Henderson CBI: CEOs are Underpaid

A provocative title, no? Well, Todd Henderson's a provocative guy. On Wednsday, May 9, 2007, he delivered the talk on "CEOs are Underpaid." As he said, he may not have convinced the audience that CEOs are underpaid, but he was pretty convincing in explaining that they seem to be efficiently paid and not overpaid. You're going to have to listen to hear for yourself. The blurb for the talk is after the jump.

Conventional wisdom suggests that CEOs make too much money and  that agency costs explain the excessive amounts and inefficient forms of compensation.  Consider two famous people who share this view: New York Times pundit and corporate critic Gretchen Morgenson wrote: “Executive compensation is the cancer of corporate America.  CEOs have too much power and it has been directed at their own enrichment”; her view is shared, more or less, by Earth’s second richest man, Warren Buffett ($52 billion +/-), who calls current pay practices “[i]rrational and excessive.”  These views are shared by most academics.  Harvard law professor Lucian Bebchuk recently argued that the way to rein in pay is by empowering shareholders, that is, by reducing agency costs.

As usual, conventional wisdom is wrong.  Drawing on his research and that of several other Chicagoans across the Midway, Professor Henderson will argue that, if anything, CEOs are, on average, underpaid; and reducing agency costs is unlikely to fundamentally alter the amounts or ways in which CEOs are compensated.

Comments

[abb1]

Yeah, right.

[Wes]

Will the blog administrator kindly post the charts and graphs on the blog? The lecture was great without them, but I'd like to see the visuals that were referenced.

[Procrustes]

I listened to Todd Henderson's paper arguing that the CEOs of the large U.S. companies are efficiently paid (versus shareholder and other interests). His study relies heavily on the fact that when his sample of companies pass through bankruptcy (and thus have an opportunity to renegotiate the contracts with their top executives), they don't significantly change the contracts.

I'm wary of how well this evidence supports Henderson's conclusions. First, is it a fair sample when you look at the companies that survive bankruptcy, rather than completely collapsing or being cut up and sold in bits? They are going to be among the (bankruptcy-prone) companies that were better managed in the first place.

Second, the remuneration of your top executives (publicly known and discussed) may seem a signal to the market as to the quality of the management- a CEO paid less than average seeming like less than average in ability, connections, etc). Do you really want the company that you are administering, so that it will soon emerge out of bankruptcy (and issue bonds and shares into the market), to give that sort of signal (even if it would be true).

On the other hand you would expect any able and effective executives that you would recruit to join the company to demand a risk and reputational premium for being associated with it, not be satisfied with the going rate in the industry.

[LAK]

I've said it once and I'll say it again: in the case of Good v. Evil, Evil always seems to be well represented by a Kirkland lawyer.

[Todd Henderson]

"Procrustes" makes some nice points. I encourage you to read the paper, which is available here:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=927081

Quickly, let's put aside issues of how much CEOs are paid by bankrupt or formerly bankrupt firms, and instead ask how the amount of compensation is delivered. It might be (although I doubt it) that the market for CEO talent is so broken that the amounts are in excess of the marginal contribution (in expectation) of the CEO to firm value, in which case a critic of the paper could argue that bankrupt firms, as price takers, have no choice but to pay the (broken) prevailing wage. I doubt this is true, but let's say it is. Even if true, there is no reason why the amount of compensation must be delivered in an inefficient way.

Take a simple example: Firm X is in bankruptcy, and it must pay $10 million per year in total compensation to attract a CEO of high talent. Even if the $10 million is excessive (by some metric), there is no reason why Firm X has to pay the $10 million in ways that critics of executive compensation claim are inefficient -- like non-indexed stock options. If it is the case that giving the CEO a combination of cash and indexed stock options is the most efficient way to deliver the equivalent of $10 million in utility, then there is no reason that I can think of that Firm X, when debiased of shareholder agency problems, would continue to pay in non-indexed stock options, unless there is something else going on here. I claim that there is, and that the agency-cost/managerial power view of the world is too simplistic. It is actually a very simple, and, it seems to me, non-controversial claim.

As for "LAK", I've said it once and I'll say it again: one doesn't win arguments through name calling and sophistry. I'm impressed by ideas, even when they show I'm wrong; I'm not impressed with insults.

[LAK]

Well Todd, perhaps you and your ilk should take it as a compliment! Money goes to value right? Evil does pay well, doesn't it? So well you even write papers for it.

And you seem to assume I'm trying to win this argument. Not sure why you'd think that. That you would take up the task of trying to justify CEO compensation in its current state is the beginning and end of the discussion. I'm much more curious as to how you take yourself seriously as an academic. Now where is my rationally priced $4000 handbag? I need the feather I keep in it to make myself puke.

“For each new class which puts itself in the place of one ruling before it, is compelled, merely in order to carry through its aim, to represent its interest as the common interest of all the members of society, that is, expressed in ideal form: it has to give its ideas the form of universality, and represent them as the only rational, universally valid ones.”