May 27, 2018
Roger Lowenstein had a column in the Washington Post criticizing Elon Musk for his new contract as Tesla’s CEO that could net him $50 billion. I see the story somewhat differently.
Lowenstein essentially is blaming Musk for being incredibly greedy and notes that most other trailblazing entrepreneurs of the past and present have not needed lavish paychecks to provide them with incentive. While I totally agree with this point, there is a deeper issue that I see here. How is Musk able to get a contract that pays him so much more than necessary to do the job? (Actually, I’m not sure Musk’s contract pays him so much, as I will get to later.)
The issue is that if CEOs are routinely paid more than necessary to get someone to the do the job they are doing, they are effectively taking money from shareholders. The question is then, why are shareholders allowing the CEOs to rip them off? Would they be okay if 1000 line workers pulled $10,000 a piece out of the cash register? If not, then they should not be looking the other way when a CEO gets $10 million more each year than is needed to get someone to do their job. (I’m defining “job” here narrowly as producing returns for shareholders.)
This isn’t an issue of having sympathy for shareholders. We all know that ownership of share is hugely skewed to the top 10 percent and especially top 1 percent, although tens of millions of middle-income people own stock through 401(k)s and pension plans also are large shareholders. But the more important point is that bloated CEO pay affects pay structures throughout the economy.
If the CEO is pocketing $20–$30 million a year, then the next in line folks are likely getting around $10 million and the third tier can easily be getting paid more than $1 million annually. This also leads to bloated pay at the top elsewhere. University presidents and heads of major charities (including those dedicated to combating inequality) routinely earn more than $1 million a year.
Contrast this with a scenario where CEOs were still making 20 to 30 times the pay of an ordinary worker, say $2–$3 million a year. In that world, the second tier is likely getting just over $1 million and third echelon executives are in the high hundreds of thousands, as are the top execs in the non-profit world. And, as economic theory teaches us, less money going to the top means more money for everyone else.
So for me, the big question is how are CEOs able to rip off shareholders by getting outlandish paychecks at their expense. I have argued that it is a problem of corporate governance where the directors who most immediately set CEO pay have more allegiance to the CEO than the shareholders who they ostensibly represent. Since incumbent directors are literally almost never defeated in re-election campaigns, they face little risk from not providing an adequate check on CEO pay. There is much research that supports this view, including a recent paper I did with Jessica Schieder of the Economic Policy Institute.
Getting back to Elon Musk’s contract, I was considerably less upset than Lowenstein. The main reason is a point that he brings up at the end of his piece, Musk only gets this money if the value of the company increases by more than a factor of ten. Since Tesla is known primarily for missing its production schedules and producing cars that don’t meet safety standards, it seems more likely that Mr. Musk will end up working for free.
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