I’m puzzled by executive compensation

I find it easy to understand that Dan Brown makes $22e6 a year: He writes books, people buy them. He gets paid a percentage. I can even understand that Judge Judy makes $47e6 a year: she stars in a TV show that people (effectively) pay to watch. What I can not understand is how an executive at a big company can get paid $57e6.

I don’t read Dan Brown’s books and I don’t watch Judge Judy. But I can understand the cash flow. Privately, I think people could spend their time and money better, but that is a taste thing. I spend money and make people rich in ways that other people would not understand or approve of. Both Dan and Judy produce something that others consume and they get paid market rate.

I have not the foggiest idea of what it is that upper level executives in big corporations do to earn $57 million dollars a year. I realize that it is market rate in that lots of big corporations pay people amazing sums to work in an office, but I don’t know what it is that they produce.

I realize that corporations need management, just like they need engineering, but what kind of management costs $57 million a year? How many people do they manage? What intricate secret of management do they know that they can get more out of people than the manager at the local FedEx Kinko store doesn’t have?

Do they constantly meet with people and micro manage them. Do they have to think out work strategies for thousands of people and tell them what to do every day? That would be worth 57 million dollars because of sheer volume but I doubt any human can do that. What is it exactly that a highly paid “big” executive in a big company does?

It can’t be anything spectacular because organizations are pretty much inefficient and unresponsive and most companies with such enormous executive pay don’t really make any advance I would consider meaningful or provide any amazing service.

People who provide meaningful service to us on a day-to-day basis, like Doctors, Police, Fire, shopkeepers, teachers, professors all kind of have compensation within a order of magnitude. Everyone makes somewhere between $40000 and $250000 a year in general. Doctors go beyond that upper range (I know a doctor who gets paid $400000 or so in salary) and I kind of understand that, but again not really.

Personally, I would pay teachers, doctors, fire and police about the same. Those are very, every important things for me – and I think I would be happy if they earned about $150000 a year (using the Boston area in 2014 as a reference). I think that’s what they are worth. Teachers get paid far less and Doctors far more and I think this is strange.

In the end the ‘market’ decides the pay. I don’t think the ranking and disparity is ‘fair’ but that’s only a personal opinion and people vote with their feet to decide how much they will pay for the different services. I think, in the end, we kind of end up with a pay scale that, within an order of magnitude, makes sense given the services and products these professions generate.

What I can just not understand, is what is it that an executive physically does do take home $57 million a year? What is the product? What is the service? What do they produce each hour that some one eventually buys, that, when you add it all up, comes to $57 million in one year?

My conclusion is that it is basically hush money paid for inside deals done within the executive’s network.

What executives do in these positions is bring a ‘network’ of other people they can
a) Ask about important decisions in other companies or the government
b) Use to influence important decisions in such other organizations.

This kind of inside information allows the parent company to get ahead of the competition not by making a superior product but by rigging the customer’s decision process. The enormous compensation packages are paid not because they make something better. They get it because they are saboteurs destroying the ideal of the free market, where the consumer gets to see the wares and gets to decide what is better.

I am, at the core, an engineer type. I understand when some one builds something, repairs something or teaches something. I can even understand when someone manages a project. I understand this in the form of understanding how one guides a vessel. When it’s a small boat you can row and steer and decide where to go. When the boat gets bigger, you need an oarsman, a steersman and a lookout. They need to work together, so you need a captain. The best captain is one who has been, in turn, an oarsman, a steersman and a lookout. See, I’m no commie: I get management.

But I still don’t get $57 million dollar executives. I think I finally understand why they get paid $57 million dollars – it’s the same reason Dick Cheney is on the board of an oil company. It’s not that Dick knows a lot about geology and the use of machine learning to analyze oil field surveys. He knows something better than that: Dick knows people in the government who can effectively rig the price of oil. And that’s why, like all the other people in high places, he gets to be on boards and gets executive pay.

I don’t mean to pick on Dick in particular, but while I get executive pay, I don’t understand it and I don’t like it: it represents a grave inefficiency in our technologically driven free-market world.

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4 thoughts on “I’m puzzled by executive compensation

  1. Kelly says:

    One of the factors is the level of education required to hold the position. Doctors are paid more because they, on average, incur $250,000 of debt in their graduate studies alone. If they could not make enough to pay off that debt, we would all be in for a real problem. The more education a profession requires, the more money it tends to make. This is a gross generalization, but it is a starting point.

    The other factor I’ve come to notice is the risk. If you are an executive and something major goes wrong in the company, it’s you who is hung out to take all responsibility. If it means the error is so bad that you lose your job, and at this point no one is going to hire you for some time, you need to have enough to live off of until memories become hazy and you are able to be hired again. Why some of these people get bonuses nearly equal to their pay at this moment still eludes me. If I’m fired, no one gives me a bonus. Maybe they let me take a mug, but that’s not a bonus.

    I won’t even touch the teacher issue. Their under payment infuriates me to a level I prefer not to post online.

  2. KG says:

    Hi Kelly,

    Thanks for commenting! The cost/time of education is a factor, but I suspect it does not really reflect how much it costs to educate but rather what people will pay to be educated in that field (because they expect to be remunerated in kind).

    I partly agree with the risk angle. The people I personally admire (and think deserve large returns) are people who start companies with their life savings. These are people with real skin in the game. They have a strong incentive to perform well and bring some advance to the table.

    On the other hand, It’s not common for executives to be penalized for poor company performance or to be held accountable for illegal/immoral decisions (for example some one totally not involved is taking the heat for the GM switch debacle – I don’t see any of the executives who actually made these immoral decisions taking any loses or seeing any jail time. They are quietly enjoying payouts – hush/blood money) so I don’t see executive pay as any kind of compensation for risk.

    Best

  3. I had the same feeling as you about executive payouts. And this is what I realized.

    I agree on your point of network/insider dealing (especially in a country like India), but this may not apply to all cases. There are indeed some market-driven ones.

    Say I am a big food company. I need to add a new product – either chocolates or chips. If the decision is successful, it can get me 200 million, otherwise it may give me a loss of 100 million. But some one has to make that decision – so who do I pick to make that decision? Some I believe will make the correct decision (based on track record, connections…whatever). I really don’t mind giving 10% of potential profit, as long as he makes the right decision- because I get to keep the other 90%. Ultimately the final decision may have been a grossly uninformed decision or even the result of coin toss. The whole thing may require little or no skill. But their decisions have HUGE effects. That is what pays those guys so much money. Decision to make a 4.5 inch screen or 5 inch screen may make or break a billion dollar market.

    Its like a betting game with extremely high stakes. There is a need for someone to take a stand and make BIG decision – and the price for success or failure is bound very high.

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