Introduction

Square-Off: Is Executive Pay Too Low, Too High, or Just Right?

It probably won’t ever be possible to resolve the societal debate over the proper amount of compensation that should rightly be awarded to top corporate executives. It may be no more achievable than national consensus on how to approach health care, taxes, or gender and racial equality. People in business, though, generally take it for granted that the apt amount to pay CEOs and CFOs is best left in the hands of the company’s board of directors. Among the 20 or so folks who responded to o ..

Jennifer Lawrence made more than $50 million last year. Is she worth that?

Marc Hodak

Marc Hodak

You should ask the people paying her. Studio heads are nice-enough folks, but they aren’t giving up that coin to a 26-year-old for no reason. They pay her what they do because her face on posters will put our bottoms in theater seats. Studios expect that every dollar they pay her will bring in multiple dollars in additional revenue. The fancy finance term for that is marginal revenue product.

And what are the customers buying? A young woman dressing up in costume and reading lines written by others while emoting.

I don’t say that to denigrate her talent or her craft. Rather, it’s to point out that if Jennifer Lawrence is worth $50 million — and I sincerely believe she is — how far do we really have to stretch credulity to believe that the leader of the largest multinational corporations, managing tens of billions in assets and employing hundreds of thousands of people, might be worth $15 million, the average income of a S&P 500 CEO?

One could argue that CEOs have power over their nominal bosses (e.g., the board of directors) that Ms. Lawrence doesn’t have over hers and can therefore use that power to boost their pay. But this idea of “managerial power” is one of those unchallenged assumptions in nearly everything written about CEO pay.

I’m not going to suggest that CEOs don’t have such influence. They do. The Achilles Heel of the “managerial power” argument, though, is this: Even the most vocal corporate critics acknowledge that in the decade after 1992, when CEO pay rose faster than at any time in history, power shifted decisively from CEOs toward increasingly independent boards. Accordingly, we can assume “managerial power” is not as strong an influence on compensation as some claim.

Some will argue that CEOs don’t do their big jobs all by themselves, or that they are often paid big bucks even if their companies don’t perform. But the same can be said of entertainers. Jennifer Lawrence is just one of hundreds of people involved in making a film. Everyone’s contribution counts, right? And a fair portion of any star’s films will disappoint at the box office. Even Will Smith and Johnny Depp have been in flops for which they pocketed $20 million. And their pay, unlike that of most CEOs, generally doesn’t vary with performance.

Today’s boards are, in fact, highly attuned to how much the boss is paid, especially pertaining to performance. My experience with directors is that they are conscientious and informed. Do they always make the right bet when signing lucrative pay packages? Of course not. Nobody has a crystal ball.

But the competition for talent is real. Every month, I see prospects walk away from large offers. They are amont the surprisingly few people who are considered capable of adding that last billion to the value of a sprawling corporation.

Every board wishes their company could pay its top people less. But they can tell the difference between a $1 million executive and a $10 million executive the way a realtor can tell the difference between a $1 million and a $10 million home. Some people are simply worth more. Despite boards’ manifest imperfections, no one is in a better position to judge how much CEOs are worth than the boards that hire and pay them.

Marc Hodak is a partner at Farient Advisors, a compensation consulting firm.

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