THE BLOG

Super Egos Without Superegos: Continuing Corruption in Corporate Compensation

06/02/2015 08:17 am ET | Updated May 30, 2016

The latest compensation data for the CEOs of the largest 200 public companies indicate that the average compensation package for these corporate leaders increased about 9.2% from the previous year and is now $22.6 million. Meanwhile, the average salary for employees in general increased about 3% in the past year.

This comparison prompts thoughts of Sigmund Freud's tripartite division of cognitive function into ego, id, and superego. In Freud's scheme (or at least my simplified version of it) the superego (i.e., conscience) prevents the ego from satisfying its nearly endless id-energized appetites and desires. In the absence of fully developed consciences, people tend to gratify their appetites without regard to relevant societal norms.

In this light, consider the astonishing increases, over the last three decades, in compensation for top managers at major corporations (i.e., companies with capitalizations in the many billions of dollars), but not just the bankers and executives at financial firms most prominently in the news of late. For the sake of simplicity, we can focus on chief executive officers (CEOs). While specific cases may deviate from general patterns and merit individual assessment, space limitations necessitate a focus on broad trends.

In 1980, the average CEO of a public corporation made about 40 times as much as the typical employee of such a company. Currently many CEOs of public U.S. corporations receive annual compensation about 250-400 times as much as the typical employee. Of course, a few executives are blessed with yet higher levels of pay. This astounding inflation in the ratio of compensation for CEOs versus typical employees presents a bit of an economic conundrum that has been insufficiently explored.

How could CEO performance, on average, increase roughly ten-fold relative to employee performance so as to justify the quantitatively parallel increase in compensation? Have corporate IQs, on average mind you, increased by ten-fold to around 1300 or 1400? Or, perhaps, CEOs now work ten-times longer, on average, putting in 400 hours per week. This level of commitment would be truly impressive since a week only has 168 hours. Such exceptional dedication would require that CEOs, out of a deep sense of obligation to their employees and shareholders, permit their bodies to be accelerated to velocities near the speed of light so as to exploit relativistic time dilation.

Of even more compelling interest, since this extent of increase in CEO-to-typical employee compensation is an average, it suggests that a large fraction of CEOs have exhibited major performance gains, if, in fact, such gains are at the root of the increases in compensation. Of course, if improved performance is not the basis for greater pay (or at least the better part of it), then, on economic, legal, and moral grounds it is not justified.

The answer is that CEO performance, on average, could not conceivably have increased sufficiently to account for the average increases in CEO compensation. In fact, relevant measures of CEO performance must take into account two factors: 1) corporate performance relative to other corporations (run by other CEOs) competing in the same markets and 2) changes in corporate productivity. It may well be logically impossible for aggregate CEO performance to increase at all on the basis of the first factor (relative performance in a market). Based on the second factor (average employee productivity), CEO performance, and especially aggregate CEO performance, could not be expected to increase more than a very modest amount indeed. After all, if the CEO's performance is perceived to have improved by virtue of improved performances from subordinates, then the ratio of performances (and pay) should not change dramatically, the possibility of truly exceptional corporate leadership notwithstanding. From this perspective a few percentage points of annual improvement would be a very big deal for a single CEO, and it stretches credulity to propose that most CEOs could massively and simultaneously increase their contributions to corporate success.

The implications of this line of reasoning, contrary to the self-serving claims of some, is that many members of corporate board compensation committees are either not too inquisitive, not too attentive, or not too ethical. Regardless of which option or combination of options applies these individuals are, in many instances, guilty of egregious failures to fulfill their duties and meet their obligations to shareholders. While it is disturbing that scoundrels ran a few companies, such as Enron, WorldCom, Adelphia, and Tyco, it is even more scandalous that numerous public corporations have been managed by executives willing to reward themselves so excessively with the complete connivance of board members. The outrageous ratio of executive compensation to executive performance is perhaps a rough measure of the ratio of ego or id to superego for both executives and board members

It is necessary to emphasize that the problem is not merely that the compensation packages were extremely large, thereby creating a 'problem of perception.' The problem is that the compensation was, literally, not earned, thereby pushing it into the realm of theft. Corporate executives have no trouble comprehending the grudging nature of true market forces when it comes to increasing pay for typical workers. Every tiny increase for subordinates must be rigorously justified in terms of what has already been accomplished. Yet, when the compensation of these faux capitalists is at issue there is a remarkable, if unsurprising, loss of rigor in the requisite justification. A favorite compensation committee maneuver when the CEO has presided over a year of dismal performance is to reward his or her positioning of the company for incredible growth in the coming years. So while non-executive employees can only be rewarded, if at all, for past performance, CEOs and other top executives can be rewarded for imagined (and quite often, imaginary) future performance.

Those executives who claim that their rewards are conferred by the logic of the market are either lacking in economic understanding or are being disingenuous. There is no honest market for corporate leadership. In contrast to real markets, in which valuations go down as well as up, the executive marketplace was distorted beyond recognition by incentives for board members (who are frequently executives themselves at other corporations) and 'independent' consultants alike to push for ever higher levels of compensation regardless of the tenuousness of the justification. In recent years, some CEOs have actually been forced to accept decreases in annual pay, but one wonders if the apparent decrease will really be meaningful. The main reason that the pattern of ever-increasing compensation was able to continue for so many years is that the people (i.e. shareholders) paying the bills for this flagrant abuse are, with rare exceptions, individually powerless to stop it. The consequence is that billions, perhaps tens or hundreds of billions, of dollars have been diverted from the pockets of shareholders and employees alike into the pockets of individuals deserving of another fate altogether.

As Thomas Jefferson pointed out in his Notes on the State of Virginia (1782):

"In every government on earth is some trace of human weakness, some germ of
corruption and degeneracy, which cunning will discover and wickedness
insensibly open, cultivate and improve. Every government degenerates when
trusted to the rulers of the people alone" (emphasis added).1

Corporate governments, collectively, have evolved into an approximation of such a closed and degenerate ruling class, a feudal form of capitalism that renders the efforts at economic improvement for many of the less affluent futile or nearly so. Whatever the shape of the solution to this problem, it is clear that more shareholder input and greater executive and board accountability are urgently needed. Recent developments suggest that shareholders are becoming more active in policing executive compensation, but the gap between current and ideal practices remains immense.