Big business CEOs are frequently criticized for receiving astronomically high salaries
However, some economists contend that the reality is the reverse. Do they deserve to be paid more?
The High Pay Centre campaign group claims that at noon on January 6, when most of us were still recuperating from New Year's parties or seasonal bugs, the CEOs of FTSE 100 companies were silently celebrating the fact that they had already earned more in a few grey days than the average employee in their companies would make in a year. CEO compensation for companies in the blue-chip stock index is £4.22 million, which is 113 times more than the median salary for full-time employees, which is £37,430. According to Jasper Jolly of The Guardian, bosses reached this milestone a little faster this year than they did last.
While the pay of bosses is at record levels, the pay of workers improved somewhat more quickly over the course of the year, with CEOs' pay increasing by 2 to 5 percent compared to workers' 7 percent. Despite shareholder protests, AstraZenecas Pascal Soriot earned 18.7 million in 2024, making him the highest-paid CEO on the FTSE 100. Both Tufan Erginbilgi, the head of Rolls-Royce, and Erik Engstrom, the head of data company Relx, received £13.6 million. Compared to what their US counterparts receive, even those amounts are insignificant. Alphabet, the parent company of Google, gave its CEO, Sundar Pichai, £226 million (177 million) in 2022. Most infamously, Elon Musk, the CEO of Tesla, has been battling the legal system to obtain a £56 billion (47 billion) award that was approved by directors and shareholders last year.
To the average person, those figures will seem incredibly high, and it is only natural to assume that there must be some sort of abuse or market failure. Who, we sniff, could be worth £56 billion? On the October All Else Equal podcast last year, Dirk Jenter, a professor of finance at the London School of Economics, offers a different perspective that is sure to irritate almost everyone: How can such high CEO/worker pay ratios be justified? Aren't we all rowing the boat? According to him, CEO compensation is incredibly low.
The value added is minuscule.
They are, at least, based on one of two crucial factors. The first is that it stands to reason that an individual's compensation should be commensurate with the value they add to their work. When celebrities in sports or entertainment make enormous sums of money, nobody complains. Why shouldn't they keep the fruits of their labor for themselves? If that justification is valid for football players, why not for CEOs? They obviously bring joy, inspiration, and enjoyment that millions are willing to pay for.
It could be argued that money managers only make their enormous profits because they are in a prime position to collect rents at the expense of their investors. Similar to how it's normal to anticipate that a pig farmer will return home with dirt on his boots, we might anticipate that those who spend vast sums of money every day will return home covered in filth. Actually, though, it's challenging to argue that point to corporate executives. Jenter, who has been researching CEO compensation and related topics for over 20 years, summarizes his own research and his reading of the academic literature. He says that there is no proof that high CEO salaries are caused by corporate governance issues, nepotism, or misconduct; those theories simply don't fit the data.
Over the last 40 years, when corporate governance has generally significantly improved, CEO compensation has really skyrocketed. For instance, Musk's enormous compensation award at Tesla was contingent on overcoming performance standards, all of which he easily met. Musk had to increase revenue and profits by many multiples and meet aggressive share-price targets in order to receive the full value of his package. He succeeded. When Musk's compensation package was put to a shareholder vote, it was approved despite a court's objections and blocking of the payment. The court remains unimpressed and is adamant about its decision. This example is applicable more generally because, in spite of the occasional uprising, shareholders typically support and are willing to pay high CEO compensation.
Why? Jenter asked UK corporate boards what they would think would happen if CEO salaries were cut. The answer is that shareholder value would suffer. Therefore, it is not the case that people are being forced or duped into giving their millions to companies. Businesses offer high salaries because they believe their bosses are deserving of it and are working to maximize value for shareholders. This opinion is supported by the fact that, for instance, when top CEOs leave their position to take a new one, the stock of the company they left may decline while the stock of their new company may soar. And that's how you know if a CEO is doing their job and making money. Even though CEO compensation is extravagant, it still falls far short of the billions of dollars in additional market value that are generated. In actuality, it frequently represents a negligible percentage of the value added. A CEO who adds just 1% to the value of a £50 billion company generates £500 million, which is a substantial amount but only a small portion of the salaries that CEOs usually receive. The CEO is widely credited by shareholders for that success.
No one is saying that CEOs have it easy, after all. Jenter claims that the CEO's job is very different from any other and is strange and demanding. CEOs must be exceptional people managers who can inspire their team to work hard on the right things, handle reports, and possess all of the so-called "soft skills" of people management. However, they also assume a great deal of responsibility, not the least of which is the obligation to make wise choices regarding significant strategic choices. Even though they might only need to make one or two of these in the terms they serve, if they do it incorrectly, the business might be doomed. Consider the former market leader in mobile phones, Nokia, which paid a high price for failing to adjust to a changing market, or the CEO of Intel, who turned down the chance to make chips for the Apple iPhone because it wasn't thought to be a significant enough opportunity in comparison to pcs\..
All things considered, Jenter claims that there is "absolutely no evidence that CEOs are overpaid" and that there is solid proof that the compensation they receive is only a small percentage of the value they contribute, as they work in a very challenging position with many responsibilities.
How much does a CEO get paid?
Jenter continues by explaining that this is not the only factor to take into account. Two points regarding the factors that determine CEO compensation are made by basic economics. According to the first, a CEO's compensation should never exceed their anticipated value to the company. As was previously mentioned, that does not appear to be taking place. The second is that if you are providing a lower quality than what they could find elsewhere, you will not be able to recruit and hire a competent CEO. This argument is frequently made to support the boss's high salary: if it weren't high, the CEO would find another employer. Can you confirm this?
This probably applies to the majority of workers, including possibly the money managers mentioned above. CEOs' knowledge and abilities, however, might not transfer all that well from one company to another. The value they can be expected to add will likely be significantly less if they are taken from one company where they are familiar with the culture, the procedures, the connections, the knowledge, and everything else they need to perform their jobs well, and then parachuted into another where they lack these things. For example, a CEO may contribute £1 billion in added market value to one company, but only £100 million to another, in which case his compensation should be lower. The two factors that determine pay, the amount of value that is expected to be added, and the "outside offer" may therefore differ significantly.
The fact that CEOs usually stay at home and grieve instead of going elsewhere and earning the same salary after being fired or resigning is evidence that this is true, according to Jenter, who also questions whether they will ever work again.
They undoubtedly see a sharp decline in their earnings. It also clarifies why company insiders make up over 80% of newly hired CEOs. The few times that CEOs are brought in from outside are typically during crises when things have gone horribly wrong and a drastic approach needs to be tried, ideally by no one connected to the old, unsuccessful plan. And when this occurs, as the theories presented here would suggest, companies typically seek out superstar CEOs who have experience handling turnaround situations.
As a result, CEO compensation will actually be decided by a negotiation over how the CEO's possible surplus to the company will be split between the CEO and shareholders, taking into account what the CEO could make elsewhere.
The specifics of that negotiation will vary greatly depending on a number of intangible factors, including social and cultural norms, the CEO's and board's psychology, and ideas of fairness. According to Jenter, the actual distribution of the surplus varies greatly between countries like the US, Sweden, and Japan.
The bottom line is that CEOs usually receive a lot more than the outside offer, but less than the value added. Negotiation will determine the exact amount. The commotion surrounding CEO compensation is centered on an imaginary issue.
Perhaps there's a better way.
There are issues with this argument, though. One is that ordinary people are frequently left perplexed, repulsed, or both by what economists find to be perfectly logical. Economists discover new theories to explain why everyone else is so irrational as a result of this fact. The rest of us are left wondering if there might not be a problem with a field of study that finds simple excuses for things that make us sick, like markets for human kidneys; "surge pricing" for concert tickets as an alternative to the antiquated and presumably discredited wisdom of "first come, first served"; and multi-million-pound payouts for bosses while many others in their companies are barely making ends meet.
Additionally, it fails to consider power dynamics, as Stefan Stern, the former director of the High Pay Center, argued in The Guardian last year.
Nobel laureate economist Angus Deaton asserts that "it is difficult to understand inequality or much else in modern capitalism without an analysis of power." It disregards the data showing that CEO compensation demotivates workers and harms a company's reputation. As Stern noted in the Financial Times more recently, it also ignores the difficulty in determining the precise impact of the CEO. According to him, football fans can easily observe how well their team is performing and who is responsible for success or failure. It is considerably less clear with CEOs. Naturally, leadership is important. However, the contributions of hundreds or even thousands of people are vital in a large, complex organization. The disproportionately large compensation for a single individual at the top is more reminiscent of fairy tales than of strict performance management. Furthermore, it contradicts the corporate governance debate that has been going on for more than thirty years.
There may be a straightforward fix. As Ludovic Phalippou, a professor of finance economics at Sad Business School, noted on X, if a CEO makes millions and his company's stock rises by billions, the story goes that the CEO created those billions and is therefore entitled to a portion of them. But what if sales suddenly take a nosedive, the shares fall, and the CEO leaves? Was he skilled or just very lucky to have some skill? And considering the massive losses he has overseen, doesn't he owe the company money now that less value has been created, or perhaps lost? If the CEO is that skilled and confident in his own abilities, why not accept a more modest wage and use his own money to purchase call options at the market price? If he makes out like a bandit in that way, who would argue?
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