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

ies that received the most federal bailout money, slashing the base salaries of those top executives and setting top pay at $200,000 for AIG executives in the financial products division.

Until now, however, there has been no scientific way of determining executive pay.

"We now have a rational quantitative basis for setting the fair base pay scales for the top management, and any added incentive pay package might then be linked to measureable and meaningful performance metrics that promote long-term survival and growth for the organization," Venkatasubramanian said.

Fair pay for an average S&P 500 CEO should ideally be in the range of 8 to 16 times the lowest employee salary, Venkatasubramanian said.

"It's interesting to note that Warren Buffett, CEO of Berkshire Hathaway and an outspoken critic of executive pay excesses, drew an annual salary of $200,000 in 2008," Venkatasubramanian said. "This makes his pay ratio 8-to-1, assuming a minimum employee salary of $25,000 per year, which fits the ideal benchmark estimate for fair CEO pay almost exactly. Mr. Buffett's instincts about fairness seem to be amazingly accurate. The top pay set by Mr. Feinberg for the AIG executives is almost exactly the amount recommended by the new theory."

As a contrast to the United States, average CEO pay ratios were about 11-to-1 in Japan, 15-to-1 in France, 20-to-1 in Canada, and 22-to-1 in Britain in 2006.

"These ratios are not that far off, when compared to U.S. ratios, from the ideal benchmark estimates from my theory," Venkatasubramanian said. "Even in the United States, the CEO pay ratios in the 1960s and 1970s were much more reasonable and in general agreement with the ideal values. So the executive pay excesses appear to be a recent phenomenon. This appears to be another valuation bubble - the CEO valuation bubble - much like the ones we have witnessed in stocks, real estate, commodities, etc."

William A. Masters, pro
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Contact: Emil Venere
venere@purdue.edu
765-494-4709
Purdue University
Source:Eurekalert  

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