Sam Bowman: How should employers position high executive pay in the current financial climate?

sam bowman

According to the High Pay Centre, chief executives of large firms are overpaid. They are certainly paid a lot: the average FTSE 100 director is paid £2.4m annually, and the average chief executive officer (CEO) is paid £3.3m.

But does this mean they are overpaid? No. Most people agree that it’s fair to pay workers what they’re worth to the firm. ‘Fair’ may be a misnomer here: it is not ‘fair’ that some people are much better at playing football or running large firms than others. But that’s life. Firms will try to attract the best people possible by bidding against each other, and that bidding means higher pay for CEOs. It’s difficult to argue that firms should not spend their cash on trying to attract talent, but here we are.

Are they wrong about the value of CEOs? Well, probably not. The decisions that CEOs make are very, very important for their firms. This is reflected in organisational values; when a promising CEO is hired or a bad CEO is fired, a firm’s values often rise significantly. Angela Ahrendts’ departure from Burberry in 2013 wiped £536m off the firm’s value; Tesco became £220m more valuable when its CEO merely announced that he would take an active role in managing the firm.

Are failing CEOs still paid a lot? Usually, yes. Firms usually decide pay packets at the outset of a CEO’s tenure, as with other employees. Performance-related pay is difficult to do well, because it can incentivise CEOs to target something other than the broad success of the firm. And it only solves incentives problems; an incompetent CEO cannot be incentivised into being good at his or her job, or into being luckier. There may be little advantage for a firm to pay by results.

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Ultimately, the complaints of the High Pay Centre sound hollow. If it was onto something, why has no firm succeeded by listening to these? It only makes sense to think that employers are systematically overpaying CEOs if we think that firms are not all that interested in making money. This is not a particularly persuasive criticism of most large corporations.

Sam Bowman is executive director at the Adam Smith Institute