Is High CEO Compensation Justified?

By Simon Nguyen

CEO compensation has always been the subject of heated discussions. The main contention is with regards to the significant disparity between the salary of the average worker and that of a CEO; a typical CEO earns many times more than the typical worker. While the position of CEO is one of great significance, it is hard for one to accept the notion that a corporate executive would be astronomically more productive than the average worker.

As an economist, I tend not to make inferences based on raw numbers. Economists don't really care how much a CEO is paid as long as his or her performance justifies the huge salary. For example, one CEO's actions are found to have improved the company's profits by $1 billion. I have no problem with the company paying the person tens of millions of dollars a year in compensation; his pay is well-justified.

Unfortunately, measuring a CEO's performance is an extremely difficult task. Business is highly cyclical with performance peaks and valleys. More importantly, luck (both good and bad) plays a critical role in the success or failure of a business. Case in point, the swine flu epidemic has brought booming sales of face masks and flu vaccines. One can't really attribute the increased sales and revenues to the performance of pharmaceutical CEOs, as this is more or less a random event.

As one can see, raw numbers do not always accurately reflect performance. Just because a company is making a profit doesn't mean that the CEO's actions have had a positive effect. In fact, a company could very well have made even more profits had not for the CEO's bad decisions. Equally, a CEO should not be punished solely for the fact her company is reporting a loss. It could very well be that the loss would have been larger had not for the CEO's excellent stewardship.

CEOs generally get paid more in times of favorable business environment than in times of less favorable environment. In good economic times, everyone feels good and is thus willing to pay CEOs more regardless of their performance. On the other hand, good leadership during tough economic times is often overlooked and undervalued. The only silver lining is the fact that CEOs of profitable but under-performed companies tend to earn less than those of better performed firms within the industry. CEOs who perform well and have good luck are deservedly getting their share.

The unreliable measuring of CEO performance is the reason why some CEOs opt for fixed compensation over performance-based compensation. They don't believe in the validity of performance metrics; they certainly don't want to be punished for their bad luck while other CEOs are being rewarded for their good luck.

Another factor in play is the fact that it is difficult for a fired CEO to find a job; this prompts CEOs wanting greater financial security and fixed compensation is the likely answer. It is my hope that you have gained some fresh perspectives on the issue of CEO compensation and will be less critical of some corporate executives getting a well-deserved bonus.