. Therefore, large companies bid up prices across the board for the small number of men and women deemed capable of managing them. The reason CEO pay in other countries (such as Germany) tends to be lower is that the “big” companies abroad are generally smaller than the big companies in America. We do not yet have a global market for CEO talent. 

More here.

*Just noted that this is old news, Brayden posted on it nearly two years ago.

Written by teppo

March 10, 2008 at 5:06 am

6 Responses

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  1. For example, if a given firm substituted the most talented CEO for the 250th most talented CEO, its market capitalization would only increase by 0.016 percent. But for a $500 billion company like ExxonMobil, 0.016 percent is equivalent to some $80 million. In other words, as companies get bigger, a talented CEO can have a greater impact.

    This is a rather odd argument, no? I mean, can you imagine the CEO of ExxonMobil — let’s say he’s the most talented one — justifying his salary by saying, “The difference between me and the 250th best guy is worth an amazing $80 million bucks to this company!” Presumably the response would be, “Uh yeah, are you aware that that’s a whole 0.016 percent of our market cap?”

    Given the differentials quoted, is the finding of this paper basically that very highly paid CEOs effectively capture (in their salaries) all of the difference they personally make to the company’s bottom line?

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    Kieran

    March 10, 2008 at 6:04 am

  2. Hmm, good question. There is of course also the question of whether the CEO’s capture (given that presumably there are also others involved in both the generation and creation and appropriation of rents/value) is rightly specified in the first place; we do tend to impute much of the effort to the top. There is the CEO/leadership-effect literature that has teased out the various nested effects on organizational performance via variance decomposition (industry, mgt team, CEO — e.g., Lieberson & O’Connor, 1972, ASR), though that also has its problems.

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    tf

    March 10, 2008 at 2:23 pm

  3. Now why don’t employees’ salary correlate with company size as well?

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    Caminadella

    March 10, 2008 at 6:03 pm

  4. Actually lower level managers’ salaries do correlate with the salary of the CEO.

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    brayden

    March 10, 2008 at 6:14 pm

  5. It’d be interesting to parse this all the way down to the organization as a whole — to see both how rents are generated throughout (hard to tease out of course given team production) and how then appropriated/imputed. Given causal complexities, my guess is that a bulk of the imputation/credit still goes to the leadership-effect.

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    tf

    March 10, 2008 at 6:27 pm

  6. Touché. But I was thinking of lower rank employees, not the first 5 management levels.

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    Caminadella

    March 10, 2008 at 6:31 pm


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