The compensation of Chief Executive Officers of large American corporations is about 300 times more than that of the average employee. Such a big gap in pay is often criticized as immoral and is generally attributed to “greed” or to general unfairness of the “system.”
I argue that such large differences in compensation are moral (provided, of course, that a company’s financial performance has demonstrably improved while the CEO has been at the helm). Why? The CEO’s contribution to a company’s performance is much more significant than that of the average employee who works on some narrow aspect of operations, such assembling products or selling them to customers. While each employee’s contribution is important, it is the CEO who sets the direction and strategy for the company and builds the organization to carry them out. Without a CEO as their leader, the employees would not know which tasks to perform. It is the CEO who is responsible for the company’s performance and is accountable to its shareholders. These are big tasks, and if performed well, of great value to shareholders who gain a significant return on their investment in the company. Besides being just, it is in the shareholders’ self-interest to compensate their company’s well-performing CEO at the level that entices him to stay with the company and to continue creating value for its owners.
The market for CEOs of large corporations is small, and this explains why the CEO compensation is so high. (The pool of people who are capable and willing to take on the demands of the job of a CEO, particularly in today’s environment of ever-expanding government regulation of business, is limited.) If companies do not pay market salaries to their CEOs, they will lose them to competitors or to companies in other industries. This is a fact that compensation committees of boards of directors cannot ignore—if they want to attract and retain talented CEOs who keep creating value for shareholders.