EVEN THE business press is increasingly upset at the exorbitant salaries paid America's top corporate executives. In their annual tabulation of executive earnings from corporate annual reports, Business Week and the Wall Street Journal each expressed almost populist indignation over the widening disparity in the salaries and benefits paid to CEOs and to ordinary mortals.
During the 1980s, Business Week reported, chief executive compensation jumped 212 percent. The stock market average, reflecting company profits, went up 78 percent, while the pay of the average factory worker went up just 53 percent. These figures are not adjusted for inflation. If you factor in rising prices, factory workers took a real cut, while executive pay nearly doubled.
How did this happen? Economists have no good explanation why executive pay went into orbit.
Indeed, the statistics reveal little correlation between the level of executive pay and the performance of a company. United Airlines chairman Steven Wolf emerged as the highest paid chief executive. Last year, he "earned" in salary and bonuses over $18 million or about 1,200 times the pay of a beginning flight attendant. And the airline he runs has been in a long-term nosedive.
Conversely, some of the most profitable large companies, such as Bionet, Nike and Amgen, have chief executives whose annual pay doesn't even reach a paltry million.
Some windfalls to corporate chief executives were the by-product of the merger boom -- and perhaps one of its causes. A mega-merger creates a larger company, which in turn justifies higher CEO pay. Time Warner's Steven J. Ross reaped a $74.9 million dollar bonus on top of his $2.3 million dollar salary when the merger of Time Inc. and Warner Brothers went through.
Some economists, such as Michael Jensen of the Harvard Business School, have argued that hostile takeovers must be efficient for the economy (or they wouldn't occur -- right?), and that windfalls to executives that expedite such takeovers must therefore be efficient, too. Jensen even defends "golden parachute" payments to displaced executives as necessary lubrication to grease such deals.
But episodes like the Time Warner deal give pause. It may well be that the real cause and effect is the opposite of Jensen's claim. Far from financial incentives to CEOs expediting efficient deals, a more likely explanation is that the prospect of private windfalls gives executives a personal motive to promote deals that may be bad for the larger economy.
In economic theory, there must be a sound economic reason for what a free market does. The so-called "efficient market hypothesis" holds that markets must make efficient decisions, because companies that fail to operate efficiently in the long-run will be driven out by more efficient competitors.
That sounds logical enough as theory. But in the short-run companies enjoy a lot of wiggle room. The verdict on whether a given decision maximized "efficiency" comes long after the fact. The pay level that a CEO extracts has more to do with his power on the board of directors, his ego and customary norms about what is fair than with any precise calculation of economic efficiency. Otherwise, we'd see a far greater correlation between company performance and executive pay.
Steven Wolf's inflated paycheck may offend our sense of equity, but if Wolf took a pay cut of $10 million, it would raise UAL's dividend per share, or its employees' pay, by only a trivial amount. The performance of United has little to do, either way, with Wolf's inflated salary. He commands an $18 million salary because he persuaded a friendly board that he was worth it.
Executive pay levels soared in the '80s for reasons unrelated to merit or efficiency. They soared because the spirit of the decade celebrated an ethic of personal enrichment rather than stewardship, and because numerous CEOs simply took advantage of the power to set their own salaries. In order to buy off skeptical corporate directors, the compensation paid to directors soared, too.
As customary notions of social fairness fell away, superstars in other fields also charged whatever the market would bear. With entertainers, athletes, and junk-bond promoters enjoying incomes in the tens of millions, corporate CEOs making only a million or two felt underpaid.
Thanks to these mutually reinforcing trends, the gap between the workaday earner and the boss kept widening. Japan, incidentally, prospers with a ratio of executive pay to worker pay of about 17-to-1, compared to 85-to-1 in the United States.
All of this suggests that widening disparities in pay reflect widening disparities of political and social power and changing norms of what is fair. In a different era, the Securities and Exchange Commission might have clamped down on excess CEO pay as fleecing the stockholders. Or unions might have demanded redress.
A pay package of $18 million is a nice deal if you can get it -- and that's all it is. It has no transcendent virtues, and nothing to do with economic necessity or economic efficiency. Doubtless, somebody perfectly competent would take the job for a mere million.
Robert Kuttner writes a syndicated column on economics.