Why Are CEOs Paid So Much?

Successful CEOs are as indispensable to their companies as Super Bowl-winning quarterbacks are to their teams.

By Elan Journo

As millions of Americans watch the Seattle Seahawks take on the Pittsburgh Steelers, every minute of the game will be scrutinized, with slow-motion replays and a torrent of statistics. But, amid the cheers and groans, don’t expect to hear complaints from fans about the players’ multi-million dollar salaries. Fans know just what the players had to accomplish to reach the Super Bowl and recognize that the players have earned their pay, that the MVPs are indispensable to their teams, and that it is morally proper to reward achievement.

Yet MVPs of the business world are not admired for their achievements, but reviled as overpaid fat cats. Many people are indignant about CEOs collecting pay packages worth upwards of $230 million a year and enjoying perks like corporate jets for personal use. Astonished to learn that what an average worker earns in a year, some CEOs earn in less than a week–people ask themselves: “How can the work of a corporate paper-pusher be worth so many millions of dollars?”

The answer is that successful CEOs are as indispensable to their companies as Super Bowl-winning quarterbacks are to their teams. They earn their rewards.

How big an influence can one man have on the fortunes of the entire corporation? Consider the impact of Jack Welch on General Electric. Before his tenure as CEO, the company was a bloated giant, floundering under its own weight. Splintered into dozens of distinct and inefficient business units, GE was scarcely making a profit. Welch turned it around. He streamlined and reorganized the company’s operations and implemented a sound business strategy yielding more than $400 billion worth of shareholder wealth.

In business, success requires long-range thinking. But CEOs must project a strategic game plan in terms not merely of a month or two, but of years and decades. A biotechnology company, for example, may spend 15 years and billions of dollars developing a new cancer-fighting medicine. Success is impossible without the business acumen of its CEO. For years before a marketable product exists, he must raise sufficient capital to sustain the research. What long-term business model will attract venture capital? Should the company accept short-term partial sponsorship from a large drug manufacturer in exchange for a modest royalty on the drug in the future–or risk going it alone and possibly running out of funds? It is on such decisions that a company’s success is made–and lives of cancer patients may depend.

In order to be successful in the long range, the CEO’s strategy must encompass countless factors. He must devise a plan to grow the business in the face of competitors, not only from within the United States but from any and every region of today’s global economy. The CEO calls the plays for a team of tens (and sometimes hundreds) of thousands of workers. All of the actions of every employee and every aspect of the business must be coordinated and integrated to produce the cars, computers or CAT scanners that yield profits to the company. It is the CEO who is responsible for that integration.

To successfully steer a corporation across the span of years by integrating its strengths toward the goal of creating wealth and requires from the CEO exceptional thought and judgment. Excellent CEOs are as rare as MLB-caliber pitchers or NFL-caliber quarterbacks. And in the business world, every day is the Super Bowl. There is no off-season or respite from the need to perform at one’s peak.

Given the effect a CEO can have on a company’s success, we can understand why their compensation packages can be so high. One way employers reward excellence is through bonuses. For many CEOs, bonuses amount to a large portion of their earnings. Some CEOs are paid a token salary, but are rewarded with large parcels of company stock. As is the case with athletes and other individuals whose talents are rare and much prized, the CEO’s pay package is calculated with an eye on the competition. Companies pay millions of dollars to a valuable CEO, one who they judge will produce wealth for the shareholders, in part so he will not be hired away by a competitor.

On the gridiron, the baseball diamond and the basketball court, we see and admire the physical prowess of a superlative athlete–one who earns the title of MVP–and we understand that it is morally proper to reward him accordingly. Though the efforts of CEOs are not televised on Monday Night Football, their achievements are real and have a profound benefit to all our lives. It is time that we learned to appreciate the work of successful CEOs and recognize that they deserve every penny of their salaries.

Elan Journo is a junior fellow at the Ayn Rand Institute.

FILED UNDER: Economics and Business, General
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Comments

  1. Anderson says:

    JJ, can we please get a post from you on What Ayn Rand Means to You? A malodorous mix of Herbert Spencer and Elisabeth Forster-Nietzsche.

    The instant post is a predictable exercise in fact-free rhetoric, which might merit a B+ in freshman comp. Anyone who troubles to read the newspapers (not, evidently, required reading at the Ayn Rand Institute) knows that failed CEO’s typically collect the same gigapackages of $$$ that successful ones do.

    Of Rand herself, one cannot improve on Dr. Johnson’s putdown of an earlier fraud: “where he is interesting, he is not original, and where he is original, he is not interesting.”

  2. jimbo says:

    One problem is that so much of a CEO’s compensation is based on short-term financial results. Ford and GM spent the last few years building and pushing SUVs because of their high margin. When fuel prices started rising and SUVs were sitting on the lot, they tried to goose sales with phony discounts and rebates. Where was the strategy in this?

  3. Anon says:

    This post seemed to lack any real substance.

    One hypothetical that I think is interesting is: Suppose you took a well-educated, well-trained MBA, making say $200K a year. You let them make all the business decisions for a company for five years. Would the average CEO actually make better decisions? Or does the salary of a CEO not actually reflect his business skills, but rather other skills, such as social networking, political in-fighting, etc.

  4. Aaron's cc: says:

    Imagine that same quarterback firing members of his front line.

    Baseball manager Billy Martin used to destroy teams by burning out his pitcher’s arms in one season.

    Is the goal to win one season or to fill the stadium for a decade with a competitive team?

    How about linking stock options to layoffs and outsourcing. Fire 10% or outsource 10% and you forfeit 10% of your stock options.

    Any CEO caught having illegals working under his shift ought to make the company legally constrained from laying off or outsourcing 5x the number of illegals caught for five years.

    Until there are disincentives for the golden parachuted, there is no accountability.

  5. Jeff Medcalf says:

    I concur that there is a problem, unacknowledged in the post, in that bad CEOs get just as much as good CEOs. However, this is a problem of corporate governance, and the proper way to punish this is to pull your investments from companies whose boards hire ineffective CEOs. (If large institutional investors did this, corporate governance would get cleaned up quickly.)

    Aaron’s cc made some fascinating suggestions. Not very useful, but fascinating. The reason that they are not useful is because they misunderstand the purpose of a corporation: a corporation does not exist to employ people, but to deliver a return to their investors. If that were not the case, investors would not invest. (Putting money into a corporation that does not generate a return is not investment, but spending, and what did you buy, exactly?) And if investors do not invest, there is no corporation, or the corporation shrinks dramatically as its funds dry up.

    Stock options are directly linked to performance in that realm: if the value of the stock increases (a reflection of the return to the investor increasing), the holder of the options can sell the options and make money. If the value of the stock falls, the holder of the options doesn’t make any money from them.

    There are two reforms, though, that could make stock options a better tool for getting good CEOs: value the stock options against an index (if S&P 500 goes up 10%, and your stock goes up 8%, you didn’t do as well as the broader market and thus the value of your options should be such that you don’t make the 8%; this is a way of taking inflation into account) and give out fewer stock options. The sheer amount of the stock options most companies offer their executives, combined with the special perks like pensions or health care that survive bankruptcy, so distort the corporate executives’ compensation that their decision making is forced to the short term.

    Is the goal, to paraphrase Aaron’s cc, to have a team with 150 people on it, or a team that can win?