When and Why CEOs Are “Accidentally Overpaid” Bloomberg View

[Kelly] Shue found that having the right friends matters a lot for executive pay. She looked at MBA graduates of Harvard Business School who were randomly assigned to different class sections. The class section assignments naturally created human networks — people know the people they went to school with. She then looked at HBS graduates who became executives later on, and found something startling. The difference in pay between different sections was larger than the difference within different sections. 

Remember that these sections were randomly created. So Shue’s finding means that human networks were a very important determinant of pay levels. She also found that when one executive’s industry experienced a boom, the compensation of that executive’s former HBS section-mates in totally unrelated industries would go up as well. 

In other words, Shue found that when it comes to executive pay, it’s often who you know, rather than what you do, that determines how much you earn. Somehow, these human networks seem to persist from business school all the way to the boardroom. The fact that the pay boost holds across unrelated industries means that some of it is almost certainly not based on the real productive power of business networks, but on humans’ natural tendency to pay their friends more. 

Now, Shue has another paper that reveals a second sobering fact about executive pay. Along with co-author Richard Townsend of Dartmouth, Shue looked at the stock options granted to CEOs and found that there are quite a lot of years in which the number of options granted doesn’t change at all….That means that, in a whole lot of years, companies simply grant their CEOs the same number of new stock options that they gave them last year. 

That will tend to make CEO pay grow over time. If we keep giving CEOs the same number of new stock options every year, then what happens is that a run of good recent performance increases the amount that CEOs get paid for good future performance. That means some CEOs are getting paid too much for performance. And if the stock market goes up — as it usually does, and has in recent decades — that excess compensation will be larger. As Shue and Townsend also show, salaries aren’t being adjusted to offset this. 

via When CEOs Are Accidentally Overpaid – Bloomberg View.

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