“It’s a false paradox. The peer group is based on the theory of transferability of talent. But we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often, but when they do, they’re flops.”

-Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware



Over the past three decades, there has been a radical rise in CEO compensation. The typical chief executive used to make 30X what the lowest paid person at the firm made. Recently, that was as high as 400X.

A new study has an intelligent theory for why this is: Inappropriate peer benchmarking.

This form of comparison is a similar problem that Housing suffered during the 2000s real estate boom: Appraisals based not on any method of intrinsic value, but on comparables to similar homes in the region. This contributed to an upward spiral. Anytime someone overpaid for a home — a regular occurrence in an era of no doc loans and free money — it dragged nearby home prices higher as comps.

The appraisal process, as currently practiced, is misnamed. It does not actually determine a fair or intrinsic value, but rather validates mispricing when prices are spiraling. Most appraisals only contribute to bubbles forming in a loose credit, rising price environment.

We seem to have suffered the same sort of issue with executive compensation, according to a paper published this summer by Charles M. Elson and Craig K. Ferrere. The key problem is the standard practice of benchmarking pay to that of peers only exacerbates an unjustified upward spiral.

Elson and Ferrere observe:

“In setting the pay of their CEOs, boards invariably reference the pay of the executives at other enterprises in similar industries and of similar size and complexity. In what is described as “competitive benchmarking”, compensation levels are generally targeted to either the 50th, 75th, or 90th percentile. This process is alleged to provide an effective gauge of “market wages” which are necessary for executive retention. As we will describe, this conception of such a market was created purely by happenstance and based upon flawed assumptions, particularly the easy transferability of executive talent. Because of its uniform application across companies, the effects of structural flaws in its design significantly affect the level of executive compensation.”

This might explain the mechanics of the upwards executive compensation spiral, but it does not address the failures of various corporate governance that allowed it to happen. In my observations, there are 5 factors that contribute mightily to this absurdity:

1) Compensation Consultants: they mostly perform non-value based peer comparables, guaranteeing an upward spiral;

2) Crony capitalists on Boards of Directors who are unusually friendly to the CEOs who placed them there; Compensation Committees of Corp Boards are unusuall deferential to these consultants. All this does is give the Board cover on the issue.

3) Stock option grants get an absurdly favorable tax treatment. This amounts to a massive transfer of wealth from shareholders to insiders.

4) Faulty theories of market efficiency: Assumes incorrectly that shareholders can track this. Consider a 20 stock portfolio — that likely has between 160 – 240 board members. Individual investors cannot possibly keep up with all of those Directors.

5) Mutual Funds that are the primary holders of stocks are complicit with this theft of shareholder value. They need to become more activist, protect their investors.

This is an issue that demands further exploration. I plan on revisiting this issue frequently in the coming new year.


Note with this post, we introduce the category Crony Capitalists.



Executive Superstars, Peer Groups and Over-­‐Compensation – Cause, Effect and Solution
Charles M. Elson and Craig K. Ferrere
University of Delaware – Weinberg Center for Corporate Governance, August 7, 2012  

C.E.O.’s and the Pay-’Em-or-Lose-’Em Myth
NYT, September 22, 2012  

Lavish CEO pay doesn’t work as intended: study
Martha C. White
NBC News, September 27, 2012 2:46pm

Category: Corporate Management, Crony Capitalists, Really, really bad calls

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

33 Responses to “CEOs of Public Firms Are Wildly Overcompensated”

  1. constantnormal says:

    Perhaps a “CEO mobility index” should be published for publicly owned companies, ranking right up there with the quick ratio and return on equity metrics …

    When I initially read the part of the quote that said “… we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often… ” I about snorted my morning beverage through my nose.

    But then upon reflecting, perhaps the reason that I remember the many instances of rotating door CEOs so well is that they were, as the quote continues, “flops” … and colossal flops at that … thinking back on the many companies that are well-managed, I realized that there is a pretty good correlation between their performance and a promote-from-within mindset …

    Indeed, when we look at our financial industry, what do we see there? How many CEOs has BAC had in recent years? Is not Citi scrambling to replace their CEO installed to “fix” that company?

    OTOH, having a CEO welded into the top spot is no guarantee of corporate success, Mr Softee …

  2. constantnormal says:

    Some suggestions as to what we might do to address the issues BR has presented … in no particular order …

    #5 can be fixed by allowing only beneficial owners of shares to vote them. Indirect owners would effectively become owners of non-voting shares … makes the mutual fund’s job easier … not having to check the “vote these shares according to the company’s recommendations” box on the proxy every time, for thousands of stocks owned by the funds.

    I thought that the stock options backdating fracas a while back had eliminated #3, with the companies I own having shifted to restricted stock grants from stock options as a bonus medium. But I’d be in favor of eliminating the corporate issuance of stock options entirely. There are better more honest ways to overpay people.

    #1 might be addressed by a few splashy stockholder class action lawsuits against compensation consultants, in cases where their recommendations were hand-in-glove with poor CEO performance. I doubt that any would win, but the expense of defending themselves might force these parasites into honest careers.

  3. Orange14 says:

    Among the many problems is that shareholders really do not have any say in compensation. I routinely vote my few hundreds of shares against stock options because I think the reward short term behavior from CEOs rather than long term. However, most company stock is held by institutions (pension funds, mutual funds, etc) and even though those institutions are ‘supposed’ to be responsive to the folks whose resources they are investing, they seldom vote in the best interests of them. Sure, we now have these advisory votes on compensation but they are just that. Until shareholders are empowered (which has as much chance of happening as political civility in the US) I don’t see things changing at all.

    The compensation consultants have sold the shareholders a damaged bill of goods that only enriches the senior managerial class. Should we be surprised about the 1/99 percent divide? I think not. Too sad really.

  4. constantnormal says:

    hmmph. looks like I goobered up the strikethrough closing tag on my last entry. the only word with a line through it should be “better”.

  5. [...] The truth about corporate executives are so ludicrously overpaid.  (TBP) [...]

  6. Orange14 says:

    @constantnormal – agree with you completely on the restricted stock compensation approach. Unfortunately I still see most of my holdings going the option route. I’ve known my share of hardworking CEOs (pharmaceutical industry) and don’t object to their being compensated adequately. However, when a former hamburger flipper gets $20 million/annum for driving a perfectly good company into the ground something is wrong.

  7. wayk says:

    My working theory is that the prime driver of CEO pay inflation is that everyone wants to believe the new CEO is above average, including the board and the new CEO. This makes it easy to negotiate a compensation package that is, indeed, above average for their size/industry. Every CEO does this at every opportunity, so the average skyrockets while value delivered remains roughly constant.

  8. ByteMe says:

    I have friends who are “compensation consultants” and they also say it’s a scam to push compensation rates upward. There are two parts to the scam:

    1) The consultants say “you want to pay your CEO as an average of the top 5 (or 10) in the industry.” Well, if your company currently pays your CEO as #20, you’ve just added your company to the top 5 (or 10) in the industry. Which pushes the average higher, since the bottom one falls out. And the next company to use the same consultants — and there aren’t many at the high-end of the market — will get the same advice, continuing the cycle.

    2) The other board members who approve the consultants’ work are often also CEOs (of other companies) and are using this same trick to push their own pay higher. So it’s self-perpetuating. Doesn’t matter if they like the CEO or not… they’re doing it out of their own self-interest.

  9. ByteMe says:

    Oh, forgot the third part to the scam: the CEOs on the compensation committee who hired the consultants won’t hire the consultants again (or for their own companies) if they don’t get this kind of screwed-up/totally logical-sounding advice. So it’s in the consultants’ interests to perpetuate this situation.

  10. wayk says:

    @Orange14: Failure obviously shouldn’t be rewarded, but the success case is also a bit nuanced. There are any number of heavily compensated CEOs whose companies are thriving, but where it’s not at all obvious that the success was due to their strategies. I’m sure we all have holdings that skyrocketed not because of executive genius but because of macroeconomic forces or competitors missteps; companies where any semi-competent executive with a basic knowledge of the terrain would’ve made exactly the same strategic decisions.

    If I wanted to pay a middle-manager 2x or 3x the rest of the tier, I’d need to prove not only that they were succeeding, but that they were delivering far more value than others could. We don’t seem to have this test for CEOs. We treat all gains as alpha.

  11. Thanks for the post. This is obviously true, and has been for quite a while.

    What should our policy response be? Pretty much everyone would be uncomfortable with the government just passing a law that says, “a company’s highest-paid employee shall receive no more than 1500 times the per-hour rate of its lowest-paid employee” or whatever. So do we push for laws that strengthen shareholder democracy, or restrictions on what compensation committees can do, or what? Do we push the exchanges to make restrictions that are tougher than we’d want to see from states or the federal government?

  12. Asymptosis says:

    And that study doesn’t even take into account the role of chance: that there will always be leading and lagging companies, and that any CEO’s “success” has a great deal to do with happening to get a gig with a company that is positioned to be a leader with any reasonably competent CEO — of which there are perhaps at least tens of thousands available.

  13. Tarkus says:

    ByteMe Says:
    October 18th, 2012 at 8:09 am
    I have friends who are “compensation consultants” and they also say it’s a scam to push compensation rates upward. There are two parts to the scam:

    1) The consultants say “you want to pay your CEO as an average of the top 5 (or 10) in the industry.” Well, if your company currently pays your CEO as #20, you’ve just added your company to the top 5 (or 10) in the industry. Which pushes the average higher, since the bottom one falls out. And the next company to use the same consultants — and there aren’t many at the high-end of the market — will get the same advice, continuing the cycle.

    Everybody wins except the shareholder.

    I think guys like Gates or Ellison or (formerly) Jobs are a different breed (they started companies) and deserve the high pay. Guys who sit in the chair and can’t perform should have their comp halved every year they underperform. Then you’d really see who was worth the money.

  14. Seaton says:

    Couldn’t agree more with this posting, BR. On a similar (or not?) note, your 30x lowest-paid-employee’s salary figure. (and the 400X I’ve read elsewhere as well) Was it Sam Walton who posited that he felt he should be paid 7 times what the store managers were paid? And Store managers should be paid no more than 7 times what their lowest paid employees’ wages were? Does that ring a bell, anyone? And, similarly, the ratios of payment in Japan, employee-up-to-CEO, not so sure but what I’ve read they’re paid more similarly to Sam’s dictum, instead of America’s (& Europe’s?) current mania?

  15. CSF says:

    “Mutual Funds that are the primary holders of stocks are complicit with this theft of shareholder value. ”

    The pervasive shift from actively managed to ETFs won’t help this trend, I imagine. Aside from a few large institutional investors, most shareholders lack the time, focus, or leverage to make a difference.

  16. A says:

    You can get a pretty good sense of the ‘crimes’ that go on regularly:


  17. sellstop says:

    What!? Reflexivity in the efficient markets!? Say it ain’t so!

  18. philipat says:

    And, it needs to be pointed out, this applies in particular to the Financial Services Industry. In general, Management has hijacked the division of rewards between shareholders and themselves because of poor Corporate Governance. In particular in the Financial Services Industry, ccompensation is totally out of control when Mangement compensation exceeds shareholder returns by a significant amount. In no other industry is their such a huge discrepancy between the share of returns between Management and Shareholders.

    Fortunately, this is imploding under its own weight so will probably not survive much longer.

    IMHO, Banksters should be allowed into the casino only using their own dime. Casino Banks should be allowed, of course, but as Private Enterprises, using the capital of their Partners. But NOT using the capital of general shareholders in Public Companies.

  19. uzer says:

    “Over the past three decades, there has been a radical rise in CEO compensation. … A new study has an intelligent theory for why this is: Inappropriate peer benchmarking.”

    I have a much simpler theory “for why this is”: fraud

    Coincidentally, I have the same theory for why the “financial crisis” was.

  20. Lowrie Glasgow says:

    Something like this might work, http://www.moxyvote.com/. Y ou would direct your broker to give your proxy(s) to a pro shareholder group ( something like Vanguard ) which would vote the aggregate shares for investors as they feel best for the the group. I would gladly pay for this service . There could be different proxy groups for different types of shareholders.

    I think that with all the new web systems that this could be set up and be a profit site or a nonprofit for a group of brokers as a service.


    BR: Moxy vote closed ; (

  21. Orange14 says:

    BR – are there any good resources out there for individual investors? It’s not that I struggle reading proxy statements, one can pretty much dispense with reading 80-90% of it and cut to the important stuff. The bigger problem is one of corporate governance and I’ve not found a good website for us ‘small’ folk. I would appreciate any tips.

    The other thing I feel is important is to get companies to disclose all of their ‘political’ contributions, including membership in all trade associations and other IRS favorably treated organizations. I don’t care what a company PAC does as that is employee money and they can throw that out there in any direction they want. What I want disclosed is the the corporate money since that’s really what the shareholder is interested in. I’ve been toying with some language that can be introduced for shareholder vote though I’m not optimistic about passage (though one needs to start somewhere). I know for a fact (having worked at two trade associations) that dues to these organizations can be pretty substantial.

  22. willid3 says:

    just wondering if stock holders aren’t part of the problem (and not intentionally either). but most ‘stockholder’ only temporarily own the stock. and then there is the rule that they aren’t responsible for the companies failure (though they will loose a lot if they companies crashes). but they tend to favor risky behavior and CEO’s have an incentive to do the same (since their compensation is tied to short term results. not long term ones). but then shareholders dont get any say on compensation. so in reality have little to do with how the company is run long term any way. in theory (legal rule) boards work for the corporation, and are supposed to do what is best for it, they really dont work for shareholders. but the theory for the last 30 or so years that shareholder value is good for corporations only really works in a very limited situation, where a single shareholder (not a fund etc) is focused on the company. otherwise it really fails to work in reality. some thoughts, if we limited the deduction of total executive pay to say no more than 100 times the lowest pay at the company . and then either require funds (401k etc) to either find out how those who have money in the that company want to vote (and vote that in there percentage) , or to not vote at all. as it is. the funds want to vote the way management wants them too because they want to keep the companies 401k and other investments in their funds.

  23. wally says:

    Excellent points, both about CEO compensation and the comparison to the appraisal method of using “comps”.

    As commenters point out, shareholders do not have any real power to alter this. That’s also the flaw in the Supreme Court’s ruling about corporate political contributions. With no real shareholder power, the power of those in controlling positions is greatly magnified and they simply use it to further their own personal welfare.

  24. Kevin_In_Philadelphia says:

    Piggy-backing on what ByteMe and Tarkus had to say, how does CEO (and let’s be honest about it, all C-suite and executive management) overpayment square with a public company’s duty to shareholders. My understanding has been that companies have a legal obligation to maximize the profit of their “owners”, so over-paying executives would cut directly in profits of the company, which could be better used for investment in a new product line (for example) or just to pay dividends to shareholders. That CEO pay is NOT maximizing shareholder value or profit, it is squandering.

  25. VennData says:

    We need to ignore this and “broaden the base.”

    How can a CEO be expected to perform when he’s not incentivized properly? I mean, the board gives him this pay and the gov’t wants to take it away (And for what? roads, schools, military, the Library of Congress.) How does that make him feel? I never used the Library of Congress in my life, let along watched Sesame Sreet.)

    When I see a Democrat talking about taxing CEOs I say “Watch your wallet! The Democrats are coming after you!

    When I hear a Republican person talking about broadening the base, they mean someone else.

    – Jack Welch

  26. VennData says:

    These CEO’s don’t make enough. They should take out a second CEO job, and would if the gov’t would cut their taxes for once. And I want a pony…

    – Jack Welch’s Third Wife.

  27. DeDude says:

    I am still looking for a mutual fund that pick stocks based on a lack of overcompensation of the leadership. But maybe that would be too much to expect that the leadership of a mutual fund firm would brake ranks. The next best thing would be a list of companies with their CEO compensation index (based on how excessively the CEO is compensated). Then we could begin pushing for rules that public pension funds should be banned from investing in companies whose CEO compensation index was higher than x.

  28. EdDunkle says:

    Try Hollywood. Our CEO makes 1700 times what the lowest paid worker earns.

  29. willid3 says:

    maybe its difficult for the board of directors to really judge the management, since they are most often made up of current or former CEO’s. and they have a lot of sympathy to management.

  30. farmera1 says:

    John Bogle the founder of Vanguard has a good book on this subject including suggestions for fixing the mess. The name of the book is:


    His main point is that we’ve moved from ownership capitalism to managerial capitalism. Companies are now managed to maximize the wealth of management. Customers and owners (stock holders) be damned.

  31. [...] It will come as news to no one that the CEO’s of public corporations are wildly over-compensated, but it’s interesting to see the claims of “competitive necessity” for that kind of compensation debunked. [...]

  32. jonas says:

    There are the direct reasons, and there are the underlying psychological reasons. Even if you implemented everything perfectly, you would still have this problem. The inflation would just manifest itself more slowly.

    The problem with benchmarking is the Lake Wobegon effect. Every board believes its CEO is above average (or they wouldn’t be hired). No matter what the survey says, very few CEO will less than the average on account of the fact he or she is below median. Much less than half, even though half theoretically should.

  33. [...] on CEOs of Public Firms Are Wildly Overcompensated for comment on the Elson-Ferrere study by Barry Ritholtz on his The Big Picture web [...]