Monthly Archives: September 2013

The Right and Recovery, from the AEI

The American Enterprise Institute hosts a blog called “AEI Ideas“.  Today, James Pethokoukis released a piece, “What the right keeps missing about the recovery“.  In it, he suggests that the economic performance of the US has not been as negative as conservatives and Republicans suggest in public debate.  He advises the center-right to avoid “too much negativity and pessimism” and eschew “easy answers” without sufficient justification.

A comment from the Editor has been posted in response.

Calculating “Appropriate” CEO Pay

CEO pay, and whether it is excessive, is a recurring motif in discussions of whether the economic lot of average people in the US is improving or not.  One’s beliefs on CEO pay usually relate to whether one believes income or wealth inequality is, in itself, a problem and whether one views manual labor as being intrinsically worth more or less than intellectual (managerial) labor.

The ice cream company Ben and Jerry’s was noted in the 1990s for having tried to tackle income inequality by limiting the CEO’s pay to a fixed multiple of the lowest-paid worker’s pay.  The ratio was initially 5:1 then became 7:1 and eventually 17:1, in order to attract and retain applicants for the top job.

The numbers seem somewhat arbitrary, though a rationale for these particular values may exist.  As an alternative way to think about the calculation, consider two key questions:

  • How much does a line worker’s mistake cost the company vs. a mistake by the CEO?
  • How much does a line worker’s good idea benefit the company vs. a good idea by the CEO?

In other words, if an assembly line worker accidentally shuts down a line, or damages a part, or even breaks a machine, the error may affect only his job (he gets fired) or a relatively limited number of produced units.  Only a really egregious error or malicious action — for example, poisoning a particular lot of a food — could actually destroy the entire company.  So, the price of a bad decision by a line worker is limited, mostly to his own job.

Consider the CEO, using the same criteria.  A bad investment or a series of strategic blunders could cost the company its existence, including the jobs of everyone there.  Moreover, the cost of firing the CEO is much more significant: big decisions must be placed on-hold, the board’s time will be consumed by the executive search, and the culture of the company could be radically changed by the successor, assuming the company survives.  In short, the downside risk of a CEO blunder is significantly larger than that of the line worker.

The same logic applies to upside risk – the line worker’s good idea will likely be fairly limited in effect, while the CEO’s good idea (or successful implementation of someone else’s good idea) could have unlimited upside.  This is one reason, as an aside, to implement paid suggestion boxes or other ways to compensate line workers for their good ideas, in order to increase the upside for good thinking and initiative.

Calculating the relative impacts is still somewhat difficult.  But a rough number could be found simply by the number of employees involved: according to 2012 data from web searches, Ben and Jerry’s Ice Cream employs 446 people.  If the CEO could end up destroying the company, but a line worker couldn’t, that makes the appropriate CEO pay for Ben and Jerry’s 446 times the line worker’s, which makes the “right” number (using 2000 pay numbers, at least) $13,244,416, plus 13 years of inflation, not including stock options and other benefits.

Enjoy the Chunky Monkey…