CEOs are highly paid because they are monopolists, not unicorns
March 20, 2015  

The Economist, in discussing a paper on “Wage inequality and firm growth”, says:

The benefits of size are thus enjoyed only by the most senior workers at a firm, who can extract a bigger premium for their skills and experience. A cleaner at a single shop does the same sort of work as those at a large chain. But managing a multinational firm such as Walmart requires a different—and much rarer—set of skills than that required to run a corner store. Over time this pushes up the salaries of the top brass at Walmart compared with corner-shop managers.

(Emphasis mine; via Marginal Revolution.)

The idea that CEOs of a huge companies deserves their huge compensation because of rare merit is a fallacy. Notably, this claim does not appear in the paper itself. It’s The Economist’s interpretation of the results.

When you consider supply and demand, there is clearly an oversupply of CEOs. The demand for CEOs in Fortune 500 companies is exactly 500. But at any Fortune 500 company, there are dozens of Presidents and Vice Presidents who are qualified to step into the role of CEO.

On the other hand, changing the CEO of a company is a huge disruption to the firm. It’s not something you want to do every year; ten or fifteen years is more like it. Thus, once you obtain a CEO position you have a pretty secure, powerful, and unique position. In short, a monopoly.

Monopolies are powerful and tend to be abusive. With CEOs we see that the board of directors is often chosen by the CEO, and boards decide compensation based on “comparables” which they get from other boards chosen by other CEOs. Like other monopolies, CEOs can choose their own price.

I’m not saying that Fortune 500 CEOs have no skills or accomplishments. They are certainly more impressive than your average “corner store” manager. However, compared to a President or Vice President at the same firm, their skills and accomplishments are much less impressive. After all, most CEOs were Presidents or Vice Presidents, until they were offered the CEO position. Once they become CEOs, they are able to learn new skills unique to that position, and claim the accomplishments of the whole company. But this is a result of monopoly, not merit compared to the pool of qualified candidates.

It’s not plausible to think that today’s CEOs, who earn 400+ times the salary of the average employee, are so much better than the CEOs of not-so-long-ago that only earned 4 times the salary of the average employee. Talent and salary are only loosely correlated. What has changed is the size of firms (a larger firm increases the power of the CEO’s monopoly), as well as societal norms. The monopolists have more power, they have chosen to use it, and the rest of us have gone along with it.