Comments on: Will limiting exectutive pay send American business leaders packing for Europe? Probably not… http://welkerswikinomics.com/blog/2008/10/02/will-limiting-exectutive-pay-send-american-business-leaders-packing-for-europe-probably-not/ for students and teachers of Economics Thu, 09 Feb 2012 09:13:55 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Gary Williams http://welkerswikinomics.com/blog/2008/10/02/will-limiting-exectutive-pay-send-american-business-leaders-packing-for-europe-probably-not/comment-page-1/#comment-7750 Gary Williams Thu, 26 Mar 2009 03:12:09 +0000 http://welkerswikinomics.com/blog/2008/10/02/will-limiting-exectutive-pay-send-american-business-leaders-packing-for-europe-probably-not/#comment-7750 1. Baseball researchers look at the concept of the "replacement-level player"; one with a level of skill that, while far better than that of most of us, is, nevertheless, readily available for the 30 or so slots at a major league level. The question is: what do these relatively modestly-compensated players save a team in dollars versus what they cost in wins. Has any such research been done with respect to CEOs? How much would a "replacement-level" CEO have cost Wal-Mart, how much would one have cost a less successful company, in terms of profit-loss vis-a-vis what he would have saved them in salary? I suspect such research would be incredibly difficult to do well; but without it, how can we form any reasonable idea as to what a CEO is really worth? 2. Adam Smith, I understand, was not particularly keen on the concept of the corporation, for he felt that hired management would always have its own interests rather than the interests of the owners as its first priority. An attempt to align the interests of owners and management was the stock option; but this has backfired as CEOs (maybe influenced by their boards and current stockholders' expectations) have been mightily tempted to play for short-term stock price increases rather than to take a longer-term view of what is good for the firm. Would there be any merit to a compensation system that compensated CEOs with stock options, but provided that the options could not be exercised for, say, five years from issuance? Since the CEO would be getting new options each year with an exercise date at least five years away, he would be always looking at least that far ahead. And as a side benefit, he'd have at least some incentive to train a good replacement to make sure that he really would have something worth cashing in five years after his retirement. Is such a concept being considered by compensation committees, or by economists? 1. Baseball researchers look at the concept of the "replacement-level player"; one with a level of skill that, while far better than that of most of us, is, nevertheless, readily available for the 30 or so slots at a major league level. The question is: what do these relatively modestly-compensated players save a team in dollars versus what they cost in wins. Has any such research been done with respect to CEOs? How much would a "replacement-level" CEO have cost Wal-Mart, how much would one have cost a less successful company, in terms of profit-loss vis-a-vis what he would have saved them in salary? I suspect such research would be incredibly difficult to do well; but without it, how can we form any reasonable idea as to what a CEO is really worth?

2. Adam Smith, I understand, was not particularly keen on the concept of the corporation, for he felt that hired management would always have its own interests rather than the interests of the owners as its first priority. An attempt to align the interests of owners and management was the stock option; but this has backfired as CEOs (maybe influenced by their boards and current stockholders' expectations) have been mightily tempted to play for short-term stock price increases rather than to take a longer-term view of what is good for the firm. Would there be any merit to a compensation system that compensated CEOs with stock options, but provided that the options could not be exercised for, say, five years from issuance? Since the CEO would be getting new options each year with an exercise date at least five years away, he would be always looking at least that far ahead. And as a side benefit, he'd have at least some incentive to train a good replacement to make sure that he really would have something worth cashing in five years after his retirement. Is such a concept being considered by compensation committees, or by economists?

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]]> By: Steve Latter http://welkerswikinomics.com/blog/2008/10/02/will-limiting-exectutive-pay-send-american-business-leaders-packing-for-europe-probably-not/comment-page-1/#comment-5988 Steve Latter Fri, 03 Oct 2008 00:10:01 +0000 http://welkerswikinomics.com/blog/2008/10/02/will-limiting-exectutive-pay-send-american-business-leaders-packing-for-europe-probably-not/#comment-5988 Hi Jason, All good points, as always and its always a good idea to have a balanced perspective. A little rock 'n roll or a little country...there's always another great perspective around the corner which is why we call the application of economic principles "normative" economics! And I certainly agree with you that not all US talent would go running for Europe or Asia. The question would, of course, be how much would compensation limits affect the talent pool and of course that would depend on the extent to which the compensation would be limited and what the compensation would be for alternative choices. Here's another view, just for fun: This is a good ratio that might show CEOs are not so highly paid relative to their value. 2007 Wal-Mart Actual results: 2007 Profits: $12, 731,000,000 ($12.7B) 2007 Profits excl. CEO comp $12, 701,000,000 ($12.7B) CEO compensation/Company profits: .2% (owners get 99.8% of profits) Of course, this is one of the very best CEO comp/profits ratios along with, say, an Exxon-Mobil, Johnson & Johnson, or Coca Cola. If we did this comparison this year with an AIG, Lehman brothers, or Merrill Lynch it would be CEO compensation on top of losses which is why it is being discussed so much. Here's another perhaps more powerful analogy: On average, I would estimate that CEO compensation as a % of Corporate profits of the 500 largest companies is about .5%. Hey I usually tip 15% of my bill to my waiter, so giving a .5% "tip" to my CEO is nothing even if he screws up on me. On really bad restaurant service (analogous to losses in Corporate America)) I still give at least a 5% tip to my waiter 'cause it really might not be the waiter's fault. Hi Jason,

All good points, as always and its always a good idea to have a balanced perspective. A little rock 'n roll or a little country…there's always another great perspective around the corner which is why we call the application of economic principles "normative" economics! And I certainly agree with you that not all US talent would go running for Europe or Asia. The question would, of course, be how much would compensation limits affect the talent pool and of course that would depend on the extent to which the compensation would be limited and what the compensation would be for alternative choices.

Here's another view, just for fun:

This is a good ratio that might show CEOs are not so highly paid relative to their value.

2007 Wal-Mart Actual results:

2007 Profits: $12, 731,000,000 ($12.7B)

2007 Profits excl. CEO comp $12, 701,000,000 ($12.7B)

CEO compensation/Company profits: .2% (owners get 99.8% of profits)

Of course, this is one of the very best CEO comp/profits ratios along with, say, an Exxon-Mobil, Johnson & Johnson, or Coca Cola.

If we did this comparison this year with an AIG, Lehman brothers, or Merrill Lynch it would be CEO compensation on top of losses which is why it is being discussed so much.

Here's another perhaps more powerful analogy: On average, I would estimate that CEO compensation as a % of Corporate profits of the 500 largest companies is about .5%. Hey I usually tip 15% of my bill to my waiter, so giving a .5% "tip" to my CEO is nothing even if he screws up on me. On really bad restaurant service (analogous to losses in Corporate America)) I still give at least a 5% tip to my waiter 'cause it really might not be the waiter's fault.

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