Supply and demand at work, or just good bargaining? The reality behind CEO pay

A report published by Deloitte a couple of weeks ago will have enhanced the feeling of holiday wellbeing for many people. The median annual pay for bosses of FTSE 100 companies fell in 2018 to £3.4m, compared to £4m in 2017. This is the lowest level since 2014, when the UK brought in rules which require firms to report a single figure for chief executive pay. Criticism of the remuneration of top corporate executives has been growing strongly for some time. In June, for example, the shareholders of Netflix voted down – albeit by a very narrow margin – the firm’s executive officer compensation plan. Netflix grew from nothing in 1997 to a current value of around $150bn, and over the last four years its share price has almost trebled. But shareholders still did not like the chief executive’s proposed package. Top executives may feel rather aggrieved at this mounting unease over their “emoluments” – a much more suitable word for these grandiose packages. After all, does not basic economics provide a sound justification for their pay? In the textbooks, prices are set by the interaction of supply and demand. If something is in short supply, such as the skills of executives, the price will be bid up. Remarkably, a more sophisticated version of this argument is advanced by some leading members of the economics profession. Greg Mankiw, a top Harvard economist, is one of the biggest cheerleaders. Technological change, he argues, usually increases the demand for skilled labour. As such, unless society is able to educate and train people so that the supply of skilled labour increases at least as much as the demand, the earnings of skilled workers will rise relative to the rest of the labour force.   Technology is further invoked by some to justify the pay of those at the top. Because of a truly dramatic increase in the level of connectivity in society, highly talented individuals have been able to leverage their talents across global markets and capture rewards that would have been unimaginable in earlier times. This is certainly the case with stars of popular culture and sport. A hundred years ago, for example, the only people who could have any direct experience of Manchester United playing football live were those present in the stadium during the game. Now, the team can be watched by literally billions around the world, using a variety of delivery channels, and the players reap huge amounts as a result.  However, it is not at all apparent that the same argument applies to corporate executives. The huge growth in business schools in recent decades, for example, has presumably led to a substantial increase in the supply of people capable of filling top executive roles. The fact is that, in many situations, there is an inherent indeterminacy around a price – or a pay package – when it is being set. The Oxford economist Francis Edgeworth argued over a century ago that “in pure economics there is only one theorem, but that it is a very difficult one: the theory of bargain”. Corporate executives have certainly exhibited great bargaining skills in recent decades. But it seems that, at last, their bluff is being called.
Paul Ormerod
As published in City AM Wednesday 28th August 2019
Image: Handshake via pxhere licensed under CC0 1.0

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ELLIE EVANS

Partner

e: eevans@volterra.co.uk
t: +44 020 8878 6333

Ellie is a partner at Volterra, specialising in the economic impact of developments and proposals, and manages many of the company’s projects on economic impact, regeneration, transport and development.

With thirteen years experience at Volterra delivering high quality projects to clients across the public and private sector, Ellie has expertise in developing methods of estimating economic impact where complex issues exist with regards to deadweight, displacement and additionality.

Ellie has significant experience in estimating the economic impact across all types of property development including residential, leisure, office and mixed use schemes.

Project management of recent high profile schemes include the luxury hotel London Peninsula, Battersea Power Station and the Nova scheme at London Victoria. Ellie has also led studies across the country estimating the economic and regeneration impact of proposed transport investments, including studies on HS2 and Crossrail.

Ellie holds a degree in Mathematics and Economics from the University of Cambridge.