It never fails. Certain people will come up with executives at various companies as a reason for worker pay not being as high as it is (look how much the CEO gets! Of course they can afford to give workers a raise) or prices or…well, whatever economic woes they’re talking about this week.
Apparently these executive compensation packages are the result of unbridled greed. How does that work exactly? Greed only speaks to, can only speak to, what someone wants to get. No amount of greed is going to get someone to offer more. What these people need to start asking is why those kind of salaries and other components of exectutive compensation are being offered. Why is the company willing to pay that much?
Of course, it’s economics so the answer is “supply and demand”. But that just restates the question: why is the demand so great as to support such a price?
Well, let’s look at an example. Walmart. Everyone loves to snipe at Walmart. In 2017 Walmart had a total revenue of just over $485 billion (yes, that’s a “b”) dollars. With a gross margin of 24.7% (I looked these numbers up) that gives us a total expenses of about $365 billion. Now, if the decisions made by an executive at Walmart affect either of those numbers by as little as 1%, that executive can save or cost the company more than 3 and a half billion dollars in a year. Walmart can pay $22.8 million (CEO compensation at Walmart for to get a CEO that will be on the “plus” side of that rather than the “minus” and end up making an extra 300 times as much (+1% vs -1%) than is being spent on the executive.
Someone who can add fractions of a percent to the efficiency of a company is worth billions to a company of Walmart’s size. Getting that someone for millions is an incredible bargain.
But what about cases where companies pay millions in severance packages to executives that are failing. What about those “golden parachutes?
Have you ever been in a relationship that went really sour? It started as looking like a good thing, maybe it was a good thing at the time, but things changed and it turned ugly. And instead of a clean break (maybe there are legal contracts involved. Maybe there are kids. Whatever.) you end up getting in argument after argument after argument? No? Well, not everyone has but I’ll bet you know someone who has. And in such a situation, wouldn’t it be great to just be able to pay the other party to. go. away?
Well, that’s what we have with these golden parachutes. Look back up and see how much going 1% the other way could be costing the company ten million dollars a day while still in place and making those decisions that aren’t even bad, just fractionally not as good as someone else could make. If the person fights being removed, that can cost even more. From an economic standpoint it could be simply cheaper to pay them that severance package to get them to leave now rather than after an extended fight during which the company bleeds money or more importantly the resources that money represents.
The case of Sewell Avery and Montgomery Ward is illustrative. At the beginning of the Great Depresssion J. P. Morgan hired Jewell to run the struggling Montgomery Ward and turn it around. He succeeded and ran it well for some years. Then, in the post war years the market changed with, among other things, an increasing demand for durable goods and Avery failed to adapt to the changing market. A power struggle continued for some time with Montgomery Ward sinking further and further behind rival Sears Roebuck and Co. When Avery finally resigned in 1954, Montgomery Ward stock rose dramatically, but the company was never again regained its former position. Had Montgomery Ward been able to get rid of Avery cleanly and, most importantly, quickly, when it became clear his position was harming the companies position, the company could well have earned millions, if not billions, that were forever lost to it.
The people making the decision have more information to decide how much they should offer an executive to work for them, how much to offer to make him go away. A failing executive is more willing to jump, after all, if he has a nice parachute.
People sitting on the outside, just do not have enough information to second-guess the people actually making the decision with both their own money and their own responsibility to the stockholders, at stake. But all too often people sitting on the outside, with no idea what’s involved or what’s at stake, think they’re qualified to tell those people what they should or should not do.
And we’re back to why economics is “the dismal science.”