This reasoning applies even more so to leadership positions in large companies. Especially when considered in the aggregate, if "outrageous" compensation packages are forbidden, the quality of corporate leadership will suffer. These people aren't qualified for just CEO spots, and they're well aware of the social stigma against big business. If the compensation packages are as high as they are, it's because that's what firms need to offer to attract and retain these highly skilled individuals. Of course, this phenomenon isn't peculiar to corporate-leadership positions; if we declared tomorrow that brain surgeons could only make 50 percent of their current salaries, the frequency and quality of brain surgery would plummet.
Cost-Cutting Will Not Result in More Money for the Shareholder
Of course, any reader who has actually worked in (or owns stock in) a large corporation may reject the above description as naive. In the real world, such a reader might object, most shareholders in practice exercise no control over management. Suppose, for example, that 85 percent of the shareholders (consisting of thousands of people who each owned far less than 1 percent of the stock) thought the CEO made far too much money. Even so, would it really be worth it for them to organize and demand that the corporate board do something? After all, the increased dividends made possible by such cost-cutting wouldn't translate into very much per shareholder. In this environment, management becomes entrenched and a lavish corporate culture takes over, with kept board members approving the jet-setting lifestyle of the CEO and his cronies.
As some of the recent scandals suggest, there definitely seems to be at least a grain of truth in such claims. Yet it nonetheless remains a puzzle to the free-market economist. For even if individual shareholders wouldn't find it worthwhile to organize and put an end to profligate abuses by management, such waste would nonetheless show up in the stock price of the firm. If, for example, management collectively frittered away $10 million per year in unjustifiable expenses, the total shares of the corporation would be valued around $200 million less than they otherwise would be, assuming an efficient stock market and an interest rate of 5 percent. (This is because $200 million is the present discounted value of a perpetual stream of $10 million annual dividends.) Such a corporation would then be a prime target for the much reviled corporate raider. The raider would institute a "hostile takeover," in which he bought up a controlling share in the corporation (by offering far more than the current price per share to the stockholders) and then used his power to fire or straighten out the inefficient managers. After cleaning house the corporation's dividends and/or stock price would rise accordingly, netting the raider a profit.
Thus we see that in the free market, even the realistic problems with "democratic" mechanisms can always be overcome in the final analysis by a "strongman," i.e. the corporate raider. (It should go without saying that these political metaphors are just that; in a free market all transactions are voluntary exchanges of property.) Consequently, if CEOs and other members of upper management make incredibly high earnings year after year, it must be that the shareholders find their services worth the expense. In some cases it may take the outside analyst some effort to discover how, but we shouldn't doubt that the shareholders are careful with their money.
Unfortunately, I cannot close the analysis on this optimistic note. For the above relies on the assumption of a free market in corporate takeovers, and that is decidedly lacking. In the present legal and cultural environment, so-called corporate raiders are even more despised than golden-parachuting CEOs. Regulations severely restrict so-called hostile takeovers, and hence hamper the ability of shareholders to restrain their managers. For example, the federal Williams Act (1968) compels a would-be raider to declare his intentions after acquiring 5 percent of a corporation's shares. Declaring one's intention to take over a company would likely push up the stock price, making the takeover plan unfeasible.
f CEOs and other members of upper management make incredibly high earnings year after year, it must be that the shareholders find their services worth the expense.
The market's other checks on inefficient management are stifled as well. After all, even before the financial innovations allowing the issue of "junk bonds" and hostile takeovers, there was always a sure-fire way to keep corporate officers in line: any firm that wasted too much money on fancy offices and executive perks would be vulnerable to its competitors. Again, this initially poses a puzzle for critics such as Crowley; if outrageous compensation for CEOs is so endemic in American corporate culture, why don't new firms enter these industries and drive the old ones out of business?
But as with hostile takeovers, so too with new entrants to industry: Government regulation muffles this threat and thus allows entrenched businesses a margin of profligacy that they otherwise would not enjoy. Many people (especially young students) new to the ideas of laissez faire believe that big business opposes government meddling, but this is naïve and contradicted by the history of actual legislation. Ironically, the profitability of big business can actually be enhanced when the government regulates an industry, because the big firms can more easily handle the fixed costs of filling out paperwork, providing a "safe" working environment, proving that they are making every effort to comply with affirmative action goals, and so on. In this environment, would-be competitors face additional hurdles if they want to challenge the large incumbents, and thus the latter may indeed get away with lavish expenditures that would be short-lived in a truly free market.
In the opinion of the demagogues inequality in what they call the "distribution" of wealth and incomes is in itself the worst of all evils. Justice would require an equal distribution. It is therefore both fair and expedient to confiscate the surplus of the rich or at least a considerable part of it and to give it to those who own less. This philosophy tacitly presupposes that such a policy will not impair the total quantity produced. But even if this were true, the amount added to the average man's buying power would be much smaller than extravagant popular illusions assume. In fact the luxury of the rich absorbs only a slight fraction of the nation's total consumption. The much greater part of the rich men's incomes is not spent for consumption, but saved and invested. It is precisely this that accounts for the accumulation of their 5 great fortunes. If the funds which the successful businessmen would have ploughed back into productive employments are used by the state for current expenditure or given to people who consume them, the further accumulation of capital is slowed down or entirely stopped. Then there is no longer any question of economic improvement, technological progress, and a trend toward higher average standards of living.
—Ludwig von Mises, "Inequality of Wealth and Incomes"
