Blogs & Comment

Executives and their income

On the difference between pay, compensation, income—and justice.

(Photo: REB Images/Getty)

I’ve blogged a number of times about what is commonly and loosely called “executive compensation.” The term is woefully imprecise. In point of fact, most “compensation” is not, in fact, compensation. The carrot dangled in front of a horse is not compensation; it is motivation. Compensation is what you give someone after the fact as reward for a job well done, or at least for a job that met contractual requirements. If I hire the neighbour’s kid to mow the lawn, and he does so, then I should compensate him. Most of the money garnered by senior executives at publicly-traded companies these days is not, in fact compensation. It’s money they get from selling shares in the company, shares granted to them as part of an effort to align their interests with the interests of shareholders.

The looseness of use of that word in the realm of finance is not at all unique. Witness the “bonuses” paid to AIG employees two years ago, which were not in fact performance bonuses at all but rather retention payments designed to keep key employees on what seemed at the time to be a sinking ship.

See more recently this piece by Peter Whoriskey for the Washington Post: With executive pay, rich pull away from rest of America. Here’s just a taste:

The top 0.1 percent of earners make about $1.7 million or more, including capital gains. Of those, 41 percent were executives, managers and supervisors at non-financial companies, according to the analysis, with nearly half of them deriving most of their income from their ownership in privately-held firms….

Notice that (contrary to the article’s title) the key factor in the growth of executive income here is not in fact “pay.” The key factor is investment income. And it’s not even “pay” in the loose sense of ‘money given by an employer,’ since there’s no indication here what portion of that investment income comes from shares in a CEO’s own company, say, versus a diversified portfolio. But it’s hard to hold Whoriskey to blame for the linguistic imprecision here; confusing pay and compensation and income is altogether standard.

The other point to be made here is about justice. According to Whoriskey, “…executive compensation at the nation’s largest firms has roughly quadrupled in real terms since the 1970s, even as pay for 90 percent of America has stalled…” Setting aside imprecision of language, that suggests a significant disparity — not disparity of outcomes (which are a given, here) but disparity of rate of improvement.

Now according to Leslie McCall, a sociologist quoted in Whoriskey’s story, people become concerned about such inequality “…when it seems that extreme incomes for some are restricting opportunities for everyone else.” And that may be true about people’s reactions. But of course, it’s very hard for people to tell when it is actually the case that extreme incomes for some are restricting opportunities for others. As economists often point out, income is not a fixed pile, waiting to be handed out. The way you distribute income actually changes the size of the ‘pie’ due to the way money incentivizes. Incentivizing executives with stock and stock options may on the whole be a failed experiment, but that doesn’t change the fact that it is impossible to know whether the average worker would be better or worse off had those incentives never been offered.