Why Boards Pay CEOs More

Presumably corporations would not want to overpay their CEOs, which is why they hire “compensation consultants.” The consultants study the publically available information on comparable CEO compensation so that they can benchmark their peers.

But a new study by three professors at Cambridge University found otherwise: “We consistently find evidence that supports the argument that compensation consultants are hired to justify higher C.E.O. pay to the board, shareholders, and other stakeholders.”

Why do they all bother – for which, no doubt, they charge handsomely? Either the boards that commission the research ignore the findings or the consultants consider it expedient to inflate their recommendations.

Sorkin notes the obvious: It’s a mistake to let a CEO hire his own compensation consultant. According to the study, though, when that happened it “led to a 13 percent increase in pay.” It doesn’t make sense, “but it happens more than you would imagine.”

But an even better question is why, when they have the information they commission, they ignore it?

“Let’s be honest,” wrote Andrew Ross Sorkin in The New York Times, reporting on the study, “compensation at the top level is rarely based on a true marketplace. Unless a rival company tries to poach a chief executive, it is hard to determine exactly what they should be paid.”

Trying to be honest and respectful of the data, it looks like Boards want to please their CEOs. Far from paying fair market value – and possibly disappointing the CEOs who have a somewhat exaggerated sense of their own value – they flatter and appease them. As a result, compensation has no logic, either in relation to a norm or in response to performance.

It is as if board members and CEOs are members of the same club – which in some respects they are. Board members, often the CEOs of other companies, know how they want to be treated. They travel in the same circles and they are attentive to the perks and rewards they others are getting. Indeed, many of them are competitive and envious of those perceived to be better off than themselves.

Sorkin reports a story Warren Buffett tells about the time he ran Salomon Brothers. “At Salomon, everyone was dissatisfied with their pay, and they got enormous amounts. They were disappointed because they looked at others, and it drove them crazy.”

We are forced to think, though, that more than envy is at stake. CEOs are the nucleus of a new elite class. They often move from job to job, expecting the same privileged treatment, the jets, the bonuses and stock options that entitle them to extraordinary lifestyles.

For most boards, Sorkin concludes, “the best chief executive makes the most money.” That is, by definition. The greater the compensation, the best the performance must be. And those with the most compensation increasingly run the country with the power they exert not only through their corporations but also with their personal fortunes.

They endow new museums, concert halls, and hospitals. They fund schools and university departments, buy newspapers and magazines, create new charities – and, of course, donate heavily to political campaigns to maintain their access to power. In helping each other, they are also helping to establish their class and cementing their social position for years to come.