The Economics Of Pay

I’m a vocal opponent of the minimum wage.  The idea, of course, is that when you implement a minimum price for labor, you get an excess of labor.  In other words, higher unemployment.  I’m equally a vocal opponent of a “maximum wage.”  When you place a maximum price on labor, you get a shortage of it.  In other words, you can’t find people to hire.

For this reason I take the decidedly unpopular combination of policy stances that we should abolish the minimum wage AND allow corporate CEOs to earn as much money as they can command.

However, this does not mean that I am in favor of just throwing money at the executive suite.  The money should be commensurate with the level of competence.   And a recent study is finding that it’s not always the case:

To determine how much to pay a CEO, corporate compensation committees look at how much the chiefs of similar companies earn, which has the result of lumping together all CEO talent into one pool. Elson and Ferrere argued that expertise in management isn’t the same, and isn’t as good, as having a deep base of knowledge in one particular industry.

Many of the skills that make a chief executive successful don’t translate to another company. “The theoretical underpinning of [peer grouping] became the notion of transferability,” Elson said. “That was false. The superstar theory of the CEO failed, and if transferability failed, the peer system has to fail.”

“There’s been a sense for some time that the external view of pay-setting has been a problem in ratcheting up pay,” said Paul Hodgson, chief research analyst at corporate governance research company GMI Ratings.

Elson and Ferrere said benchmarking against what other CEOs make is flawed in several ways that inflate pay packages.

One problem is that the definition of what constitutes a “similar” company can be manipulated to skew pay higher by including larger companies or ones in different industries. Institutional shareholders are “very, very suspicious” of that practice, Hodgson said.

Even without manipulation, Elson said companies should decide how much to pay a CEO based on performance, not how much his or her counterparts earn. “If you don’t have that internal benchmark you’ve made a mistake to begin with,” he said.

Make no mistake, highly successful corporate managers earn every dollar they make.  But when companies don’t link pay to success, they are hurting themselves.

4 responses to “The Economics Of Pay

  1. I just read a blog entry at Woodgate’s view evoking Dickins and the modern economic situation:

    The thing is: markets plus human nature lead to a result where winners will use their resources to structure the game in their favor, and once that leads to separate classes, they’ll rationalize their wealth as earned and find ways to justify not helping the poor, or not changing the rules of the game which advantage them. CEO pay is one of those cases – the system is structured so as NOT to force CEOs to be accountable.

    And the idea that a CEO deserves tens of millions for his work, while a laborer doesn’t deserve minimum wage seems absurd. Markets aren’t magic, they are manipulated to benefit some at the expense of others. That’s not a conspiracy of the wealthy or some kind of Marxian capitalist set of contradictions, it’s just human nature.

    • markets plus human nature lead to a result where winners will use their resources to structure the game in their favor,

      And where, good doctor, will you find the angels that will run our markets for us? Should I trust the government or the free market?

      Who among us isn’t greedy?

      while a laborer doesn’t deserve minimum wage seems absurd.

      I went to the movies the other night. The guy behind the ticket counter couldn’t tell me sowing movies and show times. He nonchalantly refereed me to the marque. He was unable to perform the math required to give me a total for adults and kids; he needed a machine to total my bill and then make change.

      The snack counter was worse. Wrong soda, wrong size and twice had to ask me what candy. Again, watching him make change was torture. Not only does they not deserve minimum wage, they don’t deserve a job.

      It’s an economic law, as sure as gravity, raise the cost of labor and the market will buy less labor.

      • You can’t trust the free market – it will inevitably devolve into mafia like gangs and power concentrated in the hands of a few. Free markets NEVER work because human nature goes against it. Even Adam Smith recognized that. You can trust either a strong sense of social/ethical norms (Smith speculated on that too) or government limited by accountability to the people through democracy and rule of law. People can hold the government accountable, and those without power can have a voice.

        And really? Somebody at a movie theater does crappy work and so you conclude that everyone making minimum wage deserves what they get? I’ve been helped by very friendly people working minimum wage jobs, and people who work very hard. Heck, I managed fast food restaurants where some of the best workers were uneducated young adults making minimum or barely above, but who were excellent workers (the ones who were likely to not work as hard were the kids — they didn’t take the job seriously). So from my experience, also working in a kitchen cabinet factory, is that the low paid working poor often work very hard and take pride in what they do.

        I believe that a high percentage of them probably work as hard as you do, but the structure of the system or choices they made when they were young put them in a place where they don’t earn as much. That’s cool – you deserve to be rewarded for good choices, and the chance of life is part of the whole experience. But if the system gets warped so that real opportunity isn’t shared, or that people can’t afford basics while others have massive amounts of excess wealth, then something is wrong.

        Ultimately, with democracy and government, we make that call. There is no “right” answer that you can objectively find. Free markets don’t work, full government planning doesn’t work. Marx and Rand were equally deluded. We learn as we go and make calls that aren’t based on simple ideology but a complex process of thinking about human ethics as well as economics.

  2. I should like to find you the Walter Williams article on this; it was very good….. Here’s one:

    I just trolled over at your buddy’s site. Oh, I forgot to say thank you for your article! Thank you.

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