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Explaining CEO Pay

JC Myers examines the ability of orthodox marginalist analysis to explain one of the more striking features of the US economic landscape in recent years: the dramatic rise in CEO pay.

J C Myers

Issue #73, April 2005

In the spring of 2003, financial journals, then the media at large, began to report on the plans of the Pentagon's Defense Research Projects Agency (DARPA) to set up an exchange through which investors could wager on the likelihood of a terrorist attack. The basic idea behind Futures Markets Applied to Prediction (FutureMAP) was that if given the opportunity to turn a profit, investors would draw on a wide variety of information sources, ultimately revealing in the movements of the market more than could be gleaned from satellite photos and telephone taps. The plan was quickly dropped, though the criticisms directed against it focused more on the sordid nature of the opportunities it offered than on the flaws in its logic. Though they were lambasted for a titanic lapse in moral judgment, what the designers of FutureMAP truly suffered from was a surplus of confidence. Just as the politicians who favored privatization of electric utilities mistakenly assumed that investors would never attempt to manipulate power markets (as they did during California's Rolling Blackout summer of 2001), the DARPA researchers must surely have assumed that terrorism futures investors would be ethically restrained from attempting to profit by withholding information about planned attacks - or even assisting in them.

Honestly You Can Make Five Hundred Dollars

Yet, the confidence displayed by FutureMAP was not so much in individual investors as in the market itself. The invisible hand not only guides, it knows. As supply meets demand, a future is created, independent of any plan, but revealed in the trajectories of market forces. Thus the confidence with which orthodox economists stride the halls of the contemporary academy: theirs is a reliable social science; the others just meaningless speculation. Care to know what the effects of a hike in the minimum wage would be? You can waste your time with the sociologists and political scientists, or you can plot the supply and demand curves and be certain.

In the wake of the late 20th century assault on empiricism, it seems more difficult now than it once might have been to pit social scientific methods against one another. Different social sciences, the post-structuralists will now remind us, see different worlds. There is unquestionably an important truth to this position, but it often risks bending the stick too far: some explanations of social phenomena may differ from one another while remaining within the realm of possibility; others may simply fail to explain. It is with this in mind that I would like to examine the ability of orthodox marginalist analysis to explain one of the more striking features of the US economic landscape in recent years: the dramatic rise in CEO pay.

To Market, To Market

According to data compiled by United for a Fair Economy, between 1990 and 2003, the average US worker's pay rose by seven percent, after inflation. Considering that the 1990s were dynamic boom years for the US economy, it would seem reasonable to have expected a rising tide to lift all boats. Some boats, though, were quite a bit more buoyant than others. In the same period during which workers saw only modest gains, CEOs added 274% (after inflation) to their pay. In 1980, the average CEO earned forty-two times the wage of an average worker. Ten years later, CEO pay had more than doubled. By 2000, it reached the eye-popping figure of 525 times an average worker's wages before retreating (after the stock market slump) to a multiple of 301.

How can we explain this sudden increase in the value of chief executives? Orthodox marginalist analysis suggests that prices rise as low levels of supply meet high levels of demand. Thus, behind the extraordinarily lavish compensation paid to CEOs in the US, we should expect to find a large number of firms requiring chief executives and a small number of potential candidates to fill such positions. Between 1990 and 2001, the number of US firms with 100 or more employees grew from 84,000 to 102,000, an increase of just over twenty percent. Considering that the rise in CEO pay was more than 100 times greater than the growth in demand for CEOs, demand forces alone would seem to offer little in the way of a compelling explanation.

Perhaps, then, it was not explosive demand, but constricted supply that led to CEO pay so dramatically outstripping the wages of ordinary workers. A single key factor clearly limits the availability of potential chief executives: the highly specialized package of skills called for by the job. The head of a large firm would require advanced knowledge of business, finance, and marketing - the sort of skills taught by post-graduate programs in business administration. Yet, between 1980 and 2002 - the years during which CEO pay experienced its meteoric rise - the number of Master's degrees in business increased from 57,391 to 120,785. Rather than desperately beating the bushes for MBAs, by the 1990s, US firms were swamped with them.

Of course, while the technical knowledge certified by an MBA degree might be invaluable for those in the executive ranks of a large firm, book-learning alone could hardly prepare someone to assume command. Substantial experience and the sometimes intangible qualities of leadership might separate the competent middle-managers from the potential CEOs. We can surely assume that the need for experience, initiative, responsibility, and charisma will whittle down our applicant pool considerably. But is it reasonable to believe that while leadership skills abounded in the late 1970s, by 2000 they were almost impossible to come by? Could it be that in 2003, the bar had been set so high for an incoming CEO that only a pay raise of 274% over 1990 levels would be sufficient to draw appropriately skilled candidates out of the woods?

Come and Get It, Extra Cash

At this point, those who maintain that high levels of material inequality are, in fact, socially beneficial might insist that the function of generous compensation packages for CEOs has been misunderstood. Monetary rewards act not only as recruiting devices, they might remind us, but as incentives for performance. The CEO who knows that his or her multi-million dollar salary will only continue to be paid if the firm outperforms the competition will be driven to succeed. High levels of pay for CEOs, then, would lead to increased efficiency, ultimately benefiting the society as a whole. Unfortunately for both inequality's cheerleaders and the community at large, the correlation between company performance and CEO pay appears, in recent years, to have worked in reverse. Between 1999 and 2001, the CEOs of twenty-three companies being investigated for accounting fraud earned seventy percent more than the average heads of comparable firms ( Sumptuous CEO compensation seems to have been the reward for pillage, rather than productivity.

Red in Tooth and Claw

The failure of a widely accepted theory to provide an adequate account of a phenomenon well within its purview should be expected to send scientists in the relevant disciplines scrambling back to their drawing boards in search of a new and revolutionary breakthrough. In the case of orthodox marginalist economics I do not think that this is very likely, nor is it entirely necessary. We have possessed for quite some time a social scientific theory capable of explaining the recent spike in CEO pay, though its association with both a particular political thinker and a particular political philosophy has had the effect in the US of pushing it far to the margins of academic discourse.

Historical materialism is generally thought of as the unique brainchild of Karl Marx, yet its roots stretch much further back in the history of political thought. As early as the 5th century BCE, ancient Greek scholars recognized different regime-types as having distinct class bases. We now tend to forget that the word 'democracy' originally indicated not simply the holding of elections, but a political condition in which ordinary working people held sway over the noble elite. In the 17th and 18th centuries, European thinkers connected their understandings of governance to the state's defense of property rights, implicitly recognizing the centrality for politics of conflicts between the propertied and the propertyless. From the middle of the 19th century onward, Marx (and those who continued to pursue the research project that he initiated) specified the historical context in which that struggle went on. The technological forces with which human beings effect their survival can be put into motion in a variety (though not an infinite variety) of different ways. The door is thus left open for tests of strength - from the shop floor to the centers of state power - to determine who will control and benefit from the available forces of production. Class, in this sense, is an objective position within the relations of production and only potentially the basis for a subjective form of identity or political mobilization. But whether or not that step into self-identification and political action is taken, historical materialism recognizes class as an antagonistic relationship: in order for one to gain, another must lose.

The first step, then, that must be taken in order to test an historical materialist explanation of the rise in CEO pay would be to determine the class status of CEOs. However, such a determination could be muddied by the fact that most high-ranking corporate executives play dual roles within their firms. As major shareholders, they are owners of productive capital and employers of labor. As managers, they are themselves employed by the collective body of owners of the firm. Yet, as sociologist Erik Olin Wright has argued, the class interests of expert managers are closely tied to those of employers. Thus, in both of their roles, CEOs can be understood to stand with owners against workers.

The possession of an objective class position, though, does not automatically translate into participation in an active class struggle. What evidence is there that employers and their allies actually engaged in a campaign to redistribute power and wealth between themselves and the wage-earning majority? Cable news pundits might debate for hours the interests served by competing political parties or occupants of the White House, but the spectacularly successful de-unionization of the US workforce stands as a clear indication of the balance of class forces at the beginning of the 21st century. Following the lead of the Reagan administration's mass firing of organized air traffic controllers in 1981, corporate capital went on the offensive against organized labor, converting full-time positions to part-time or temporary slots, moving production facilities overseas, and quickly moving in replacement workers during strikes. The number of work stoppages engaged in by US workers dropped steadily from 235 in 1979 to 14 in 2003. Between 1983 and 2003, the percentage of US workers who belonged to labor unions fell from twenty to twelve. The effects of that transformation can be seen in the fact that between 1990 and 2003, wages in mining, construction, manufacturing, and transportation (formerly the four most heavily unionized sectors of the US economy) rose by no more than thirty-eight cents per hour. Productivity gains continued apace during the 1990s, so where did the profits go, if not into workers' pockets? The merry band of pirate chiefs whistles an innocent tune, as the security guards close ranks across the driveway to their gated community…

She Blinded Me With Science

The power of marginalist economics lies in its clarity and precision; its ability to thrive in the world of mathematical certainty. But its ideological value flows from its blissful ignorance of class power and class struggle. In the marginalist world, all things are worth whatever those who enter the market choose to pay for them. Everything simply is as it is. In this sense, marginalist economics (much like pluralist political science) provides useful cover for the capitalist economy. After all, what's the point in challenging the right of business executives to earn such staggering salaries and bonuses? No one would pay them so much if they hadn't earned it.

Unfortunately for the superstore cashiers, the coffee-chain baristas, and the sweatshop seamstresses, historical materialism's ability to produce a more accurate understanding of their bosses' successful self-enrichment is, in the short run, little more than trivia, lacking a mass movement capable of putting such knowledge to effective use. Yet, how many superstore cashiers are dissuaded from joining a union because, at the end of the day, they believe the capitalist economy to be fair and just? How many coffee-chain baristas and sweatshop seamstresses assume that voting for lower taxes will bring them security and prosperity? Pass the word: if the economists won't say why the boss makes so much, what else are they holding out on?

Note: Unless otherwise indicated, statistical data used in this article was drawn from the Statistical Abstract of the United States 2004-05.

JC Myers is a member of the Bad Subjects production team.

Copyright © 2005 by JC Myers. Graphics from ads in POPULAR SCIENCE circa 1960. All rights reserved.