Executive compensation

There have been calls lately to curb the compensation executives make. The idea behind this is that they are making an insane amount of money compared to their workers, which is even worst since most companies are not doing too well right now. But why are CEOs and other executives making so much? And what is really the problem.

First, here is a graph of the compensation packages of the highest paid executive in the US from 1997 to 2007 (from the Economic Research Institute). You can see that the base salary remained more or less constant (indexed to inflation) while the stock options sky rocketed. An interesting comparison is with the DJIA (from Google Finance).

 
 

The trends are similar. Executive compensation increased until the bubble burst of 2000 and went down during the following recession. When all hell broke loose however, CEOs were making the most, a bit like how it is now. This is only one prior example, but it's safe to assume, especially with the amount of public outcry this creates, that CEO remuneration will be lower in the coming years than it is now. They will be getting less stock options and the value of those will be lower (due to the market).

These stock options are a big part of the problem in my opinion. The idea is good: you link the employee's pay with how well s/he directs the company. However, since the stocks themselves are subject to the company's perceived value at a moment in time, it encourages them to do things that only affect this perception. The enduring value of the company becomes less important than the next quarterly result (this makes the partner idea of some non-incorporated firms superior in terms of long term growth). Of course, companies have tried to curb their agency problems through forbidding their executives from exercising their options before a certain amount of time which has proved somewhat successful (though probably not enough). No doubt this will keep evolving.

This blog post was sparked by a Sophie Cousineau article in La Presse Affaire's new magazine. She was actually talking of letting shareholders vote on the top executive packages. It has been done in countries such as Australia with some results. The problem is that the votes are not binding and that the Council can just do what they want. In my opinion, the shareholders are the owners of the corporation and should be able to decide its destiny. Yes, the government would need to step up and force such a vote but is this really different than the laws saying that corporations have to produce quarterly statements?

I also want to point out that I'm not saying that shareholders will necessarily make better decisions than the administrators, but that it's simply the democratic way to go about this and that shareholders should have total control over their company.