[PEN-L:11238] More On CEO & Administrative Pay

[Wojtek Sokolowski <sokol@xxxxxxxxxxxxxxxxxx>]

First, I would like to thank anyone who replied to my question of "executive
rent."  That discussion was indeed very informative and leads me to
conclude, on the pain of oversimplification that, assuming the exec's
rationality and decision making power -- all his salary is economic rent
(since under "ideal conditions" he is in the position to delegate all work
and repsonsibilities to others  for as much little pay as possible, while
paying himself as much as possible for doing nothing)  -- unless external
circumstances (such as pressures form lending institutions, government, or
stiockholders) force him to assume some of the responsibilities he would
otherwise delegate to others.  If that interpretation is correct, the
proportion of rent in executive salery would be inversely proportional to
the effectiveness of the outside oversight and regulations (which, BTW can
explain the difference between executive pay in the Us and that in Japan or
Germany, if we focus on the entire managerial class that includes middle
management as well).

As far as marginal productivity is concerned, I am somehow skeptical that it
can be zero or even negative, as some argued.  While form a Marxist point of
view that can be said of the owners, the same cannot be said of the
management because the management produces and maintains technology
(organization) that, at least in theory, increases the productivity of
labour.  While individual managers may be quite inept producers of such
technology, this cannot be said of the entire managerial class.  Of course
there is the issue of the stock option that turns managers into "partial
owners" but that, IMHO, diminishes exec's marginal productivity.  This is
so, because the more stock in the hands of the CEO, the greater his
capability to withstand the external pressure for other stockholders, and
thus the fewer the constratints to prevent him from commanding pure rent for
his "non-contributions" to the marginal product.

Approaching the issue form the transaction cost economics  or TCE (cf.
Oliver Williamson, _Markets and Hierarchies_) -- the marginal productivity
of administrative hierarchy can be conceptualised as net savings in
transaction costs resulting from implementing the hierarchy over its
alternative, independent agents in competitive markets.  Please note that
this explanation does not address the issue of marginal productivity of
individual CEOs, but of the entire managerial hierarchy.  From that
standpoint, it matters little whether the CEO rakes in a lot and pays his
henchmen who do the wage-slave driving for him next to nothing, or whether
the pay is distributed more evenly across different echelons of the
managerial hierarchy.  If we take that into account, the cross-national
differences in remuneration  of the managerial class as the whole (rather
than just the top layer of it) may not be as large as they seem to appear.

Another point is that, from the TCE perspective, the marginal productivity
of managerial hierarchy depends, for the most part, not on the individual
skills of the members of that class, but on the transaction cost of the
"next available alternative" -- individual agents in competitive markets.
That is, the lesser the transaction cost of doing business via purely
competitive markets (due to the bonds of trust, strength of informal social
networks, or government oversight), the fewer the savings resulting from
insituting the adminsitrative hierarchy, thus lower the marginal
productivity of the managerial class, and hence lower the managerial salary.

This is another possible explanation of the differences in managerial pay in
the US and in Germany and Japan.  The latter are characterised by a
relatively great deal of social cohesion which brings down the transaction
cost of doing buisness via competitive markets, while in the US, where
thanks to the suburbs and the automobile, social cohesion is low, the cost
of market market transactions is high, and so are the savings resulting from
implementing administrative hierarchies.

To summarise, the TCE approach to managerial salary as a class can offer a
plausible explanation by referring to the interaction between society and
economic instituions rather than evoking individual excesses, such as those
of the Chief Mickey Mouse Eisner  who rakes in $750 thousand salary, $7.3
million bonus and $2.3 million in stock awards (I got that info from the
proxy statement available at http://www.sec.gov/edaux/formlynx.htm).  From
that standpoint, execs make a lot of dough not beacuse they are greedy,
power-hungry pigs (although some of them undoubtedly are), but because the
forces of capitalism destroy the fabric of the society which, in turn,
increases the reliance on administrative hierarchies in carrying out
economic transactions. I find that more in line with the Marxist approach
than "voluntaristic" approaches relying on the "moral character" of
individual execs.

Any comments?

PS. I presented some of the arguments posted on that issue to my colleague.
He conceded that some of the exec salaries might be economic rent.  However,
he disagreed with the proposition that the same apply to the salaries of
university administrators.  He observed that the salaries of college
administrators are much lower than those of corporate execs, but I do not
think he is correct on that point, e.g. Bill Gates' salary is mere $340
thousand + $220 thousand bonus (based on Microsoft's proxy statement); that
is comparable to what Hopkins president got when he quit last year, a
quarter-million-dollar  bonus from a not-for-profit instituion!  My
colleague argued, however, that university presidents are more important
than their corporate counterparts beacuse, unlike corporate execs, they
raise funds for for their organizations.  Any comments?

regards,
wojtek sokolowski
institute for policy studies
johns hopkins university
baltimore, md 21218
sokol@xxxxxxxxxxxxxxxxxx
voice: (410) 516-4056
fax:   (410) 516-8233