23 Things They Don't Tell You About Capitalism

In other words, worker pay in the US has been virtually stagnant since the mid 1970s. Of course, this is not to say that Americans have not seen any rise in living standards since the 1970s. Family income, as opposed to individual worker compensation, has risen, but that is only because more and more families have both partners working.

Now, if we believed in the free-market logic that people are paid according to their contribution, the increase in the relative compensation of the CEOs from 30–40 times that of average worker compensation (which has not changed very much) to 300–400 times must mean that the American CEOs have become ten times more productive (in relative terms) than they were in the 1960s and 70s. Is this true?

The average quality of US managers may have been rising due to better education and training, but is it really plausible that they are ten times better than their equivalents were one generation ago? Even looking back at only the last twenty years, during which time I have been teaching in Cambridge, I sincerely doubt whether the American students we get (who are potential CEO material) are three to four times better today than when I started teaching in the early 1990s. But that should be the case, if American CEO pay had risen in relative terms purely because of the rising quality of the CEOs: during this period, the average CEO compensation in the US rose from 100 times the average worker compensation to 300–400 times.

A common explanation of this recent steep rise in relative pay is that companies have become bigger and therefore the difference that the CEO can make has become bigger. According to a popular example used by Professor Robert H. Frank of Cornell University in his widely cited New York Timescolumn, if a company has $10 billion earnings, a few better decisions made by a better CEO can easily increase the company’s earnings by $30 million.[3] So, the implicit message goes, what is an extra $5 million for the CEO, when she has given an extra $30 million to the company?

There is some logic to this argument, but if the growing size of the company is the main explanation for CEO pay inflation, why did it suddenly take off in the 1980s, when US company size has been growing all the time?

Also, the same argument should apply to the workers as well, at least to some extent. Modern corporations work on the basis of complex divisions of labour and cooperation, so the view that what the CEO does is the only thing that matters for company performance is highly misleading (see Things 3 and 15). As companies grow bigger, the potential for workers benefiting or damaging the company grows bigger as well and therefore it becomes more and more important to hire better workers. If that were not the case, why do companies bother with human resources departments?

Moreover, if the increasing importance of top managerial decisions is the main reason for CEO salary inflation, why are CEOs in Japan and Europe running similarly large companies paid only a fraction of what the American CEOs are paid? According to the EPI, as of 2005, Swiss and German CEOs were paid respectively 64 per cent and 55 per cent of what their American counterparts received. The Swedish and the Dutch were paid only around 44 per cent and 40 per cent of the American CEOs’ pay; Japanese CEOs only a paltry 25 per cent. The average CEO pay for thirteen rich countries other than the US was only 44 per cent of the US level.[4]

The above figures actually vastly understate the international differences in CEO remuneration as they do not include stock options, which tend to be much higher in the US than in other countries. Other data from the EPI suggest that, in the US, CEO pay including stock options could be easily three to four times, and possibly five to six times, that of their pay excluding stock options, although it is difficult to know exactly the magnitude involved. This means that, if we include stock options, the Japanese CEO compensation (with only a small stock option component, if at all) could be as low as 5 per cent, instead of 25 per cent, that of US CEO compensation.

Now, if the American CEOs are worth anything between twice (compared to the Swiss CEOs, excluding stock options) and twenty times (compared to the Japanese CEOs, including stock options), their counterparts abroad, how come the companies they run have been losing out to their Japanese and European rivals in many industries?