23 Things They Don't Tell You About Capitalism

You may suggest that the Japanese and European CEOs can work at much lower absolute pay than the American CEOs because their countries’ general wage levels are lower. However, wages in Japan and the European countries are basically at the same level as those in the US. The average worker pay in the thirteen countries studied by the EPI was 85 per cent of the US worker pay in 2005. The Japanese workers get paid 91per cent the American wages, but their CEOs get paid only 25 per cent of what the American CEOs get (excluding stock options). The Swiss workers and the German workers get higherwages than the US workers (130 per cent and 106 per cent of the US wage, respectively), while their CEOs get paid only 55 per cent and 64 per cent of the US salaries (once again, excluding share options, which are much higher in the US).[5]

Thus seen, US managers are over-priced. The American workers get paid only 15 per cent or so more than their counterparts in competitor nations, while the American CEOs are paid at least twice (compared to the Swiss managers, excluding stock options) and possibly up to twenty times (compared to the Japanese managers, including stock options) that of what their counterparts in comparable countries are paid. Despite this, the American CEOs are running companies that are no better, and frequently worse, than their Japanese or European competitors.

Heads I win, tails you lose

In the US (and the UK, which has the second highest CEO– worker pay ratio after the US), the compensation packages for top managers are loaded in one way. Apart from being paid excessive amounts, these managers do not get punished for bad management. The most that will happen to them is to be kicked out of their current job, but that will almost always be accompanied by a fat severance payment cheque. Sometimes the expelled CEO will get even more than what is required in the contract. According to two economists, Bebchuk and Fried, ‘when Mattel CEO Jill Barad resigned under fire [in 2000], the board forgave a $4.2 million loan, gave her an additional $3.3 million in cash to cover the taxes for forgiveness of another loan and allowed her unvested options to vest automatically. These gratuitous benefits were in addition to the considerable benefits that she received under her employment agreement, which included a termination payment of $26.4 million and a stream of retirement benefits exceeding $700,000 per year.’[6]

Should we care? Not really, free-market economists would argue. If some companies are stupid enough to pay gratuitous benefits to failed CEOs, they would say, let them do it. They will be outcompeted by more hard-nosed competitors that do not engage in such nonsense. So, even though there may be some poorly designed compensation schemes around, they will eventually be eliminated through competitive pressures of the market.

This seems plausible. The competitive process works to eliminate inefficient practices, be they obsolete textile technologies or biased executive pay schemes. And the fact that American and British companies have been losing to foreign companies, which on the whole have better managerial incentives, is a proof of it.

However, it will take a long time for this process to eliminate wrong managerial compensation practices (after all, this has been going on for decades). Before its recent bankruptcy, people had known for at least three decades that GM was on a decline, but no one did anything to stop the top managers from receiving compensation packages more fitting to their predecessors in the mid twentieth century, when the company had absolute dominance worldwide (see Thing 18).

Despite this, little is done to check excessive and biased (in that failures are hardly punished) executive pay packages because the managerial classes in the US and Britain have become so powerful, not least because of the fat paycheques they have been getting over the last few decades. They have come to control the boardrooms, through interlocking directorship and manipulation of information that they provide to independent directors, and as a result few boards of directors question the level and the structure of executive pay set by the CEO. High and rising dividend payments also keep the shareholders happy (see Thing 2). By flexing their economic muscle, the managerial classes have gained enormous influence over the political sphere, including the supposedly centre-left parties such as Britain’s New Labour and America’s Democratic Party. Especially in the US, many private sector CEOs end up running government departments. Most importantly, they have used their economic and political influence to spread the free-market ideology that says that whatever exists must be there because it is the most efficient.