Research says: the companies that paid their CEOs the most saw their stocks do the best, and those that paid the least saw their stocks do the worst

Widespread Wealth Has Active Causes – Most Notably, Entrepreneurship by Don Boudreaux of Cafe Hayek.

"Here’s a letter to the Washington Post:

Robert Samuelson correctly notes that CEO pay over the past three decades has become tied more closely to the value of share prices and that CEO pay today is generally higher than it was thirty years ago (“The CEO backlash,” June 22).  But crediting only lower inflation and interest rates, Mr. Samuelson errs in asserting that “CEOs had nothing to do with this” rise in the overall real value of shares – and, hence, “nothing to do” with the increase in their pay.

While improved monetary and fiscal policies are unquestionably boons (to everyone, and not just to CEOs), companies never manage themselves.  Weak leadership, failures to anticipate changing consumer demands, imprudent decisions to expand, and hosts of other executive errors lower a company’s market value – and often hurl it into bankruptcy – even under ideal monetary and fiscal conditions.  Likewise, sound monetary and fiscal policies do not themselves spontaneously generate iPads, Amazon.com, Facebook, fracking, and the uncountable other goods and services that greatly improve our lives: these things – and the all-important means of making them widely available at affordable prices – require entrepreneurial vision, risk-taking, and hard work.  Entrepreneurship, successful management, and wealth creation are not bundles of manna that rain down upon a land if only it is blessed with prudent central bankers and parsimonious budget officials.

Evidence of the continuing importance of the scarce resource ‘executive talent’ is found in research done by Steven Kaplan and Joshua Rauh.  These economists find that (quoting Kaplan) “Analyzing some 1,700 firms, we found that compensation was highly related to performance: the companies that paid their CEOs the most saw their stocks do the best, and those that paid the least saw their stocks do the worst.”*  This conclusion makes sense to everyone who understands that there is nothing routine about starting and managing successful businesses, and that wealth requires for its creation active and on-going human imagination, enterprise, and effort.

Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

* Steven N. Kaplan, “The Real Story Behind Executive Pay,” Foreign Affairs, May/June 2013.

On the more general question of the role that CEO pay has (or has not) played in raising income inequality, see this Summer 2013 Journal of Economic Perspectives paper by Kaplan and Rauh."