Why are U.S. Executive Salaries So High?

At the moment, one of the few indicators in which the U.S. economy still leads is the amount its top executives earn. To Shivaram Rajgopal, a professor of accounting at Emory University’s Goizueta Business School who studies executive pay, this suggests that something is wrong with the compensation-setting system. In particular, he sees two problems: Wall Street’s preference for short-term profit over long-term investment, and cozy corporate boards.

In an interview with Knowledge@Emory, Rajgopal details his research and the problems inherent in America’s executive compensation policy.

The following is an excerpt from the Q&A. Click here for the complete article on the Knowledge@Emory site.

Knowledge@Emory: Are U.S. executive salaries really excessive?

Rajgopal: As a scientist, I have to say it’s very difficult to show that CEOs are systematically overpaid. Having said that, as a citizen, I don’t believe that the executive labor market is efficient because I’ve seen enough cases where there is abuse. Look at Larry Ellison [CEO of Oracle]. He earns so much money, does he need another billion-dollar option grant to keep him motivated? I find it hard to believe.

Knowledge@Emory: What’s created this dynamic?

Rajgopal: If you’re worried, as many CFOs and CEOs are, of being kicked out, you’ll ask for more money upfront. In Japan or Korea, the implicit understanding is, look, even if you screw up for awhile, it’s okay, because products take a long time to materialize, and maybe the long-lead projects are the ones where we will make more money in the future.

Knowledge@Emory: Does the insecurity of some corporate executives matter?

Rajgopal: It does seem to lead to riskier behavior. Most executives expect their time with firms to be much shorter than the life of the contracts they signed. If things go bad, it’s somebody else’s problem.

Knowledge@Emory: Does this kind of short-term thinking have other consequences?

Rajgopal: You can frame the whole financial crisis in terms of corporate short-termism, from top to bottom. CEOs typically have tenures of four or five years. If you ask them how long they expect to stay, they would likely say less than six years. I saw a CFO.com survey which showed that a CFO’s expected tenure is four and a half years, which boggles my mind. How can you do anything in four years? And if you look at their compensation contracts, many of their options vest in four years, and they have a big severance package if things go badly, so whatever happens, they are fine.

EDITOR’S NOTE: This post originally appeared here, on the Knowledge@Emory site in a best of 2010 release. The next edition of K@E is scheduled for release in mid-March. Click here to subscribe.

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