Note: I wrote an overly long comment on this thread at Hit&Run, so I thought I would post it here. The thread was about a Reason debate on executive compensation, why it was so “high” and what could or should be done about it. The tone is snarky because a lot of people on the thread were being silly.
Okay, children, let me explain why executive compensation is so high. Are you ready?
Ahem: If you want someone to run your company for your interest you have to pay them more than they could make running their own company for their own interest!
Admittedly, this a concept as complicated as quantum physics for some people but I will try to boil it down.
If someone has what it takes to run a major corporation, they have what it takes to run their own business. If someone has what it takes to convince a bunch of investors to hire that person to run the investors’ business, they have what it takes to convince a bunch of investors to invest in that person’s private company.
High executive salaries trace back to investor groups buying private companies and then paying the original owner big bucks to stay around and manage.
The reason that American executives continue to pull down so much dough relative to the rest of the world is that in America you can walk out the door, start your own business and rise to the top of an industry. You can’t do that in corporatist systems like those in Europe, because the state protects large corporations from internal and external competition. It is much, much more difficult to grow a business into a giant in Europe than in American. That lack of freedom reduces the choices of executives and keeps executive compensation down.
If you want to live in a country where executive pay is low, you have to live in a country like France where the top 30 biggest companies in 1970 are still the top 30 biggest companies today. In America, 20 of the top 30 companies today didn’t even exist in 1970. As long as small companies are allowed to succeed big and big companies are allowed to fail, you will have high executive pay.
And yes, having the right executives matters, it matters big-time. People who think otherwise usually operate from a crypto-Marxist assumption that companies churn along on autopilot driven by natural forces and it doesn’t matter much who sits at the top. That’s abstract nonsense. No one can wreck a company faster than bad executives, and often all it takes to turn a failing company around is a change of management.
A clear example of this is Steve Jobs an Apple. Jobs is still the proportionally highest-compensated CEO in the world and Apple’s stockholders, employees and customers think he is worth every damn penny. I was at Apple back in the ’90s and watched two different CEOs drive the company into the ground and one CEO staunch the bleeding, but it took the unique talents of Jobs to make the company a success again. He might have been the only person in the world capable of doing so.
Without Jobs there would be no Apple. His value to the company is literally almost the entire theoretical value of the company. When his health problems were revealed, Apple’s stock tanked.
Jobs is but the most visible and extreme example of executive talent out there. There are tens of thousands of absolutely vital executives toiling away in obscurity. We have no better mechanism for choosing executives and establishing pay than the one we have right now.
Some people say that laws governing corporations have created too little feedback from stockholders on executive selection and pay. Perhaps so. In that case, the cure is to get rid of the laws and let private contracts settle matters.
When the government interferes in the management of publicly traded companies, it almost always has the effect of giving a significant advantage to privately held companies. That is what happened with Sarbanes-Oxley. If publicly traded companies can’t hire the best talent, then privately held companies will. The effect will be to reduce corporate ownership from 50% of all Americans to just a tiny subset of the population.
That is the exact opposite of what those who want to regulate executive pay claim they want to happen.