First, I've worked at a company that has undergone restructuring at a management level. From personal experience, small changes in strategic direction have a massive impact on people at the bottom of the "job-food" chain. It is easy to lose months, probably even years of work because someone above you made the wrong call. Since a CEO helps determine the strategic direction of the company, it seems reasonable to me that the pay of the CEO should scale with the sum pay of every other member of the company.
Second, there are a few studies which show a CEO's personal circumstances can have a percentage-point effect on a company's performance. A great example is a study of the effect on profit by a death in the immediate family of a CEO. Excerpt:
Sorting by the number of children we find the biggest effects on firm profitability in cases where the CEO only has one child. Specifically, one-child death shocks correlate with a 5 percentage point decline in firm profitability irrespective of the age of the child.The study goes on to show that the deaths of a spouse or child are significant events for a firm. I think the study underscores the importance of choosing the correct CEO. Though the study doesn't show the variation in profit during standard circumstances, to me it seems like a reasonable conclusion that variations in a CEO's ability to carry themselves through tough times will have a large effect on firm profit. For a company with hundreds of billions in profits per year, like an oil company, the CEO's personal circumstances could have an effect in the billion dollar range, meaning if the CEO themselves only received a fraction of this pay it would still be in the tens of millions range.
My math is a bit fuzzy here, but as always you're welcome to disagree in the comments and point out any mistakes I've made.
5 comments:
though the concept is intriguing, the paper fails to show whether or not a marginal increase in a ceo's salary is more beneficial to the profitability of a company than...say...the equivalent in free chicken and rice for employees at lunch on thursdays.
Ahhhh, the marginal increase argument.
http://www.marginalrevolution.com/marginalrevolution/2007/10/further-thought.html
I think I'd fall in line with the "1. How much better the highly-paid guy is than a less-well-paid substitute would be." argument.
i concur with that definition but take it one step further by incorporating the opportunity cost of that additional salary. perhaps $5 million less CEO = 10 additional underlings, which could achieve greater profits on net, plus more-effective hedging of key man risk. thoughts?
I don't know enough about companies and their strategic directions to say whether 10 underlings are better than 1 key man. I do know, from personal experience, that having 10 underlings make strategic decisions can turn into a giant mess when the company tries to divide responsibility. In my experience responsibility is a bit like an atom; if you try to divide it you end up with explosions, radiation and very unhealthy humans.
maybe not a decision-making underling...how about a research underling? depends what you think drives company value at the end of the day...and how much you fear a land invasion of japan...
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