Uwe E. Reinhardt, of Princeton University, published a well-written article on executive pay in the New York Times. It demolishes the common rationalizations about high executive pay, with gusto.
Now, to apply this demand-supply framework to an understanding of executive compensation in the real world, economists go on to make two crucial assumptions.
First, they subscribe to the Lone Ranger theory of management that is so popular in an adulating financial press.
According to that theory, a firm’s chief executive is the main determinant of a firm’s market “capitalization.” The economist Mr. Frank, for example, illustrates the application of the theory when he writes that “Louis V. Gerstner Jr., having produced record earnings at RJR Nabisco, was hired by I.B.M., where he led the computer giant, then struggling, to a dramatic turnaround in the 1990s.” Evidently, in the mind of economists, Lone Ranger C.E.O.’s can make truly astronomical contributions to a firm’s market capitalization, ceteris paribus, which justifies high bid prices for them. Why Lone Ranger C.E.O.’s who have trashed their firm’s market capitalization should be sent off to pasture with hundred-million-dollar golden parachutes — which occurs with remarkable frequency — seems to be not much analyzed by economists. Perhaps other things did not remain equal.
The readers’ comments at the article’s end are also worth perusing.