At noon on midday of 6 January, while most of us were still recovering from New Year parties or seasonal bugs, the chief executives of FTSE 100 companies were quietly cheering the fact that they had already trousered more in a few grey days than the average worker in their firms will make all year, according to the High Pay Centre campaign group. The median pay for CEOs of firms in the blue-chip stock index is £4.22 million, 113 times higher than the median full-time worker’s pay of £37,430. Bosses hit this milestone marginally quicker this year than last, says Jasper Jolly in The Guardian.
Workers’ pay did improve somewhat faster over the year – CEO’s pay rose by 2.5% against 7% for workers – but bosses’ pay is at record levels. AstraZeneca’s Pascal Soriot is the best-paid FTSE 100 CEO, taking home £18.7 million in 2024, despite objections from shareholders. Erik Engstrom, head of data company Relx, and Tufan Erginbilgiç, head of Rolls-Royce, both got £13.6 million. Even those sums pale in comparison with what their US counterparts are getting. Sundar Pichai, CEO of Google’s parent company Alphabet, received $226 million (£177 million) in 2022. Most notoriously, Tesla’s chief Elon Musk has been fighting the courts to get his hands on a $56 billion (£47 billion) award approved by directors and shareholders last year.
Those numbers will seem extraordinarily high to ordinary mortals and the idea naturally arises that it must be the result of an abuse of some kind, or a failure of the market. Who could possibly be worth $56 billion, we sniff. How can such high CEO/worker pay ratios be justified? Aren’t we all rowing the boat? Dirk Jenter, a professor of finance at the London School of Economics, has a different take – one guaranteed to annoy just about everyone, as he laughingly admits on the All Else Equal podcast of October last year. His view? CEOs are actually grossly underpaid.
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A trifling share of value added
At least, they are according to one of two essential considerations. The first is that it seems fair that pay for individuals should be proportional in some way to the value they create in the work that they do. No one complains when sports or entertainment stars earn huge amounts. They clearly provide delight, inspiration and enjoyment that millions are willing to pay for, so why shouldn’t the fruits of their labour go into their own pockets? And if that argument is good enough for footballers, why not for chief executives?
Critics might argue that money managers only earn their huge sums because they are ideally placed to capture rents at the expense of their investors. Just as it’s natural to expect a pig farmer to go home with muck on his boots, so we might expect people who wallow every day in huge amounts of other people’s money to go home caked in the stuff. But actually it’s hard to make that argument for the bosses of corporations. Summarising his own research and his reading of the academic literature, Jenter, who has been studying CEOs’ pay and related issues for more than 20 years, finds no evidence that high CEO salaries are a result of malfeasance, nepotism, or bad corporate governance – those theories just don’t fit the data, he says.
CEOs’ pay really exploded over the past 40 years, a period in which corporate governance has generally markedly improved. Musk’s huge pay award at Tesla, for example, was conditional on leaping performance hurdles, all of which he sailed over. To get the full value of his package, Musk had to hit ambitious share-price targets and raise revenue and profits by many multiples. He did it. A court raised its eyebrows and blocked the payment, but when put to a shareholders’ vote, Musk’s pay package was approved. (The court was still not impressed and is insisting on its ruling.) This example applies more broadly – despite the odd revolt, shareholders generally tend to be on board with high remuneration for CEOs and are happy to pay it.
Why? Jenter has surveyed corporate boards in the UK to ask what they think would happen if CEOs’ pay was lowered. The answer? It would be bad for shareholder value. So it’s not that anyone is being coerced or tricked into paying bosses their millions. High pay is offered precisely because firms are trying to maximise value for shareholders and they think the bosses are worth it. This view finds support in the fact that, when star CEOs up sticks and move to other jobs, the move can send the stock of the spurned company down and those of their new fiefdom soaring, for example. And that is the measure of whether a CEO is doing their job and earning their money. CEOs’ pay, though lavish, does not even begin to capture the billions in extra market value created. It is, in fact, often a pretty tiny proportion of the value added. A CEO who raises the value of a $50 billion company by just 1% creates $500 million in value – a huge sum, but a fraction of the salaries CEOs typically pull in. Shareholders are happy to attribute that success largely to the CEO.
And it’s not as if anyone is claiming that CEOs have it easy. The CEO’s job is a weird and demanding one, says Jenter, quite distinct from any other. CEOs have to be a leader, with superlative people skills, inspiring the troops to work hard on the right things, dealing with reports, all the so-called “soft skills” of people management. But they also take on huge responsibilities, not least the duty to make the right call on big strategic decisions. They may only have to step up and make one or two of these in the terms that they serve, but get them wrong, and the company could be finished. Think of Nokia, once the market leader in mobile phones, that failed to adapt to a changing market and paid a heavy price; or the Intel CEO who passed on the opportunity to produce chips for the Apple iPhone as it wasn’t considered a big enough opportunity compared with that in PCs.
Add it all up, says Jenter, and it would seem there is “absolutely no evidence that CEOs are overpaid”, and rather good evidence that what they get is just compensation for a hugely difficult job with heavy responsibilities that is in actuality a very tiny proportion of the value they add.
How is a CEO’s pay determined?
But this is not the only consideration, as Jenter goes on to explain. Basic economics makes two points about the factors that determine CEOs’ pay. The first says that no CEO should be paid more than their expected contribution to a firm’s value. That, as discussed above, does not seem to be happening. The second is that you are not going to be able to attract and hire a good CEO if you’re offering less than they could get elsewhere. This argument is often raised in defence of bosses’ high pay – it has to be high, it is said, because if it wasn’t the CEO would take their services elsewhere. Is this true?
For most workers, including perhaps for the money managers mentioned above, this probably generally applies. But the knowledge and skills that CEOs acquire at one company may well not transfer all that well. Plucked from one firm, where they know the culture and the processes and have the connections and the knowledge and all they need to do the job well, and parachuted into another where they don’t have or know these things, the value they can be expected to add will probably be much lower. The surplus that a CEO can bring to one firm, say $1 billion in added market value, might be only £100 million at another, where his pay should be correspondingly less. So there might well be a big gap between the two factors deciding pay – how much value is expected to be added, and what the “outside offer” is.
That this is true can be seen in the fact that when CEOs quit or are fired, they don’t typically go elsewhere and earn the same sums, but sit at home and grieve, says Jenter, and wonder whether they’ll ever work again.
Their earnings certainly go down very significantly. It also explains why more than 80% of new CEO hires are company insiders. The exceptions, where CEOs are brought in from outside, are usually in crisis situations where things have gone very badly wrong and something radical has to be tried, and preferably not by anyone associated with the old, failed strategy. And as the theories outlined here would predict, when this happens firms tend to go for superstar CEOs who have managed such turnaround situations before.
So, in reality CEOs’ pay will be a result of a negotiation over how the potential surplus the CEO can bring to that firm is to be divided out between the CEO and shareholders, bearing in mind what that CEO could earn elsewhere.
Precisely how that negotiation plays out will be very different according to a myriad of intangible factors, such as the psychology of the board and CEO, notions of fairness, and social and cultural norms. How the surplus in fact gets divided is, says Jenter, very different in Japan, Sweden and the US, for example.
In short, CEOs typically get less than the value added, but quite a bit more than the outside offer. Just how much is a matter of negotiation. The fuss about CEOs’ pay is over a problem that doesn’t exist.
There might be a better way
There are, however, problems with this argument. One is that what makes perfect sense to economists often leaves ordinary mortals confused or disgusted, or both. That fact leads economists to wonder why everyone else is so irrational and come up with new theories to explain why that is. It leads the rest of us to wonder if there might not be something wrong with a field of study that finds easy justification for things that turn our stomachs – markets for human kidneys, for example; “surge pricing” for concert tickets as a replacement for the old-fashioned and presumably completely discredited wisdom of “first come, first served”; and multi-million-pound payouts for bosses while many others in their companies are struggling to make ends meet.
It also leaves out of account relations of power, as former High Pay Centre director Stefan Stern argued in The Guardian last year.
“Without an analysis of power, it is hard to understand inequality or much else in modern capitalism,” says Nobel laureate economist Angus Deaton. It ignores the evidence that high pay for CEOs demotivates employees and is bad for companies’ reputations. It also overlooks that it’s hard to see just what contribution the CEO is making, as Stern pointed out in the Financial Times more recently. Football fans can see very clearly how well their team is playing and who is making what contribution to success or failure, he says. With CEOs, it’s much less clear. “Of course leadership matters. But in a large, complex organisation, hundreds and even thousands of people make a crucial contribution. The disproportionately vast reward for one person at the top has more in common with the realm of fairy tales than hard-headed performance management. It also flies in the face of more than three decades of debate over corporate governance.”
There might be a simple solution. If a CEO earns millions and the stock of his company goes up by billions, then the story, as we’ve seen, is that the CEO created those billions and he’s well entitled to the fraction of them he earned, as Ludovic Phalippou, a professor of finance economics at Saïd Business School, pointed out on X. But if sales suddenly take a nosedive and the shares plummet and the CEO walks out, then what? Was he skilled or not; or just very lucky, with a bit of skill? And given the huge losses he’s presided over, doesn’t he owe the company money, now that less value has been created, or maybe even lost? If the CEO is that skilled and confident in his own abilities, then why not accept a more modest wage and buy call options at the market price with his own money? If he makes out like a bandit in that way, who then would complain?
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