Justifying CEO Pay – Look, We Can Use it For Other Things Too!

Megan McArdle reviews a chapter in Tim Harford’s new book.

But Harford ably outlines an even more intriguing possibility: Michael Eisner might be worth $800 million even if he does nothing at all—indeed, perhaps he’d be worth even more if he did nothing but play video games all day.

That’s because many economists believe that CEO pay is structured as it is not to spur the CEO to ever greater heights of achievement, but rather pour encourager les autres. Michael Eisner might work just as hard for $1 million a year . . . but the gigantic payoff to becoming CEO spurs those beneath him to ever-greater heights of achievement. Basically, Michael Eisner has won the employment lottery. And because the prize is so big, all of his subordinates are dutifully beavering away, vying for a chance at the gravy train.

I worked in a Fortune 500 company for a while. The CEO was a young guy. By what must be one heck of a coincidence, the CEO was the son of the previous CEO, and the grandson of the CEO before that. Needless to say, the CEO’s family owned a big chunk of the company’s shares. Interestingly, the CEO didn’t have all that much experience in the industry – he had spent some years in an investment bank that happened to own the second largest block of shares of the company. And incidentally, the company’s business model for fifty years had been heavily geared toward picking up properties that came with big government subsidies attached.

Now, I don’t think anyone would conclude this is an unusual situation in corporate America. So its worth following through Harford’s thought process. (I assume McArdle got it right – it does sound like Harford.) How much encouragement would the more lineage-impaired employees have derived from the perks given to the CEO? My guess is that the average guy struggling to survive on a $40,000 a year income is as encouraged to work harder by Michael Eisner’s example as he is encouraged to inherit more by Paris Hilton.