Why Are CEOs Paid So Much?
By Elan Journo (Providence Journal, May 11, 2006)
The Coca Cola Co. has instituted a significant new plan for compensating its directors: they will not receive payment unless the company meets its financial targets. But even if other corporations adopted similar arrangements, it would do nothing to dispel the rampant suspicion that successful directors and managers are overpaid.
That suspicion is reinforced anew every spring, when public companies file their financial statements and we learn how much their CEOs were paid the previous year.
In 2005 the average pay for CEOs of 500 of the largest U.S. companies was $11.75 million. Some CEOs collected pay packages worth upwards of $200 million a year and enjoy perks like corporate jets for personal use. Astonished to learn that what an average worker earns in a year, some CEOs earn in less than a week--people ask themselves: "How can the work of a corporate paper-pusher be worth so many millions of dollars?"
The answer is that successful CEOs are indispensable to their companies. They earn their rewards.
How big an influence can one man have on the fortunes of the entire corporation? Consider the impact of Jack Welch on General Electric. Before his tenure as CEO, the company was a bloated giant, floundering under its own weight. Splintered into dozens of distinct and inefficient business units, GE was scarcely making a profit. Welch turned it around. He streamlined and reorganized the company's operations and implemented a sound business strategy yielding more than $400 billion worth of shareholder wealth.
In business, success requires long-range thinking. But CEOs must project a strategic game plan in terms not merely of a month or two, but of years and decades. A biotechnology company, for example, may spend 15 years and billions of dollars developing a new cancer-fighting medicine. Success is impossible without the business acumen of its CEO. For years before a marketable product exists, he must raise sufficient capital to sustain the research. What long-term business model will attract venture capital? Should the company accept partial short-term sponsorship from a large drug manufacturer in exchange for a modest royalty on the drug in the future--or risk going it alone and possibly running out of funds? It is on such decisions that a company's success is made--and lives of cancer patients may depend.
In order to be successful in the long range, the CEO's strategy must encompass countless factors. He must devise a plan to grow the business in the face of competitors, not only from within the United States, but from any and every region of today's global economy. The CEO calls the plays for a team of tens (and sometimes hundreds) of thousands of workers. All of the actions of every employee and every aspect of the business must be coordinated and integrated to produce the cars, computers or CAT scanners that yield profits to the company. It is the CEO who is responsible for that integration.
To successfully steer a corporation across the span of years by integrating its strengths toward the goal of creating wealth requires from the CEO exceptional thought and judgment. Excellent CEOs are as rare as MLB-caliber pitchers or NFL-caliber quarterbacks. And in the business world, every day is the Super Bowl. There is no off-season or respite from the need to perform at one's peak.
Given the effect a CEO can have on a company's success, we can understand why their compensation packages can be so high. One way employers reward excellence is through bonuses. For many CEOs, bonuses amount to a large portion of their earnings. Some CEOs are paid a token salary, but are rewarded with large parcels of company stock. As is the case with athletes and other individuals whose talents are rare and much prized, the CEO's pay package is calculated with an eye on the competition. Companies pay millions of dollars to a valuable CEO, one who they judge will produce wealth for the shareholders, in part so he will not be hired away by a competitor.
On the gridiron, the baseball diamond and the basketball court, we see and admire the physical prowess of a superlative athlete--one who earns the title of MVP--and we understand that it is morally proper to reward him accordingly. Though the efforts of CEOs are not televised on Monday Night Football, their achievements are real and have a profound benefit to all our lives. It is time that we learned to appreciate the work of successful CEOs and recognize that they deserve every penny of their salaries.
Elan Journo is a resident fellow at the Ayn Rand Institute, focusing on foreign policy. The Institute promotes Objectivism, the philosophy of Ayn Rand--author of Atlas Shrugged and The Fountainhead.
For more articles by Elan Journo, and his bio, click here.