Monday, January 30, 2006

Edward Lazear is the new CEA head

Edward Lazear, an economist at Stanford University, will be the new head of President Bush's Council of Economic Advisors.

The part of Lazear's work that I am most familiar with is his research on labor markets. One of his particularly interesting insights is an explanation for why companies are willing to pay ridiculous salaries to their CEOs and pay a lot less (in relative terms) to other VPs and executives that are probably just as important to the company's success. Lazear argues that the million-dollar salaries are not based on the productivity of the CEO, but rather serve as an incentive for all of the executives below the CEO to work harder to try and become the CEO one day. As Lazear himself explains: "The CEO gets to enjoy the money, but it's making everybody else work harder."

This article gives a good summary of his argument about CEO salaries, and Tyler Cowen gives a great overview of Lazear's research with this Marginal Revolution post.

5 comments:

Anonymous said...

By Daniel

I find this theory very interesting. I did not question,as i am sure many people did not, the reasoning behind the huge CEO salary. I thought, 'he is at the top, so he should get the most money'. However, I found Lazear's point convincing. Knowing that people respond to incentives, a huge salary is a huge incentive to try to become CEO. This would make all of the workers right below the CEO work very hard to earn the prized position.
I also found Lazear's second point equally important. In many companies, it would not pay off to offer large salary increases for each ascending position. Most companies benefit from cooperation. Although competition usually helps production, it can cause problems if the employees resort to sabotage. While the large salary for the CEO may work, it probably would not prove effective for all positions in the company.

Carl Youngdale said...

I can see the reasoning behind the incentives explanation. By looking at America's major corporations, we know that CEOs are more of a figurehead than an actual cog in the gigantic gear system of the company. just like the Queen of England, she really doesn't do anything, Parliament does, but she is the richest woman in England. (Well, actually, J. K. Rowling is reported as being richer than the Queen, but you get my point). So, if I was next in line to Bill Gates himself, I would work extra hard so that maybe in the future, I could be worth 90 billion dollars.

Anonymous said...

I find Lazear's theory interesting as well. However, I think his theory applies mostly to public companies where the salaries are closely watched by board members and stockholders. Over the summer, I worked for a family-owned private company. I noticed that the salaries of the CEO and the President/Chairman were much higher than those of the General Manager or VP of Marketing. Having such a high salary does not encourage others to want to be the next CEO or President, because neither executive position will be available any time soon. The workers know that there is little chance to rise in the company, but the family balances this with added benefits. This company is an exception, but it just points out that Lazear's theory is not as simple as it seems.

-TOPHURKI (chris hellmann)

Elisabeth Bentley said...

I would have never thought to have evaluated such salaries, but it is a valid notion Lazear makes. I mean, thinking about CEO's, they mostly dress well, keep up the appearances, do a little business work, and soak up the cash. But when you think of it as an incentive, I'm in total agreement. By making the highest position appealing to all workers, it makes them strive for such a high (and for most an impossible) position.
Actually, it reminds me of how Walker gives seniors such privileges. Maybe, it's to make the younger grades desire such a year, thus deterring them from wanting to leave before their final year at walker... tricky murphy, tricky.
All in all, Lazear's proving to be pretty well qualified for the job.

Anonymous said...

A large salary for the CEO is a good incentive for those lower in the chain. I also think its about the image of the CEO. If he gets a large salary it shows strength in the company. Alot of times you hear about CEOs taking salary cuts when the company is starting to go under. The salary shows the stability and strength stockholders want to see.

-Foss