Paul Krugman and the “Monday Night Football” Theory of CEO Pay

http://www.vox.com/2015/5/18/8619687/paul-krugman-ceo-pay

by jkestner • 11 years ago

46 41 11 years ago

vox.com

adventured2• 11 years ago

This is an exceptionally poor premise. It's hard to believe the writer of this article missed the obvious.

That CEO pay chart tracks the value of options granted.

What it almost perfectly aligns to is the S&P 500 chart.

Here, I did a crude overlay, it's blatantly obvious.

http://i.imgur.com/S2hN29F.png

It wasn't Monday Night Football or any other ridiculous notion. It was the greatest stock market boom in the US since the roaring 1920s, which sent the value of options soaring.

criley23• 11 years ago

"What it almost perfectly aligns to is the S&P 500 chart."

You've displayed correlation and insisted causation. Of course, Ezra seems to have done so as well, but your correlation isn't any more impressive than his.

adventured2• 11 years ago

The fact that it so closely aligns, in both spikes and drops, over a 50 year period of time, more than proves the point.

I'm insisting that such an extreme coincidence is impossible.

DamnYuppie2• 11 years ago

I agree that it doesn't improve causation but it is more realistic to expect that their increase in pay strongly correlates with the S&P 500 as stock price is the underlying vehicle of their compensation.

brockers• 11 years ago

I remember reading Krugman's article on CEO pay and just shaking my head. The reality is that he is an economic writer and not an economist any longer. I'm sure there are plenty here who will disagree but I think Krugman long ago lost his credibility as "a leading economist." Anyone who remembers the "broken windows theory and iPhone upgrade cycle" article couldn't help thinking, really?? This guy won a Nobel Prize?

slowmovintarget• 11 years ago

The reality is that he's a political writer (a.k.a. pundit) trading on economist credentials.

dimitar• 11 years ago

I remember reading the same blog post and here is what I remember: He told an anecdote told to him by someone else, wrote multiple times that he finds it ridiculous and pointed out that it is most likely a funny coincidence.

Sorry but my sympathy is with Krugman on this one - he didn't use his academic credentials as an argument on authority. It is a just a bit of brainstorming on his blog.

If anything it makes me think more highly of him - being always serious is harmful, a creative mind must dare to be silly from time to time.

fragsworth• 11 years ago

By your logic, imagine a world 50 years from now when the S&P is 500 times the size it is today (mostly due to inflation), CEOs will get paid 150000 times what workers are paid. That doesn't really make sense.

tashi• 11 years ago

Couldn't the causation also have run the other way? Say, increased CEO salaries for companies with rising stock prices led CEOs to optimize for the short term, with layoffs, cutting research departments and pension plans, etc.?

SixSigma• 11 years ago

Or: rise in CEO pay is cause of the rise stock market price, after all, you wouldn't vote to raise the CEO's wages if you didn't think it was going to improve the company now, would you?

runako• 11 years ago

I think you may be missing the point. I don't think the boom in equities escaped Krugman or other observers. I think the point is more that boom or no, boards get to approve comp packages. And when designing a comp package, it is not all that difficult to ensure that the CEO does/does not qualify for gargantuan sums of money on meeting performance targets. Further, taking this step can lead to better alignment with shareholders.

For example, one frequently recommended way to improve compensation is to compensate on alpha vs. a peer group and/or index. Clearly, every CEO in the S&P 500 didn't deserve the massive ramp in comp implied by the charts.

Bigger picture, just like with any employee, management usually has an idea of the total package value in mind and then backs into how the employee gets there. If the Board starts with an expectation that the CEO should make a gazillion dollars, they can design a package to get there. If the expectation is that the CEO should earn less, they can design a package to do that as well. The question remains why this expectation changed.

panarky• 11 years ago

So in the 1970s, CEOs were compensated at about 20 times the average worker's compensation.

In the late 1990s, the ratio zoomed up to about 300 times the average worker's compensation, where it remains today.

What can explain this? Why have average inflation-adjusted wages stagnated or declined, while compensation for top people goes up by an order of magnitude or more?

Globalization? Decline of organized labor? Private equity? Financial engineering?

stephengillie• 11 years ago

The article claims it's a change in social norms - nobody paid CEOs that much. Until, one day, someone did. From there, it was all just CEO perception and FOMO.

GFK_of_xmaspast• 11 years ago

Class warfare.

bcheung2• 11 years ago

Short answer: leverage.

The greater the leverage the more production can be multiplied and thus income.

Some things that have amplified leverage are:

1) Access to a larger talent pool (globalization) 2) More educated people 3) The Internet 4) Access to financial capital and financial instruments 5) Access to foreign labor that is cheaper

brandonmenc3• 11 years ago

CEOs appoint the committees that decide how much they’re worth

Correct me if I'm wrong, but this isn't true unless the CEO has significant voting power as a shareholder. Right?

wstrange• 11 years ago

Boards often select the management consultants that evaluate CEO pay, and it's a pretty tight and friendly circle in the industry.

The consultants want to get the next gig - and what better way than to give the board (and the CEO) a tidy bonus.

dkokelley• 11 years ago

I think what the author is getting at here is that CEO pay was in an unstable equilibrium, and that starting in the mid-90's, that balance was tipped, causing "run-away" CEO pay.

I don't particularly agree with this conclusion, but the "unstable equilibrium" hypothesis is what is implied. "The conditions were always there, but some instigator (MNF) triggered the change."

I personally think adventured's hypothesis regarding stock market performance has a bit more merit.

aetherson• 11 years ago

Klein's thesis is actually that the conditions weren't always there, they were that the conditions were set up by the Reagan tax cuts, but there was about a 10 year delay between the conditions being set up and the trigger.

Specifically, he argues that pre-Reagan, it wasn't worthwhile for CEOs to bother to try to get higher pay, because the high tax rates meant it mostly went to the government.

I do wonder whether Klein also feels that, say, higher capital gains taxes would mean falling investment because investors wouldn't bother chasing returns if the majority of them went to the government.

I also find it unimpressive for Klein to talk about 90% top marginal tax rates and then say that Reagan slashed tax rates. Just to be clear, 90% marginal taxes: 1951-1964. Reagan tax cuts: 1981. Between there: 70% marginal taxes. Does tripling the take-home pay of top earners (from 10% of nominal salary to 30%) not provoke any changes?

Finally, what's the word for "post hoc ergo propter hoc," except even lamer because it's not just post hoc it's way way way post hoc? Like, if I don't like 1916's establishment of National Parks, can I claim that they are responsible for overgrazing in the 1980s and it just took a while for norms to be overcome?

kvcc01• 11 years ago

In the typical case, CEO pay is determined by the compensation committee of the board of directors. The comp committee, in turn, hires a compensation consultant, who presents the board a study of how much other CEOs of similarly sized companies in the same industry get paid. Since no board wants their CEO to be paid "below average", they'll generally vote for a raise to bring it at least to the prevailing average. But since all boards are behaving similarly, the prevailing average ratchets up in each cycle.

This ratcheting theory is straight from Warren Buffett's annual letters, and it's a good illustration of the results of perverse incentives, considering that board members are often nominated by the CEO so there's peer pressure to "play nice" and not to antagonize the CEO.

mzzk• 11 years ago

It's not strictly the board's fault. The CEO market demands high salaries. Few worthwhile CEOs will accept a position at less than market value.

contravert• 11 years ago

I always found the free market argument hard to believe.

Why is it you can hire a world-class nuclear physicist or neurosurgeon for less than a percent of what a CEO is paid?

lordnacho• 11 years ago

I happen to agree. What's he's saying is more of a null hypothesis than an attempt at explanation. Because he doesn't actually quantify the social norms thing, it feels like a catchall for "nothing specific in terms of supply/demand".

If you look at supply, in any company there's a bunch of juniors who could (and often do) step up to the top job. There's no reason to think that companies suddenly suffered a drought of CEO candidates. Are there more companies that need a CEO? Maybe, but it's hard to see it explaining a 20-to-300 increase in salary ratio. Is it because competition gets tougher, so you need the best CEO? Maybe, but profits are also rocketing during that time, suggesting it wasn't so hard to make money after all.

If you look at how the S&P performed, it looks like there's a correlation, so probably some of it is due to option grants and such. But we're still trying to explain a huge gap.

One important thing he mentions is the scope: the Anglosphere. In fact, it's true that CEO pay is more restrained where people don't exchange as many ideas with the Anglos.

If I were to point at one thing that is in common with football, it's star worship. CEOs these days are not just professionals putting in a good shift, they're gods doing the impossible. And getting paid accordingly.

danbruc3• 11 years ago

How would you argue that a CEO deserves a higher pay than a worker in the same company working the same number of hours? I would go as far as claiming that a worker should sometimes be payed better than the CEO, for example a mine worker doing the hard work and risking his health vs the CEO of the mine pushing papers in an air-conditioned office. So what are good arguments in favor of high pays for CEOs?

brandonmenc3• 11 years ago

what are good arguments in favor of high pays for CEO

The mine worker is never going to make decisions that generate billions of dollars of revenue. That's one argument.

Another is that the pool of potential CEOs is small.

danbruc3• 11 years ago

The CEO can make decisions all day long, without miners they will not lead to a single Dollar of revenue. Not sure about the rarity of possible CEOs, it seems at least not absolutely obvious that there are many less possible mining company CEOs than possible miners (normalized by the number required).

bcheung2• 11 years ago

Krugman says nothing happened in the 1990s.

I say the Internet happened.

I also don't buy the argument that it is just social norms because income inequality is more of a social speaking point now that it was back then and yet salaries continue to rise.

The graph seems to correlate with the rise of the Internet and the dot com crash fairly well. It also seems to correlate with monetary expansion, how well the economy was doing at the time, and the real estate markets. Not saying that is the reason but it seems a much better explanation than "society allowed it".

jadell• 11 years ago

There are several possible triggers. A popular hypothesis is that in the early 1990s, the SEC began requiring the disclosure and reporting of executive compensation. The prevailing theory was that it would shine some light on the discrepancies between executive and normal workers' pay and force executive compensation down through public shaming. Instead, it did the opposite: executives started comparing their own salaries, and shopping around for the best compensation. Boards, on the other hand, started increasing executive compensation to make it look like they were recruiting only top most valuable talent. It became a positive feedback status-based market for executive compensation.

bcg1• 11 years ago

Ever been in a meeting where there is food at the back of the room but no one is eating it? But then one person stands up to go get a donut an then everyone realizes it is ok and follows suit.

According the Ezra Klein, that it the reason CEO vs. worker pay has increased since the mid 90's. Helped, according to him, by Reagan tax cuts. I beg to differ on his reasoning.

1) While the moves are more erratic in the last 20 years, the degree of change is no that different... from 1975-1995 it was around +300%; from 1995-2015 is was around +300%... suggesting that the trend goes back further than his article accounts for with respect to the Reagan tax cuts.

2) Klein's argument is quite specious in my view... stating "it just wasn't done" without supporting evidence just doesn't cut it.

One could just as easily argue that this "phenomenon" is correlated to the Clinton administration's repeal of the Glass-Steagal Act, or the Nixon administration's unilateral renege on the Bretton-Woods arrangement through the closing of the Fed's gold window. In any case, it is unfortunate that a talented writer and researcher like Ezra Klein spends his talents shilling to support a political narrative. I'm not a republican or democrat, just someone who wants to read good and truthful information.

Paul Krugman and the “Monday Night Football” Theory of CEO Pay

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