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Exploding some myths about excessive corporate salaries

By John Legge - posted Tuesday, 10 December 2002

Recent revelations of corporate excess have encouraged the almost universal belief that top executives are paid too much. One argument for stratospheric salaries and golden handshakes has been that boards must pay to get talent: the forces of competition are at work.

Several writers have pointed out that competition has very little to do with the process of setting a CEO's salary, but that is not the whole story.

Recent studies, including one published in the Harvard Business Review, have shown that there is an inverse relationship between the pay of chief executives and their company's performance. Companies that recruit a "superstar" may enjoy a short-term boost to their share price, but over the medium term their performance suffers.


The high-profile outsider may feel obliged to make changes before finding out how the company worked before his descent upon it, and changes for change's sake generally make things worse.

Sunbeam Corporation - whose shares rocketed when Al "Chainsaw" Dunlap was appointed CEO but fell to zero three years later when extensive accounting frauds were exposed and the company was forced into bankruptcy administration - is not an aberration, but typical of the superstar phenomenon. The ABC's ratings rose after managing director Jonathon Shier departed and in the period when it didn't have a chief executive.

The idea that increased pay produces increased performance runs against a long record of research.

Frederick Herzberg showed in 1966 that "too little" pay causes resentment and poor performance, but once pay is "enough", further money has no measurable effect.

A look at the Australian Football League, with its salary cap and well-documented collective agreement with the players, illuminates this issue. (Like or loathe the game, nobody could reasonably suggest that AFL players could try any harder than they do, and when splitting hairs, it is often the younger and lowest-paid players who show the least regard for their own safety.) Every club must pay a minimum of $5.14 million to participate in a complete home-and-away season.

Playing in all 22 home-and-away games earns players a minimum of $78,800. This means a club could afford one superstar on a $3.4 million deal if every other player earned the minimum - an absolute maximum differential, top to bottom, of 43 times. No club actually pays this much. Most authenticated accounts suggest that the best paid player at most clubs earns about $600,000 - less than eight times the minimum.


Until corporate governance was changed to concentrate on "shareholder value", a salary of 10 times the minimum was generally considered adequate to get the best performance from a chief executive and company employees. Nobody has suggested that Commonwealth Bank CEO David Murray slacked off when he earned a mere $350,000 a decade ago, so paying him $7 million today must include a substantial amount of economic rent. The sight of other managers being paid twice Murray's salary just to go away and stop doing damage may make Murray's salary look reasonable, but only in comparison with such rogues and incompetents. As the AFL's experience suggests, a 10- fold top-to-bottom differential is enough to draw peak performance from rookies and stars.

The whole concept of shareholder value is coming under increasing challenge: how can people who buy shares in a company, with no responsibility for its direction or its debts, be called owners? One of the world's most influential management thinkers, Professor Charles Handy, argues that shareholders are betting on a company - they are not its owners. A trainer who put the interests of the punters ahead of those of the horse would wind up disappointing the punters and killing the horse. CEOs who focus on the share price neglect their duty to the company, and it shows.

As too many examples have revealed, "shareholder value" proved no more than a convenient disguise for corporate plunderers who promoted no interests but their own.

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A longer version of this article is in the Summer 2002 edition of Dissent Magazine. This version was first published in The Age on 25 October 2002.

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About the Author

John Legge associate professor (adjunct) at La Trobe University's Graduate School of Management.

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