How to Recognize Overcompensation in CEO Salaries

We’re going to do a little Q&A today. Some people asked questions on Facebook so I’m going to answer one of them for you.

Herbert from Facebook asked:

How do you recognize whether a CEO is being overcompensated or compensation is conflicting with shareholder interests?

How CEO Salaries Increased

Back in 1980 the average CEO salary was about 44 times the amount of money that their average employee was making. So, let's say that the average employee was making $50,000, that means the CEO was making about $2,000,000 a year.

That's a pretty big executive pay gap, but still, theoretically these guys are responsible for running the entire company and we think it’s really important that we have a great CEO. That’s why management is one of the 3Ms that we look at to determine if the company is wonderful.

But, something has happened in the last 30 years. The CEOs of public companies realized that they could have a consultant come and tell the company’s board of directors what the CEO pay should be. This consultant would go out and look at similar companies and would determine the CEOs pay.

You can image how this has worked out, right? You have a consultant who goes out and looks at all of the similar companies and comes back to the CEO and tells him,

“Well, the CEOs of similar companies are making $2,000,000, BUT your company is slightly larger, AND you're a better CEO, so you really should be paid $2.5 million dollars. It’s only a little step above, but you're worth it.”

The consultant gets a big pat on the shoulder and the board says, “Sure, $2.5 million, what’s the difference?” Now the CEOs pay is 2.5 million, but the employees are still making 50,000.

The next year, another company hires a consultant and they go through the same cycle!

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