CEO compensation and Worker Job Security

That CEO's are earning big money is nothing we didn't know about. Yet, the size of their paychecks is at times enough to make those who are not earning 6-figure salaries furious. In the list of the top 15 earners for 2013, the lowest CEO compensation is at $36 million. It is true that their earnings fluctuate with the earnings and general performance of their firms. In fact, they have done a wonderful job tracking the S&P 500 especially since the 1990's:

As the reader may observe, CEO compensation was not following stock market development right from the start. In fact, for the first 10-15 years since the 1960's, the upward trend in compensation was not an outcome of a strong stock market; the S&P was on a long downwards trend during that time. Yet, in modern times, CEO's more than made up for their losses. In 1978, the CEO-pay-to-worker ratio was 26.5-to-1; in 1995 it went to 136.8-to-1 and in 2012 it was 202.3 times the typical worker's salary as the EPI reports (the peak of this ratio was in 2000 when it reached 411.3-to-1).

The difference is astonishing. Most of us would (rightly) think that we have overemphasized the importance of a CEO: she/he may be worth a lot and have much more worries than the average worker, but try working a day without him and another without 200 typical employees and see which is more important for the firm. Still, what is more interesting is not that, since the 2000 peak, the ratio of CEO pay to average worker has decreased, but the timing and reason behind that. For example, look at the following table from the same publication:

Note the two highlighted numbers: CEO compensation has actually decreased in 2011-2012, by approximately 7.1% while the decrease for workers has been a much lower 0.6%; the ratio of earnings during that period narrowed by about 6%. The problem here is worker wages are also falling during a crisis. Thus, even though CEO compensation is falling, the fall is reduced from the worker wage reduction (this is the same as debt-to-GDP ratio analysis where if GDP falls even when debt falls the ratio may remain unchanged). This isn't just the case for the US mind you; the same gap (albeit not so exacerbated) also exists in Spain (where higher salaries continued to grow through the crisis, with 2009 being the only exception) and most likely every other EU nation. As the article on Spain notes, there are two possible explanations: either CEO salaries were the first to go down so the first to go up, or firms are focusing on people who, in their opinion are bringing the greatest value in the organization.

Defendants of CEO pay might argue that since their compensation varies widely through time, indicating more risk, it makes sense that these people get more money in return. Yet, when there is mostly an upwards trend, a few points indicating a decrease hardly matter. In fact, Kaplan notes that the historical average of CEO compensation is in the mid 1990's: the figure for 1995 is 6,303 and the ratio at 141.1-to-1. Thus, even though CEO compensation has been falling since 2000 the fact remains that at its peak it was much higher than expected. Just like the dot-coms at the time, it was a bubble itself.

A more important point is that their compensation, although decreased at times of recession (contemporaneously as the data show; see 2007-2009), the value of their money was not reduced by as much, given the deflationary pressures of the time. Yet, the defendant might comment that worker wages increased during that time. This is the most interesting part of the analysis: it appears that, in 2007-2010, worker wage was increasing (a total increase of 5.6%), while CEO compensation fell by 11.8%. In contrast to what many might believe, it appears that worker compensation declines only long after the event, indicating that wages are sticky (for details see this). The bad part here is that unemployment isn't.

In fact, unemployment in the US soared to 10% from less than 5.5%, in 2008-2010. It was only after unemployment peaked, at the start of 2010, that firms decreased wages. This brings out a more important topic: that after all, worker wage is not only volatile, but workers also face the extra uncertainty of becoming unemployed. For the CEO's higher pay means that the cost of being replaced is accommodated, as is the cost of higher volatility. The problem is that the cost of being replaced isn't covered by the wage increases of the average worker.

This doesn't just happen in the US though; it is also the case in Spain, and Greece and other countries. The point is that we compensate CEO's for the higher risk of getting fired or higher volatility in earnings. Still, the wages they earn are sufficient enough for their children to live in luxury. The average worker not only does not earn that much, but also faces the increased probability of being fired at a time when it is most difficult to encounter another occupation, just because of wage stickiness.

What we have been arguing basically reduces to one of two options: either we start thinking that we are overpaying CEOs or that we are underpaying workers. I'll leave it up to you to decide. But if you ask me, lowering the ratio to the early 1990's levels would be much better.

Theories of Destruction

While the Eurocrisis is still raging many have found the opportunity to promote their own ideas of new world orders, new forms of government or economic systems. To this day, I have yet to found an alternative to the current situation which would provide stability and prosperity.

Most people's ideas are focused on the "injustices" of the current economic system. By injustices we mean the fact that companies and certain individuals have an income of multiple times the average one. Why should Mr A earn 1 million euros per year and Company B 100 million a year when Mrs C earns only 25,000? Isn't that injustice to the poor? Under other forms of government or other economic systems (the critics declare) things would be better for the common citizen. Hmmm, let me think for a minute. We are trying to find a perfect system, which would not promote either education or public health or something similar, but, it will have than monetary consequences to the ones who adhere to it!

Most importantly, the critics intend to do this by not even acknowledging the fallacies of human nature. First of all consider jealousy (although this is not the formal term for this phenomenon): if my neighbour earns 25,000 a year I would prefer to earn at least 26,000 to be happy. At the same time the neighbour would prefer me to earn less than 24,000 in order for him to be happy! If you do not believe that this is true read this, this or this. Thus, all forms of government which state that people should earn the same wage or benefits are in fact violating this principle. This would mean that these forms of government would not be sustainable in the long run.

I have to admit that capitalism has flaws. It not a perfect system, although I do not believe that we will ever have a perfect system. Systems are as good are the persons who create them, and our basic quality as people is that we are very far from perfect. Thus, having a perfect system is like looking for a perfect man or woman. You will never get something perfect, but what you should get is someone whose faults are such that are not of such significance. Unfortunately, the same holds for democracy. However, in the words of Winston Churchill "Democracy is the worst form of government except for all those others that have been tried."

Now let's think about the following scenario:

Mr A is a person who goes to a 9-5 work every day, works enough to keep his job but not so much as to earn a raise. He has an average house, with a small family and he saves enough of his salary to go for a vacation each year.

Mr B is a person who works the same hours as Mr A, but his overall productivity is lower since he does not work hard enough. He earns a slightly lower salary than Mr A and although he does not have a family, he spends so much that he never has any savings in the bank.

Mrs C, is a person who puts extra hours on her work daily, her superiors are extremely happy with her and she gets a raise almost every year. She saves enough for her to buy a new house and a new car while still maintaining a family.

Given the above scenario would Mr B. or Mr A. have any right to complain if Mrs C gets a raise? Obviously not. However, in real life, we do not understand that most of the people who earn substantial amounts of money, have to work extremely long hours, be very devoted to their work and at times put their personal or family life in second place for a number of years. I heard a story once from a person who at the time of interview was a millionaire, stating that he realized that he had a son when the boy was 18 and leaving to study.

Another thing that most people do not realize is that it takes some kind of ability to become an entrepreneur. Out of millions of small cloth companies, Zara has managed to become a worldwide brand and its founder a very rich man. The same happened to furniture giant IKEA. Why has this not happened to every other furniture or cloth store? I am guessing that it has to do with the manager's ability to work wisely towards achieving what needs to be done. It needs a lot of luck too. In John D. Rockefeller's words: "All it take to be rich is luck, luck and luck."

As for companies, which appear to be making millions of euros every year and use them at their own will, let me remind you that a public company usually has thousands of shareholders, which benefit from those millions, either directly, through dividend payments, or indirectly through increases in share prices. This would mean that public companies are in essence beneficial to an economy as they raise the income level of their shareholders and boost consumption.The only companies which promote accumulation of debt by very few person are private companies, which to be fair, are much cheaper to form when a company is young. What should happen, is that companies which reach certain levels of income or employees, should be taken public so that the regulators have a better grasp on them and their practices.

There are, unfortunately, those who manage to get rich, one way or another, not through work but through other mechanisms. These are plain crooks and should not be compared to people who devote more than 12 hours a day to their occupation. It is the idle we must not accept in society, not the hard-working ones. And trust me, most of those who inherit large sums of money do not hold their money for too long. What we should not accept is unfair and illegal gains. Those who choose to devote their lives to their careers to earn money, are obviously going to come short in another aspect of living.