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New theory on fairness in economics targets CEO pay
Date:11/3/2009

WEST LAFAYETTE, Ind. - Chief executives in 35 of the top Fortune 500 companies were overpaid by about 129 times their "ideal salaries" in 2008, according to a new type of theoretical analysis proposed by a Purdue University researcher to determine fair CEO compensation.

"One of the most pressing economic and corporate governance issues of the day is how to determine fair pay packages for CEOs," said Venkat Venkatasubramanian, a professor of chemical engineering. "The proposed theory allows us to compute what the fair pay is for a CEO, including bonuses and stock options, under ideal conditions."

The ratio of CEO pay to the lowest employee salary has gone up from about 40-to-1 in the 1970s to as high as 344-to-1 in recent years in the United States. However, the ratio has remained around 20-to-1 in Europe and 11-to-1 in Japan, according to available data, he said.

Using the new analysis method, Venkatasubramanian estimated that the 2008 salaries of the top 35 CEOs in the United States were about 129 times their ideal fair salaries. CEOs in the Standard & Poor's 500 averaged about 50 times their fair pay, raising questions about the efficiency of the free market to properly determine fair CEO pay, he said.

"You might ask why a chemical engineer is concerned with economics and CEO salaries," Venkatasubramanian said. "Well, it turns out that the same concepts and mathematics used to solve problems in statistical thermodynamics and information theory also can be applied to economic issues, such as the determination of fair CEO salaries."

Findings appeared Tuesday (Nov. 3) in the online open-access journal Entropy. The paper, "What is Fair Pay for Executives? An Information Theoretic Analysis of Wage Distributions," is available for free downloads from the Entropy site at http://www.mdpi.com/1099-4300/11/4/766

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Contact: Emil Venere
venere@purdue.edu
765-494-4709
Purdue University
Source:Eurekalert  

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