Debunking the "pay 'em or lose 'em" excuse for outrageous CEO pay

Mitch Strohm picture

I just saw a new study that persuasively refutes the most common reason corporations cite for paying their chief executives obscene amounts of money.

It’s the old "pay 'em or lose 'em" argument.

Corporations say they have to lavish money on their top managers, or they’ll just quit and take their exceptional talents elsewhere.

But as the study notes, that brain-drain argument doesn’t really add up.

"It's increasingly apparent that the pay awarded to chief executives is becoming profoundly detached from not just the pay of the average worker but also from the companies they run," write Charles Elson and Craig Ferree of the John L. Weinberg Center for Corporate Governance at the University of Delaware.

(It’s also become detached from the needs of the nation. See my recent slideshow on the 4 tax loopholes that encourage outrageous executive pay.)

They note that most public companies set CEO pay through the use of a process called "peer-grouping." Basically, corporations start by analyzing the executive pay of similar companies.

They then "keep up with the Joneses," as Gretchen Morgenson cleverly puts it in the New York Times, by basing their executive compensation on that comparison.

Most companies provide compensation packages for execs that are in the 50th, 75th or 90th percentile in their target peer comparison group, according to the study — but the 50th percentile is rarely used.

For example, the study notes that Angelo Mozilo of Countrywide Financial earned more than $180 million, and his pay was targeted toward the 90th percentile of his peers, during the five years leading up to the mortgage crisis.

Never mind that Mozilo was in the process of wrecking Countrywide — and much of the American economy — during that time.

It’s pretty easy to see how one company's overpayment affects all of those in the peer group and how that practice pointlessly boosts executive pay.

Sure, a talented individual's phenomenal performance may deserve an additional reward, but it shouldn't bolster the pay of less able executives at other companies, the authors note.

That creates a competitive marketplace where it doesn't otherwise exist.

Contrary to popular belief, there’s very limited opportunity for CEOs to change jobs.

The authors report that most CEOs simply don't have the skills to move from one company to another.

They write that "the necessary skills to successfully run a company cannot be acquired besides through actual experience at the company: Therefore, executives are not typically transferable between firms."

One study of CEO successions cited in the Delaware paper found that fewer than 2% had been public-company executives before their new jobs.

The authors argue that corporations should throw out current benchmarks for pay and instead use a shareholder-conscious compensation committee to develop standards.

"A hard and honest focus on the company itself and the accomplishments of the executive in question by the board, rather than blithely looking externally to other organizations, will best serve the company's and the shareholder's interests," the study says.

I doubt this research will pave the way for new corporate executive compensation policy.

But it's nice to see an enormous bluff get called.