Executives demand salary increase: Reasoning behind the claim for higher compensation packages.
At high noon on the 6th of January, most folks were either nursing New Year hangovers or recovering from seasonal illnesses. Meanwhile, the bigwigs of the FTSE 100 companies were popping champagne, having already pocketed more in a few grey days than the average employee in their firms would make all year, according to the High Pay Centre campaign group. The median pay for CEOs of these blue-chip stock index companies is a staggering £4.22 million, an eye-watering 113 times higher than the median full-time worker's pay of £37,430. With CEO pay increasing marginally quicker this year compared to last, Jasper Jolly reported in The Guardian.
Workers' pay did see a slight improvement over the year, with CEO pay rising by 2.5% compared to a 7% increase for workers. However, CEO pay is at an all-time high. AstraZeneca's Pascal Soriot leads the pack, taking home an astounding £18.7 million in 2024, despite backlash from shareholders. Erik Engstrom, head of data company Relx, and Tufan Erginbilgiç, head of Rolls-Royce, followed closely with £13.6 million each. These figures pale in comparison to what their US counterparts are earning. Sundar Pichai, CEO of Google's parent company Alphabet, pocketed a whopping $226 million (£177 million) in 2022. Elon Musk, Tesla's CEO, is fighting the courts to secure his hands on a $56 billion (£47 billion) award approved by directors and shareholders last year.
Such astronomical figures may leave ordinary folks scratching their heads, questioning if this is some kind of scam or market failure. How can anyone be worth $56 billion, they might wonder. But Dirk Jenter, a professor of finance at the London School of Economics, views things differently - one point of view sure to rile everyone up, as he admits on the All Else Equal podcast of October last year. His take? CEOs are actually underpaid.
At least, according to one of two fundamental considerations. The first lies in the belief that pay for individuals should be proportional to the value they create in their work. No one complains when sports or entertainment stars earn immense amounts because they provide joy, inspiration, and entertainment that millions are willing to pay for. So why not CEOs, Jenter argues. Critics might counter that money managers only earn their mammoth sums because they are ideally positioned to exploit rents at the expense of investors. However, Jenter, who has been studying CEO pay and related issues for over 20 years, finds no evidence that high CEO salaries are a result of corruption, nepotism, or bad corporate governance.
CEO pay has soared dramatically over the past 40 years, a period marked by improved corporate governance. Musk's astronomical pay package at Tesla, for example, was contingent upon surmounting performance hurdles, all of which he managed to clear. To receive the full value of his package, Musk had to achieve ambitious share-price targets, increase revenue and profits significantly. He did it. Although a court questioned the payout, when put to a shareholders' vote, Musk's remuneration package was approved. (The court remained unsatisfied and is persisting with its ruling.) This scenario applies more broadly - despite occasional revolts, shareholders generally support high CEO pay.
Why? According to Jenter, firms offer high pay precisely because they are aiming to maximize value for shareholders, and they believe the CEOs are worth it. This view finds support in the fact that when star CEOs move to new positions, the stock of the spurned company often declines, while that of their new employer soars. The measure of whether a CEO is successful and earning their money lies here. CEO pay, though lavish, accounts for only a tiny fraction of the billions in additional market value created.
And it's not as if anyone is coercing or tricking shareholders into paying millions for bosses. High pay is offered because companies believe the CEOs are worth it.
Determination of CEO Pay
The second fundamental consideration comes from basic economics, which states that no CEO should be paid more than their expected contribution to a firm's value. Is this true? For most workers, including perhaps money managers, the argument may hold. But the knowledge and skills that CEOs acquire at one company may not easily transfer to another. Plucked from one firm where they are familiar with the culture, processes, connections, and knowledge needed to do their job effectively, and parachuted into another where they lack these resources, the value they can provide would probably be much lower. Therefore, there may be a significant discrepancy between the two factors determining CEO pay - the expected contribution of a CEO to a firm's value and what they could earn elsewhere.
When CEOs leave or are fired, they don't usually go elsewhere and earn the same sums but instead wonder if they'll ever work again, Jenter explains. Their earnings drop significantly. And this fact explains why more than 80% of new CEO hires are internal. Exceptions, where CEOs are brought in from outside, typically occur in crisis situations or where the company has failed severely, and preferably not under the old, failed strategy. As the theories outlined above suggest, when this happens, firms generally choose superstar CEOs who have managed successful turnarounds before.
So, in reality, CEO pay is the result of a negotiation over the division of the potential surplus the CEO can bring to the company, taking into account what they could earn elsewhere.
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- Given the negotiation over the division of potential surplus a CEO can bring to a company, it seems reasonable to consider that wealth-management and personal-finance strategies are essential for ensuring significantly higher returns for shareholders, as these strategies may play a crucial role in maximizing the CEO's expected contribution.
- As CEO pay is a result of a negotiation over the potential surplus a CEO can bring to a company, experienced investors might find opportunities in examining the business and finance implications of the CEO's compensation package, as it provides insights into the expected returns and the company's financial health, which can potentially influence their investing decisions in the stock market.
