The Economist's lead editorial this week blasts executive compensation and urges increased shareholder activism:
This one-way trend in top executives' pay has rightly raised eyebrows, on both sides of the Atlantic. The supply of good bosses may be short, but can it be that short, even during an economic slowdown and stockmarket slump?
This is the right question.
How much you get paid depends in large part on the thickness of the market for your services. In a thick market, wages tend to be low because there are many potential employees – all more or less fungible – competing for jobs. In a thin market, however, wages tend to be high because many employers are competing to hire a small number of eligible workers. The market for burger flippers is very thick. The market for law professors is relatively thick. The market for CEOs of Fortune 500 companies is thin. I’d guess the number of people who have what it takes to run a Fortune 500 company isn’t much larger than the number of people who can run a NBA fast break. Hence, its not surprising that corporate CEOs make Shaq-like dollars. Its just supply and demand, folks.
Having said that, however, the Economist does have a point. Although I don't have the citations at the tip of my fingers, I have seen a couple of recent studies to suggest that boards erroneously believe the CEO market is thinner than it actually is, which tends to artificially inflate CEO salaries. Boards tend to want proven track records (picking an unproven CEO who tanks is bad for the board’s reputation), which limits the pool through the “Experience Required” phenomenon. Boards also tend to pick CEO candidates who resemble the prevailing demographics of the directors, which further artificially limits the pool. Hence, the Economist doubtless is right -- the supply of potential good bosses is not as short as directors believe.
The problem is that neither solution the Economist considers is desirable. The Economist is surely right that we don't want to direct government regulation of executive comp -- in particular, as I've said before, we definitely don't want to imitate Germany by criminalizing excess compensation. On the other hand, as I've also argued before, shareholder activism is hardly a panacea for the ills of corporate governance. Shareholder activism is not a solution but a problem. The only solution I can come up with is the imperfect one of independent directors incentivized to monitor executive compensation. It's not perfect, but its better than the alternatives.
Also noteworthy is the following huge whopper in the Economist's editorial: "Few public companies today in either America or Europe have a majority of independent directors." I don't know about Eurpose, but as to the US the statement is flat wrong. According to the NACD's latest survey of public corporations, 61% of US corporations had a majority of independent directors (29% had a board that was more than 75% comprised of independent directors). These are 2001 figures. Given the emphasis on director independence in the NYSE's listing standards and Sarbanes-Oxley, moreover, the figure is almost certainly higher now than it was in 2001. Once the new NYSE and NASDAQ listing standards kick in, moreover, almost all listed companies will have to have a majority of independent directors.
