Here’s Why Setting a Maximum Wage for CEOs Would be Good for Everyone

Yves here. This post does a service by focusing on how the CEO compensation process is designed to assure ever-leapfrogging pay packets, or at the article describes it, a ratchet. The comp consultants have every incentive to enable this practice, since they are usually firms that are also in the executive search business, and fees on executive searches are set as a percentage of first year expected pay.

Other members of the executive ecosystem benefit too. As CEO pay rises, it becomes acceptable to pay board directors more. And lavishly remunerated CEOs don’t mind hiring highly but lesser paid lawyers and consultants; indeed, one who isn’t raking in the super big bucks must not be very good.

The article is a little weak on debunking the claim that “competitive” pay is necessary to attract talent. Studies regularly find that the most highly paid CEOs underperform.

One idea we’ve advocated, advanced by Doug Smith, is a different version of a maximum wage, where it would be set as a multiple of 20 times of the income of the lowest-paid worker. It would need to be carefully defined so as not to allow gaming by using temps or contractors or part-timers. In 2012, François Hollande pushed for a cap the salary of corporate chiefs at 20 times the level of their lowest pay level. The Basque success story Mondragon has a maximum pay that varies by company, with the top compensation level ranging from 3 times to 9 times that of the most poorly paid worker.

By Mark R Reiff. Originally published at Aeon

Under capitalism, the argument goes, it’s every man for himself. Through the relentless pursuit of self-interest, everyone benefits, as if an invisible hand were guiding each of us toward the common good. Everyone should accordingly try to get as much as they can, not only for their goods but also for their labour. Whatever the market price is is, in turn, what the buyer should pay. Just like the idea that there should be a minimum wage, the idea that there should be a maximum wage seems to undermine the very freedom that the free market is supposed to guarantee.

This view, however, has some dramatic consequences. One is the explosion in economic inequality that almost all liberal capitalist democracies have experienced over the past 30-40 years. The difference between the top and the bottom of the income distribution now liesaboutwhere it did in the Gilded Age and the roaring 1920s, up until the Great Depression. Unlike these earlier periods, however, this rise in economic inequality has not been driven by returns on capital assets. This time, one of the most important contributors to the rise has been the payment of extraordinarily high levels of compensation to corporate executives. In 2017, for example, the 200 highest-paid CEOs in US business each received compensation of between $13.8 million and $103.2 million, well above the cut-off for the top 0.01 per cent of the income distribution, which currently lies at $8.3 million. More troubling still, while the compensation for corporate executives has been almost continually rising during this period, real (inflation-adjusted) wages for almost everybody else have been stagnating.

Many people find this upsetting but, even so, they tend to treat it as something capitalism requires us to tolerate. Others think it is something that capitalism requires us to applaud. But nothing in capitalism actually says that such sky-high levels of compensation are permissible. What capitalism says instead is that people need incentives to be maximally productive. But will someone who makes $100 million a year really work harder than someone who makes $10 million? Compensation, like everything else, has what economists call ‘diminishing marginal utility’. More of it has less and less of an incentivising effect, until eventually it has no incentivising effect at all – people are already working as hard as they can. At which point capitalism suggests that we should not pay someone evenmoremoney, for we are going to get nothing in return.

But wait – aren’t CEOs just getting paid the market rate for their labour? Their compensation is calculated according to a formula set when they were hired and, as long as this formula represents the going wage, then this is what they should receive. The market rate for CEO labour, however, is not set in a competitive manner. The formula is set by a special group of the company’s directors, called ‘the compensation committee’. It does this by commissioning a survey to see what similar companies pay their CEOs. The answer is usually expressed as a range, and while that range depends on what kind of companies are deemed similar, let’s assume for purposes of illustration that it is something like $1 million to $60 million for that particular industry and company size, with an average of $18 million. Given the fact that the CEO will ultimately be in a position to reward the members of the committee in various ways, there are obviously opportunities for corruption here.

Even setting this aside, there are problems when it comes to using the survey results to frame an offer. The committee can’t recommend an offer at the bottom of the range, for that would be saying that they think the candidate is only as good as the lowest-paid CEO. They might want to offer more than the top, just to show how highly they think of their candidate. But at the very least, they are going to offer a little more than average, for no one wants to suggest that their candidate is worth less than this. By doing this, however, the average keeps ratcheting up. Next time someone hires a CEO and another compensation committee conducts a survey, the average will be higher. The market is not bidding up the price; the price is going up simply because everyone always wants to beat the current average. We have what economists call a market failure. Setting a maximum wage would therefore not interfere with market freedom because, in this instance, the market is not working.

But if we don’t pay the going rate, how are we going to be able to hire the best people? The best people will surely want to go where they will be paid more? This is a loss, however, only if those who receive the greatest amount of compensation really are the best, which is contrary to the evidence. It is very difficult to tell who has both the skill and the talent to make an effective CEO. Past performance is no guarantee of future success. Very highly paid CEOs have run their companies into the ground, and some of the most successful companies today were started and managed by people who had absolutely no background in business. These people began working for almost nothing, yet built their companies into mammoth enterprises. Steve Jobs is an excellent example here, for Apple faltered when he left, and began to thrive again only when he came back, for a salary of $1 a year. So companies need not worry about losing the best candidate to someone who pays more. Very good people will work for say, $10 million a year, especially when given a chance to run a company. And these people are just as likely to do well as those who might demand $100 million.

Nevertheless, doesn’t this deprive CEOs of compensation they deserve? If their company does well, they should do well too. But a corporation’s success depends on the contributions of many people. If we are going to try to determine how much compensation the CEOs deserve given their contribution to their companies, this should be the test all the way down. When the company does well, everyone should get a similar percentage of the profits. But they don’t. More troubling still, when a company performs poorly, CEO compensation should not go up, yet it often does. At least it often remains disproportionately high in light of the company’s poor performance, something that itself seems contrary to the logic of capitalism. To justify this, companies often argue that the CEO shouldn’t be blamed when ‘the market’ takes a downturn. But if there are too many factors to determine why a company does poorly, then there are too many to determine why a company does well. Determining what individual employees ‘deserve’ in a large corporation is simply impossible to do with reasonable certainty.

Where should we set the maximum? We can fine-tune this as we accumulate experience, but I propose we start with a limit of $10 million in total compensation for a CEO of any company doing business in the US, with no one in the company or its subsidiaries permitted to earn more. This would put the CEO solidly among the top 0.01 per cent of the US income distribution, and this should be incentive enough to attract very good people, from anywhere in the world. For companies doing business in the US but which are not based there, are not listed on any US exchange, do not have substantial operations or employees there, and do have such contacts somewhere else, then a similar limit would be calculated according to the relevant country’s income distribution.

To avoid people trying to game the system, when companies have substantial contacts with multiple jurisdictions, the applicable limit would be adjusted to reflect the source of the company’s real economic activity. When 40 per cent of real economic activity is in a country with a lower or (perhaps in rare cases) higher limit, for example, the $10 million limit would be reduced or increased proportionally. In any case, such a limit would help to slow the growth of economic inequality and prevent reckless risk-taking by CEOs who otherwise might feel motivated to try to drive up the stock price of their company and therefore their bonus, while also discouraging the paper relocation of companies to ‘billionaires’ club’ jurisdictions, and putting younger, less traditional and potentially more creative leadership at the top.

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  1. Mickey Hickey

    At some point it will be necessary to rein in inequality. Ideally this should happen before a repeat of events similar to 1789 Paris or 1917 St Petersburg. In the home of the brave and land of the free it is highly unlikely that any government would put mandatory caps on executive income. The late great political scientist Sheldon Wolin and other academics have been promoting Rooseveltian rates of income tax which went as high as 91% as a solution to inequality. This was the rate that “saved capitalism” under Roosevelt. Trump with his corporate tax cuts has been going in the direction of exacerbating inequality. Since the plutocracy did not rein him in it would be safe to assume they do not see increasing inequality as a threat to their continued existence.

    1. Jim A.

      Even without getting all non-linear and wonky ala 1917, the economy functions less well when compensation is as unequal as it is now. We really NEED higher tax rates for incomes* greater than $1M.

      *to include capital gains.

  2. Frenchguy

    And while you’re at it, it might be a good idea to ban compensation in stocks. I might be wrong and maybe accounting standards are taking that into account but I fear that a lot of the outsized profits of US firms in recent years are just hidden executives compensation. The day the market comes to grip with that is not going to be pretty… But anyway, the max wage is a very sound idea. As you said, there’s little proof that very high level of compensation have an economic basis. Also, it seems pretty clear from they came about first of all through a slow decline in moral values of US elites (just read Barbarians at the Gate and the slow rise of corruption between CEOs and boards is quite something, and that was in the 80s). In France, Hollande did put a max wage of 450,000€ per year for CEOs of public companies and nothing bad happened. That was a really good move, politically popular, not much adverse effects (France is too small to try to impose it on private companies…) and I hope it serves as a nice anchoring point for the private sector.

    1. cnchal

      > . . . a lot of the outsized profits of US firms in recent years are just hidden executives compensation . . .

      I don’t follow your logic. Mind explaining it further?

      1. Frenchguy

        You pay an executive in stock. If you don’t do anything more, share price would fall, this would actually be a transfer from shareholders to the executive. So you rise the amount returned to shareholders (dividends would work but buybacks have been the trendy thing lately) which is paid out of profits to support the share price.

        In other words, a part of profits must be used to “sterilize” executive compensation. If you reclassify buybacks as compensation, reported profits would fall. It would nicely explain the apparent fall of the labour share that was very stable until some 20 years ago. Of course, the firms the most at risk would be those using stock compensation very widely (tech stocks…). No idea if this is a real risk or just a marginal issue in macro terms. Also accounting principles surely are trying to get this right but somehow I doubt they are airtight with huge flows one way and the other.

        Or for the short version: for large corporations with no problem to raise capital, stock compensation is a twisted way to pay employees, I don’t trust it.

      1. Frenchguy

        I gathered that it was taken into account but I’m still not comfortable. The evaluation of this cost does not seem to me that evident (people don’t sell their stocks as soon as they vest). If I’m going with a poor pun, if it’s not cash, there’s a catch. Basically, I’m looking for the missing labor share and this seems a good and likely explanation…

  3. Summer

    Yes, it would be best to make it about overall compensation rather than wage.
    Also, whatever triggers a bonus for an exec should trigger bonuses all down the line, throughout the company.

    But this may be all too late. Companies are being sucked dry by these packages.
    Lots of companies are hallow shells with a lot of marketing and design covering up lack of innovation and a general tiredness all around. Everything is run like a dry-ass bank. And then, all the short term thinking…

  4. diptherio

    Good article, until he starts talking numbers. $10 million a year?!? How about $300,000…if they do really well. How about we don’t allow people to acquire so much money that they can buy politicians? How about we don’t pay one person more in a year than most people will make in a lifetime. This guy still doesn’t get it…he thinks he does, but he don’t.

    1. NotTimothyGeithner

      How about we don’t allow people to acquire so much money that they can buy politicians?

      This is key. Politicians are notoriously cheap. With the exception of HRC’s 2016 campaign where she seemed inevitable (with universal name recognition and an msm devoted to the horse race; all the ad money was wasted), money usually pours in late in the game when the winner is known. Loyalty is given to donors who fund early, and its not for very much.

      A hard number is difficult to surmise (your $300K a year might be appropriate), but the primary goal would be to prevent the leisure class from interfering in politics with the threat dropping out of the leisure class if they give to political causes. The sociopaths will still be sociopaths, but they are often obscured by people who think they should be investing in causes that won’t if it interfered with a round of golf.

        1. NotTimothyGeithner

          It would be if we had higher taxes. Prices would simply plummet.

          My mom didn’t live in an $8 million condo in Jamaica Plains in the 60’s. It might be $8 million the last time it sold. Actually, it was $6 million. The high was $8 million. My aunt is a realtor in the area. They had the opportunity to buy it way back in the day.

    2. James

      I would think that the traditional “gold standard” of $1M/yr would be both politically palatable and sufficiently motivating to attract the proverbial “best and the brightest.”

  5. Steve Ruis

    The invisible hand has an invisible thumb on the scales benefiting the elites as it always has had. We have let capitalism drift into extremes (like the only goal of a corporation is shareholder value … sheesh) and instead of a moderate favoring of the elites by the system, we get this extreme favoring. CEOs control their own compensation, which is a fox in the hen house scenario but no one seems alarmed.

  6. Raulb

    There has been systemic regression since the late 70s actively aided by economists from various centres, think tanks, global orgs justifying dubious policies and ideas one after another. They have created and seeded ideological words like ‘wealth creators’ and manufactured narratives of ‘makers and takers’.

    We have seen massive CEO pay increases, financialization, asset inflation, deregulation, the vulgar celebration of greed by economists and on the other side wage stagnation, increasing inequality, the 2008 crisis and endless bailouts. Greenspan’s gloating to Congress about cornering workers underlines the odiousness of the entire project. [1]

    They do not even seem to believe in rule of law and basic civilization as every law is projected as a constraint on free trade, free markets, ‘wealth creators. If that is the case then these constraints exist on individuals too in any civilized society, so why not just remove them and regress to proto barbarism.

    Can Nakedcapitalism consider an economist hall of shame with all their statements and dubious ideas in one place with commentary by Hudson, Keen, Baker and others. As a profession they are operating more or less like high priests of feudalism need to be exposed and held accountable. And nothing they say should be taken seriously untill there is a complete meaculpa and clean up of corporate and vested interests from the field.


    1. Stupendous Man - Defender of Liberty, Foe of Tyranny

      “They do not even seem to believe in rule of law …”

      When/if the context is limited solely to the courts you used too many words there. Your comment would be completely accurate had you omitted the words “seem to.”

      Codes of judicial conduct, or judicial canons, in at least several states, define “law” thusly: “’Law’ denotes court rules as well as statutes, constitutional provisions and decisional law.”

      What I have witnessed in courts in numerous cases, across multiple state and federal courts, is a consistent disregard, ignoring, and refusal to comply with the law (as defined above). What is afforded to citizens is a pretense, an illusion, of due process and rule of law that is wholly lacking in substance of same.

      I’ve coined a term for this behavior by our courts that has replaced The Rule of Law: “The Rule of Whimsy.” Others are welcome to borrow/use it.

  7. Pat

    I also want the pay pegged to the lowest paid worker including subcontracted workers (the wage they are paid not the contractor rate) and part time workers (their wage adjusted to full time).

    Along with that executive employees of the company must have the same benefits package as the majority of the employees, health/retirement/termination. And all bonuses greater than wages, regardless of format, would be subject to an increased employment tax with both the Executive and the Company paying twenty five percent of that bonus for Social Security and Medicare.

    The additional constraints give the Executive class a reason to stop crapifying retirement and other benefits for the plebes, and Boards a reason to be concerned about the costs of outsized bonuses (they do hate taxes).

  8. TG

    Or… we could go back to the tight immigration policies of the 1940’s to 1960’s.

    When labor is hard to find, even the lowliest worker has considerable bargaining power. The CEO can’t get most of the profits – because high wages across the board for workers prevents it. That’s why, more than anything else in the world, the elite want cheap labor and the elite want open borders with the overpopulated third world. And of course, they also don’t want anything serious done about the poverty in the third world either.

    Profits flow to the limiting factor. When the limiting factor is labor, labor gets the bulk of the profits and increases in productivity translate to higher wages. When labor is not the limiting factor, wages are low because there is no need to make them high, and the profits go to the CEOs and rentiers.

    But as Bernie Sanders found out in 2016 (‘Racist! Fascist! Literally Hitler!’) we can’t discuss this. Because it is true.

    1. ape

      Ehhh, I think it’s that workers in some countries have been fooled into being just big wusses. It’s not “market supply” — it’s that workers don’t get together and create scarcity.

      You gotta strike, and strike again. You gotta strike in the factories, and in the nursing homes. The kindergartens, the universities and on the buses.

      It’s not “the immigrants”. It’s the wimps who won’t fight for what’s theirs.

  9. cf

    Capping pay would reduce social mobility. The very wealthy have capital gains, not income. The CEO making a large salary is a potential competing bidder for good and services with the person who inherited wealth.

  10. TheScream

    Concerned Citizens: “Mr. CEO, you should take less money. It would be better for everyone!”

    Mr. CEO: “Well, not ‘everyone.’ I would get less money.”

    Concerned Citizens: “Yes but the needs of the many outweigh the needs of the few or so said Spock.”

    Mr. CEO: “My needs are great and well-deserved. Besides, who says I can’t have more money? Who decides how much I get?”

    Concerned Citizens: “You and your cronies all decide for each other. It’s perfectly legal.”

    Mr. CEO: “Then go away. Poor people depress me. I think I will fire a bunch so my options can be exercised.”

    It’s a nice idea. Like being Christian or saving the planet, but in practice, things fall apart.

  11. Anarcissie

    This all seems like a fantasy. The ruling class likes playing with huge amounts of funny money, apparently, and there is no obvious way to get them to give them up. They can buy all the legislators, lawyers, and wealth-worshipers they need to keep things going under present circumstances. After the Collapse, yes, things will be different — although not necessarily nicer.

  12. Thuto

    Yes, we shouldn’t blame the CEO when the market takes a downturn but no one curbs our gusto when we laud them as wizards and alchemists when they’re beneficiaries of bull markets.

  13. kernel

    Seems like it would be a nightmare to implement. Over-compensated CEO’s would pay clever lawyers & accountants to get around the resulting regulations, which would then have to be revised every year but would always be playing catch-up. A new bureaucracy would have to be created to track & enforce those Regs, and then it would probably get corrupted by Regulatory Capture. And until the US Dept of Justice learns/decides to prosecute white-collar crime again, laws & Regs on this won’t matter.

    Seems much simpler to just crank the top Tax Rates back up to Eisenhower levels.

  14. Epistroply

    Increasing taxes is not the answer; nor is setting an absolute maximum salary.

    The best one can do is to follow the John Lewis approach that I understand is a part of their governance documents. Set an upper limit on CEO salary in terms of a maximum multiple of the average or median wage of the company. This would encourage the CEO to have a personal stake in the wages and welfare of the staff. Another enhancement would be employee ownership and employee membership of the board. These are all part of the John Lewis model and have served it well. The company has consistently attracted outstanding talent at the CEO level – proving that salary is not the primary factor when attracting talent.

    One of the reasons that CEO salary is so high is that the boards are crafted to support this outcome. There are a lot, and I mean a lot, of corporate board cross-membership issues with the world’s largest corporations; this should be strictly forbidden.

  15. sd

    Tax compensation once it passes over 20 times the lowest paid worker at the 90 percent tax bracket. Companies can pay executives as much as they want, meanwhile Uncle Sam levels the playing field.

  16. ape

    “Steve Jobs is an excellent example here, for Apple faltered when he left, and began to thrive again only when he came back, for a salary of $1 a year.”

    But that’s simply not true. It had long been faltering before he left. It continued to falter after he left. He was involved in NeXt computers which also faltered. He came back, and at some point after that Apple stopped faltering.

    The correlation is very weak there. The history is wrong. And in fact the cult of the CEO is actually argued against by the history — Jobs was involved with a long history and a lot of business, and sometimes the business worked, and sometimes it failed. But the story seems to hold Steve up as a great CEO who would have been worth much more than $1.

    I’m not sure. Maybe, maybe it’s just a function of hitting the lotto the first time and then people funding you enough that eventually you hit the lotto again.

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