Friday, October 22, 2010

A note on executive salaries

For a number of reasons I took down yesterday's second post for editing. I will repost later.

In a comment on Weariness with competition and the search for efficiency, KVD suggested Icarus and Phoenix: Crash and Burn as a title for a book on modern corporate management approaches. I like that.

Thinking further on the senior executive salary issue, when I first became a consultant, I was interested in varying charge rates and the relationship between those and client type and size. In simple terms, bigger clients were able and prepared to pay more per hour because the absolute size of the expected gain was higher. The same things applies with executive salaries.

High CEO salaries are usually justified on the grounds that they are market determined. At one level, that's true. Remuneration committees sit down and look at equivalent  remuneration packages and then set a package level expected to attract/retain the right person. Where a candidate is especially desired, a premium is paid. This creates the CEO salary equivalent of bracket-creep, for that higher salary is then incorporated into market data used to determine later CEO salaries. Those higher CEO packages then cascade down into adjustments to the salaries of senior executives. 

From what I have seen, companies that promote internally are somewhat less prone to salary inflation because they don't have the same need to pay a premium to attract the perceived good outside candidate. To my knowledge, I stand to be corrected, there is no statistically significant positive correlation between company performance and higher salary levels after adjusting for industry type. Indeed, the work done by American management writer Jim Collins suggests the opposite. Consistently high performing companies tend to have higher rates of internal promotion and somewhat lower remuneration packages than their less successful rivals.

If you think about it, that makes sense. Very successful companies are generally places where people want to work. They don't need to pay the same individual price premium as their somewhat less successful rivals. They certainly don't feel the same need for high profile silver bullet style CEOs.  


Augustus Winston said...

Hi There Jim

My studies in this area have revealed that there are three distinct phases in executive salary trends: a sharp decline during World War II, a modest and
gradual increase from the mid-1940s to the 1970s, and a high and accelerating growth
rate in the 1980s and 1990s.

But it's the structure of executive pay that has changed most significantly. During the past fifty years, stock options and other long-term incentive
payments have become a larger share of compensation over time.

Executives faced larger cuts in marginal income tax rates & had larger reductions in stock option grants during the 1960s, revealing
that tax policy influenced the composition of managerial pay. High income taxes also
limited the total value of compensation by changing the correlation of pay with the
market value of firms. Had taxes been at their low 2000 level throughout the past 60 years, compensation would have been 35 percent higher during the 1950s and 1960s.

So it has been progressive taxation in the past that has kept managerial compensation from keeping pace with the growing size of firms.

This of course has been tinkered with by successive governments eager to please the big end of town.

Cheers Augustus

Jim Belshaw said...

Welcome back, Augustus! The linkage between changing tax rates and pay was not something that I had focused on.

Now there are a couple of things that I'm not sure about in your comment.

I would expect changing tax to change the composition of pay. However, you argue that that also it affects the level of executive compensation relative to market value of the firm. It is this linkage that i am unsure about.

I am short of time and will need to come back here with further thoughts.