Don't Damage CEO Pay System

The giant severance package that Bob Nardelli takes with him from Home Depot raises once more the issue of whether America's CEOs are paid too much. Clearly, Nardelli was.

Resident Fellow James K. Glassman
Resident Fellow and Editor in Chief of The American James K. Glassman
But does that mean we need new laws and regulations to limit CEO pay--or even widespread public opprobrium to shame businesses into lowering what executives make? Absolutely not.

Boards of directors make mistakes, just as owners of football teams and movie producers do. No one knows when a CEO is hired whether he or she will lead a firm to higher profits and a higher stock price. The only certainty is that, in an age of giant global corporations, a CEO's decisions have a huge effect on a company's performance.

Evidence? When the announcement came Wednesday that Nardelli was out, Home Depot's stock jumped, and the company's market value increased by almost $2 billion. Investors were saying that Nardelli's successor was worth that much more to the company than Nardelli was.

In other words, CEOs count, so the demand for a potentially great one is high. The supply is small. So, naturally, the price--in terms of compensation--can be tremendous. If a change in CEOs can boost a firm's value by $2 billion, then is the pay for a CEO who makes $8 million a year (the average last year for CEOs of the big public companies of the S&P 500) too high?

CEO pay has jumped by a factor of six since the early 1980s. That may sound like a lot, but, according to research by economists Xavier Gabaix of MIT and Augustin Landier of NYU, the increase "can be fully attributed to the six-fold increase in market capitalization of large U.S. companies during that period."

CEOs are paid more because they run bigger, more valuable companies. Makes sense.

When politicians and editorialists call for constraints on CEO pay, they need to realize what's at stake in tampering with a system that is working extremely well. With 5 percent of the world's population, the United States is home to half the world's largest companies. A survey by Forbes finds U.S. businesses the most profitable in the world in nearly every sector: finance, capital goods, retailing, energy, computer software, and on and on.

Are some CEOs overpaid? Of course. So are some basketball players. The notion of linking CEO pay to performance is a good one, but, in order to lure a top executive away from another company, boards have to offer guarantees, including big severance packages. Otherwise, the executive won't jump ship.

My worry is that the political pressure on public companies is causing some boards to offer CEOs too little. "The best and brightest minds," said an article by Dominic Basulto in The American, the magazine I edit, "are increasingly drawn from running key businesses to other pursuits that may not be as socially useful--but pay much more."

Those pursuits include managing hedge funds, where the rewards for being right about the direction of Euro-bond interest rates can run into the billions of dollars.

Average shareholders, as opposed to the activists that grab the headlines, should be happy to reward superb leaders. As for CEOs who aren't worth what they get, there's a quick remedy: Sell the stock.

That is what shareholders of Home Depot were doing. And the board heard the message.

James K. Glassman is a resident fellow at AEI and editor in chief and executive publisher of The American.

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About the Author

 

James K.
Glassman
  • James K. Glassman is a visiting fellow at the American Enterprise Institute (AEI), where he works on Internet and communications policy in the new AEI Center for Internet, Communications, and Technology Policy.

    A scholar, diplomat, and journalist, Glassman rejoins AEI after having served as under secretary of state for public diplomacy and public affairs, during which time he led America’s public diplomacy outreach and inaugurated the use of new Internet technology in these efforts, an approach he christened “public diplomacy 2.0.” He was also chairman of the Broadcasting Board of Governors, the independent federal agency that oversees all US government nonmilitary international broadcasting. Most recently, Glassman was instrumental in the creation of the George W. Bush Institute, where he remains the founding executive director.

    Before his government service, Glassman was a senior fellow at AEI, where he specialized in economics and technology and founded The American, AEI’s magazine, which he led as editor-in-chief until his departure from AEI in 2007.

    In addition to his government service, Glassman was a former president of The Atlantic, publisher of The New Republic, executive vice president of US News & World Report, and editor-in-chief and co-owner of Roll Call. As a columnist for The Washington Post, Glassman wrote about political and economic issues. He was also the host of CNN’s “Capital Gang Sunday” and of PBS’s “TechnoPolitics.” In 2000, he cofounded TCS, a technology and policy website. His most recent book is “The Secret Code of the Superior Investor” (Crown Forum).


    Glassman has a B.A. in government from Harvard College where he was a managing editor of The Crimson.


     

  • Email: jim.glassman@aei.org

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