Imagine a company doing $10 billion in yearly revenue. If the right guy manages the joint, it will do $11 billion. Are you willing to pay 10 million a year for this person? What if another company in similar circumstances offers 20 million? And another company 50 million? In the end, they all have 1 billion at stake. So, they all could even offer more and still be laughing all the way to the bank. In other words, even if a CEO could only make a difference of 10% on a large company's revenues, it would still be worth it to pay him incredibly large amounts of money. Apple paying Steve Jobs $50 billion would still have been a very cheap bargain. He made a difference of way more than that.
The same could be said for any other employees. Programmers, warehouse workers or whatever. Maybe they could be paid for the difference they make too. Yet this doesn't happen, because the supply side is important as well, as well as the lack of power these people have.
From what I see, finding the right guy to manage a company is very hit and miss in the real world. Just look at Ron Johnson. He was previously senior vice president of retail operations at Apple, and then hired as CEO of J.C. Penny. He was fired as CEO from J.C. Penny in 2013, after retail sales were down by 32% and stock prices fell steeply. This was despite him having a very successful tenure at Apple. The pricing should factor in the uncertainty and risk of the performance of someone in the position of CEO.
I have probably have not touched most of things that could be issues here, such as corruption, and that some CEOs are just extremely incompetent. I remember a CEO that was given 250 million dollars to leave because he had that much negative impact on the company he was running. This was someone that the board thought was a great hire.
Anyway, I find the post I am replying to is way too simplistic and looks at CEOs with extremely rose coloured glasses. There is a lot more to consider.
The same could be said for any other employees. Programmers, warehouse workers or whatever. Maybe they could be paid for the difference they make too. Yet this doesn't happen, because the supply side is important as well, as well as the lack of power these people have.
No, this can't be said for every other employee. The best warehouse worker is not adding $1B or anything close to it to the bottom line.
It can be said for some programmers and these programmers do tend to make lots of money. (Though in many cases they are given titles other than "programmer", e.g. "managing director" of a team of 0.) See also top traders - at many firms they can make more than the CEO.
The fact that not all CEOs are perfect doesn't contradict this claim. In fact, if you are attributing JC Penny's 32% loss to the CEO you are supporting the claim of gizi.
If you read the paragraph which you say I am attributing 'attributing JC Penny's 32% loss to the CEO' then you will find that I was talking about it being unpredictable when a new CEO is hired, he had a good track record at apple before he ballsed it up at J.C. Penny by not taking into account that the customer demographic was different, he just went with the one thing that worked for him before. And no, what I said doesn't support the claim of Gizi because showing someone can destroy or damage a company does not show they can run one excellently, or that a high paid CEO will run one better than someone who is willing to work that job for substantially less.
Here is an article that shows that higher pay only increases performance until a point, then performance drops:
http://eganassociates.com.au/high-ceo-pay-inspires-better-pe...
These results came from data that compared CEO remuneration to average employee remuneration. This directly contradicts what Gizi was proposing, because the real world data shows a negative correlation between CEO pay and performance after a point. The full paper is available here http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2529112 if anyone is interested in it.
Consider the GFC, it shows how well upper management really stuffed things up at the largest companies and still got away with it, no problems, still getting huge payouts for sub par leadership. Yet when things go well, the CEO gets bonuses for things that may have had nothing to do with them. Random fluctuations are wrongfully attributed to CEOs, and they get hefty bonuses for it as well. Here is a study that shows this http://www.sciencedaily.com/releases/2015/10/151022192337.ht... , unfortunately the original source is behind a paywall so I am not linking it.
...showing someone can destroy or damage a company does not show they can run one excellently...
What it shows is that the marginal effect of a CEO is large - multiple percentage points of the company's value. Therefore, the difference in value between a good and bad CEO is equally large.
Gizi: "If the right guy manages the joint, it will do $11 billion. Are you willing to pay 10 million a year for this person?"
Repeat the math with $10B and $7B, and you'll still see that $20M or $50M is a very reasonable pay package to get the guy who is less likely to screw things up. Of course, if you truly believe CEOs have an insignificant effect, I encourage you to invest in companies with CEOs who are perceived as being terrible.
These results came from data that compared CEO remuneration to average employee remuneration.
Your linked study provides very weak support of these claims. It's restricted to bank holding companies and thrifts during the financial crisis. In fact, there is a pretty obvious alternate explanation of it's results - banks with a high pay ratio consist of a CEO + lots of tellers, mortgage officers, etc (e.g., Citi, Countrywide). In contrast, banks with a lower pay ratio consist of CEO + quants, traders, etc (e.g., Goldman, Morgan Stanley).
Can you think of another reason why banks with lots of mortgage officers might have performed worse during the crisis?
Just because someone burns a house down while most people don't, doesn't show that the same percentage of people can build one in the time it takes to burn a house down. I'm disappointed I had to make an analogy like this to show the flawed logic that led to that silly idealised simplified math that ignores reality. I have already shown that the effects of hiring a different CEO are unpredictable.
The support of having is stronger than you suggest. The study showed a significant negative association between firm performance and pay disparity in the Korean companies as well, from a separate study where more financial information is required to be disclosed.
I will also say that the CEO compensation is reasonable in most companies, it is just that after about the 8th decile performance starts decreasing and risk increases. The real problem seems to be the more extreme CEO to average employee pay ratios.
Can you think of another reason why banks with lots of mortgage officers might have performed worse during the crisis?
A larger pay gap in the executive ranks promotes greater risk-taking.
By the way, there was the highest CEO compensation compared to employee compensation just before the GFC hit.
...I encourage you to invest in companies with CEOs who are perceived as being terrible.
I would say that is terrible advice that has nothing to do with the conversation, as we were discussing pay ratios.
The same could be said for any other employees. Programmers, warehouse workers or whatever.
Some programmers, maybe, but very few could move large company's revenue by 10%. And almost certainly no one moving physical stuff around in a warehouse could.
> no one moving physical stuff around in a warehouse could [move large company's revenue by 10%]
Sure they could. They're the feet on the ground, so to say, and so they have the best insight into inefficiencies which are occurring on a day-to-day basis. You can bet it wasn't a CEO who discovered UPS' "only make right turns" trick. Or Bezos who optimized Amazon's warehouses.
A 10% reduction in costs is very realistic for these kinds of finds, and those reduction in costs are worth more than a 10% increase in revenue.
I was referring to the amount of money the employee makes for the company.
Does the employee get near what they make the company? I doubt it.
Does the company need to pay the employee near what they make the company? No.
So a company does not need to pay the CEO the difference that they supposedly make the company. They just need to pay what someone will accept to do a similar job (I am not saying worse in any way), just like other employees.
This is an argument that a lot of people make in a lot of business cases. It is not a correct argument.
Find huge amount. Say "if only X%" (usually 1% or something else low) then increase of 1%*huge amount which is still a huge amount!
Somehow the argument of "if only X%" is meant to avoid the need to prove that you can, in fact, do X%.
1% of extra revenue is hard. 1% time save across the board is hard. If you claim 1%, you better have some strong arguments as to how you can achieve 1%, not do "handwavy do something with synergy or extra information - even if we just get 1% which is a low number, 1% of something huge is still huge. We think we can do more than 1%!".
It is almost as pervasive as hindsight arguments that ignore risk costs. "I put all my money on black at the roulette table and my business is up 100% in the last year - I will bring huge wins to you".
It is a partially correct argument. If you apply a method to something small and it has an x% effect then your compensation will always be limited by that upside. Applying that same method (or knowledge) to a larger entity potentially has a larger upside and so your room for negotiation expands. Whether or not the difference in percentage is the same is of course debatable but if there is an upside in both cases then the upside is likely to be larger in absolute terms when applied to the larger company. And so those large companies will be able to pay higher compensation for the same skill levels.
That's not at all the same as playing roulette and it does not mean this argument is not correct. It's correct in principle, you may want to argue about the degree to which it transfers from smaller companies to larger companies.
It failed to address the fact that it may not even be possible to increase anything. What if revenue is limited by the product? Then it's not the CEO that can impact it. What if the odds of ever changing anything fall as the company grows? Then there's no scale gain for the CEO's work.
There's a huge number of problems that may impede that scenario, and the argument just distracts people away from those.
You have a good point, but it's clear that CEOs do have a huge effect on company fortunes. When you get a rockstar CEO, the upside is obvious. And when you get an idiot CEO, so is the downside.
Kind of. One problem is that Wall St isn't great at distinguishing between idiot CEOs who sweat companies in the short term but kill them in the long term, M&A shopaholic and management-by-rebrand CEOs who flap around doing a lot of useless stuff with no actual clue, rock stars who grow companies with a vision, and bullshit CEOs who churn through investor cash and wishful thinking but create no real profitability.
The issue of distinguishing high-quality execs from low-quality ones is one of the points mentioned in the Jacquart & Armstrong paper that I think the article was referencing[1].
If a given CEO really is 10% better than the guy who'd do it for $49 million less, then sure, he's a bargain. But is there any evidence that he's actually 10% better?
Imagine a company doing $12 billion in yearly revenue. If "the right guy" manages the joint, it will do $11 billion. Are you willing to pay 10 million a year for this person?
You can get the exact same increase in profits by investing 10 million a year in a talented group of developers and having them produce mobile games. Or a fleet of truck drivers. Or anything, really. 10mil/yr is enough to finance a small enterprise, so you can realistically branch out into anything that makes money.
Upping the revenue from 10B dollars to 11B relies on the infrastructure, capital, corporate relationships, etc, etc that were previously built by a company. The new CEO didn't just create 1B of additional wealth out of thin air, he was provided a lot of expensive tools to carry out his vision.
Well yeah, if I just make up numbers and imagine a world where a single CEO would have the same impact on multiple companies. Of course that's not reality at all, well unless the increase in revenue comes from political connections that supply legislation that favors your business of course.
I think that if it was my business, I would prefer to hire a good CEO, instead of a star, and use the rest of the money to hire one hundred talented CEO assistants with different expertises. Sounds like a better investment.
Lets assume that CEO can fuck up so bad that it will bancrupt a company.
Star CEO has 0,1% chance of fuck up/year.
Good CEO has 0,2% chance.
And completely mediocre would be about 0,4%.
Hire three mediocre dudes to CEO the company so that they are always deciding on everything together. You have now 0,064% yearly chance of bancrupty, while you can easily pay them just 300k each.
It seems like high CEO pay is often a result of CEO holding the company as hostage. Not not necessarily conciously, but from shareowners point of view. Distribute the risk of bad moves and you should get OK performance cheaply.
CEO is just a human. With about 16 wake hours per day.
When company get's big enough, the role of CEO gets more and more about enabling the employees to create value. Consistency is valuable on it's own right. And it increases as company gets bigger.
Companies typically have board to put a degree of democracy in the big moves. So that mistakes get unlikely as 10 people are not very likely to do the same mistake at the same time. But they are not part of day to day operations, so they usually suffer from lack of data.
