Why Do Executives Earn So Much?
Executive compensation at financial firms continues to make the news. Executives of financial firms make incredible amounts of money. People wonder what for.
People wonder "what for" mostly because of the recent financial crisis and economic recession. Before that, very few people questioned why certain executives made millions - even tens of millions - in bonus money. When times are good, it's "let the good times roll." When things turn, everyone looks out for what or who to blame.
The latest flap over Goldman Sachs is only the tip of the iceberg. I think the charges against Goldman will lead to more investigations at Goldman and other firms. In fact, we're already seeing that. As people learn about some of the practices these firms engaged in, they will be amazed at how much money these practices earned for the executives responsible.
Not that this pot hasn't been stirred already. It has. Lots of people are already worked up about executive bonuses at financial firms. This will just add fuel to the fire.
But there's more to this executive comp story. Hardly anyone talks about the real issue. The real issue is since when do executives - in general - make all this money? And I'm not just talking about executives of financial firms.
For example, in the 1950's and 1960's, a CEO might make 40 times what the average worker in the company earned. Now, it's more like 400 times!
In the past, the big money-makers weren't executives. They were typically business owners. And, of course, many business owners still do quite well. (Most don't. Most small business owners simply work very hard and, if they're lucky, earn a decent living, maybe even a good living.)
In fact, if you look at history, who were the big earners in the past? Names like Rockefeller, Carnegie, Vanderbilt - these were all business owners. Sure, there were always bankers like JP Morgan and his partners. But bankers, while they were rich, didn't make the sort of money that the big name business owners did.
When you think about it, it makes sense. The businesses those folks owned produced things. Rockefeller produced oil, Carnegie produced steel, Vanderbilt built and ran railroads. Morgan and the bankers that financed these businesses earned fees and interest. Sure, they got rich. But not as rich as the guys who owned the companies.
Of course, these are BIG examples. But it was the same for smaller businesses too. For the most part, business owners made the big money. Executives might be paid well, if they were senior enough. But not like today.
Things started to change around 1980. At least that's what I see. In 1980, financial firms made up around 4% of the S&P. Now they make up around 17%. Not so long ago, they made up almost 30%. The percentage shrank when the financial crisis hit.
Even at 17%, that's a large part of the businesses in the U.S. To give you some perspective, the industrial sector and the health-care sector each make up 11%.
As the financial services sector grew, financial firms made more money, hired more people and the top executives got richer and richer. In addition, they created more and more ways for non-financial businesses to access more credit. With more credit, businesses could "leverage" their business - borrow money to make the business bigger, or increase their revenues - and with leverage, there was more money to pay out bigger salaries.
I know this is a rather broad statement, but I think it captures what's gone on since 1980.
In fact, if you look at the growth of credit in this country - both for individuals, businesses and (of course) government, you'll see that it really exploded starting around 1980. And as credit exploded, so did the financial services sector (starting with the banking industry).
So, while it might sound trivial, executives earn so much because there's been a lot more money to pay out. And, guess what, most of that money went to the top guys, not the average, ordinary worker.
What's really striking is the simple fact that executive pay hasn't really decreased much, if at all. This tells me that the credit bubble that built up since 1980 really hasn't deflated much, if at all, in spite of what you read. So we're probably still in some kind of credit bubble. Therefore we're probably going to see another blow-up before too much time passes.
As for the executives and their pay, they'll take what they can get while they can get it.
People wonder "what for" mostly because of the recent financial crisis and economic recession. Before that, very few people questioned why certain executives made millions - even tens of millions - in bonus money. When times are good, it's "let the good times roll." When things turn, everyone looks out for what or who to blame.
The latest flap over Goldman Sachs is only the tip of the iceberg. I think the charges against Goldman will lead to more investigations at Goldman and other firms. In fact, we're already seeing that. As people learn about some of the practices these firms engaged in, they will be amazed at how much money these practices earned for the executives responsible.
Not that this pot hasn't been stirred already. It has. Lots of people are already worked up about executive bonuses at financial firms. This will just add fuel to the fire.
But there's more to this executive comp story. Hardly anyone talks about the real issue. The real issue is since when do executives - in general - make all this money? And I'm not just talking about executives of financial firms.
For example, in the 1950's and 1960's, a CEO might make 40 times what the average worker in the company earned. Now, it's more like 400 times!
In the past, the big money-makers weren't executives. They were typically business owners. And, of course, many business owners still do quite well. (Most don't. Most small business owners simply work very hard and, if they're lucky, earn a decent living, maybe even a good living.)
In fact, if you look at history, who were the big earners in the past? Names like Rockefeller, Carnegie, Vanderbilt - these were all business owners. Sure, there were always bankers like JP Morgan and his partners. But bankers, while they were rich, didn't make the sort of money that the big name business owners did.
When you think about it, it makes sense. The businesses those folks owned produced things. Rockefeller produced oil, Carnegie produced steel, Vanderbilt built and ran railroads. Morgan and the bankers that financed these businesses earned fees and interest. Sure, they got rich. But not as rich as the guys who owned the companies.
Of course, these are BIG examples. But it was the same for smaller businesses too. For the most part, business owners made the big money. Executives might be paid well, if they were senior enough. But not like today.
Things started to change around 1980. At least that's what I see. In 1980, financial firms made up around 4% of the S&P. Now they make up around 17%. Not so long ago, they made up almost 30%. The percentage shrank when the financial crisis hit.
Even at 17%, that's a large part of the businesses in the U.S. To give you some perspective, the industrial sector and the health-care sector each make up 11%.
As the financial services sector grew, financial firms made more money, hired more people and the top executives got richer and richer. In addition, they created more and more ways for non-financial businesses to access more credit. With more credit, businesses could "leverage" their business - borrow money to make the business bigger, or increase their revenues - and with leverage, there was more money to pay out bigger salaries.
I know this is a rather broad statement, but I think it captures what's gone on since 1980.
In fact, if you look at the growth of credit in this country - both for individuals, businesses and (of course) government, you'll see that it really exploded starting around 1980. And as credit exploded, so did the financial services sector (starting with the banking industry).
So, while it might sound trivial, executives earn so much because there's been a lot more money to pay out. And, guess what, most of that money went to the top guys, not the average, ordinary worker.
What's really striking is the simple fact that executive pay hasn't really decreased much, if at all. This tells me that the credit bubble that built up since 1980 really hasn't deflated much, if at all, in spite of what you read. So we're probably still in some kind of credit bubble. Therefore we're probably going to see another blow-up before too much time passes.
As for the executives and their pay, they'll take what they can get while they can get it.
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