The Chief Executive Compensation Premium

The NYT reports that the rewards of scaling the very top of the corporate ladder have grown significantly in the last few decades. A study put out by Carola Frydman of MIT and Raven E. Saks of the Federal Reserve found that chief executives today earn 260% more than their third ranked executives. Compared with the 1960s and 1970s, this represents a massive increase from the previous 80% premium.

The NYT is perhaps more interested in the implications of this shift in terms of basic fairness and economic equality, but their single-minded approach to the issue ultimately misses the point. The economic ladder of the 1960s and 1970s was indisputably flatter than the one today, but it didn't reach nearly as high. Obviously, the economic relationship between top-tier compensation and economic well-being does not automatically follow in the same way that straightening a ladder inevitably makes it taller. But the basic fact that most journalists overlook is that the changes in terms of executive compensation have come about as a result of a fundamental shift in the way society seeks to compensate its highest performers.

Stock options were almost unheard of in the 1960s and 1970s, but today most of the highest paid executives receive the great majority of their pay in the form of stock options. This dramatically increases the chances that the CEO is going to get a massive payout on retirement, but it also more closely aligns the financial interests of the CEO with the shareholders of the company.

Stock options lead to wildly inflated pay packages that "fairness" types are going to criticize as being basically unfair to Joe Six-Pack. Yet Joe Six-Pack actually does better if the CEO is working non-stop to get that titanic payout than if the CEO spends the day at the golf course - which is precisely where the old fixed compensation scheme left the incentives for the CEO to go.

Society in general has become a much better place to be if you're the CEO. But if the CEO is watching out for everyone's interests in order to advance his or her own, everyone ends up better off.