Professor Steven Kaplan Speaks Against Regulations for CEO Pay

Regulating CEO pay could bring about “negative unintended consequences,” said Steven Kaplan, Neubauer Family Professor of Entrepreneurship and Finance.

“Why are people talking about regulation? The typical CEO is not overpaid,” Kaplan said at the Myron Scholes Global Markets Forum on December 2 at Gleacher Center. The Initiative on Global Markets sponsored the forum.

The Obama administration and Congress have proposed new pay regulations in the form of mandatory “say-on-pay” votes for all companies. But, Kaplan said, shareholders already can challenge CEO pay they find objectionable. He compared company disclosure to the SEC with going through an airport X-ray machine. “Having a ‘say on pay’ on top of that is like getting a physical search even after you’ve gone through the X-ray machine and nothing has shown up.”

Kaplan said increased regulations could make it less attractive for top executives to run public companies and more attractive for them to leave, particularly for private equity funded companies when private equity inevitably rebounds. “The more you make it tougher to be a public company executive, the more you make it more attractive to go elsewhere,” he said.

Part of CEO pay comes from restricted stock and options, so expected pay may differ from realized pay. Average expected pay of S&P 500 CEOs has declined by nearly 40 percent from $16 million in 2000 to about $10 million in 2008, Kaplan said. Median pay, meanwhile, is “basically flat” at about $8 million a year. Average realized pay during the same period also was down by 30 to 35 percent, Kaplan said.

Kaplan also argued that CEOs are paid for performance. When Kaplan and Josh Rauh compared realized CEO pay and performance, they found “the highest-paid CEOs have the highest returns and the lowest paid CEOs have the lowest returns,” Kaplan said.

And realized pay varies with the stock market, he said. He pointed to a graph of CEO pay and the S&P 500 that showed the two lines were closely related. “Boards are doing their jobs,” Kaplan said. CEO pay hikes likely are driven by market scale, globalization, and technology, he said.

Income of the top 1 percent of all earners in the United States since the 1920s has curved down and curved back up to a high point in 2007, the last year such data were available, Kaplan said. “Income inequality has received a great deal of policy attention,” Kaplan said.

Compared to other top earners like athletes, entertainers, and lawyers, however, CEO pay has fallen short, he said. “This is very surprising,” he said, displaying a chart of expected CEO pay of the S&P 500 relative to the top 1 percent of taxpayers. The chart showed that in 2007, the CEO level is almost half of where it stood in 2000.

“The CEOs are about where they were in 1993 and 1994,” Kaplan said. “So boards have been cutting the CEOs back, relative to other highly paid groups.” A chart of realized pay shows “a little bit more stable” levels through 2007, he said, but no increase since 1997.

There also is “no evidence that pay practices played a significant role in the financial crisis, relative to other factors,” Kaplan said. Better ways to prevent such a crisis from happening again would make bank capital requirements stronger, encourage them to be pro-cyclical – building in booms to be ready for busts, and employ contingent or convertible long-term debt.

Greg Stolowitz, a second year student in the Full-Time MBA Program, said he still had “some personal questions” on whether CEOs are worth their pay, “but Professor Kaplan made it very clear that from an opportunity/cost standpoint, in a traditional Chicago fashion, they’re paid what the market pays.” Stolowitz said Kaplan made a “compelling argument” that CEO pay has gone down and is in line with other top wage earners.

Another second-year student, Jonathon Anderson, said Kaplan “did an effective job” in showing that CEO pay has declined relative to other top earners such as investors, athletes, and lawyers. “My reaction is that, for those individuals, pay is very tightly tied to performance; it’s very transparent.” For lawyers, pay is based on fees brought in, for athletes, it’s based on fan base, apparel sales and the like, Anderson said. The tightness of the connection between CEO pay and performance “is a little less transparent. I would like to see the stats on how much a CEO’s pay relative to the average employee has increased” and whether that’s a fair reflection of the CEO’s contribution to the company versus the contribution of the average employee.

Kaplan made the point that “there are pay-for-performance components for CEO pay,” said second-year student Amish Shah, “and that they have suffered in line with overall company performance. But we have to see, are the breakdowns of their compensation among salary, bonuses, stocks, and options appropriate?” Shah wondered if CEO pay is too heavily weighted on nonperformance components relative to pay-for-performance components.

                                                                                                                        — Mary Sue Penn