If you're a baseball aficionado these days, you've heard of Barry Zito, the San Francisco Giants pitcher who, as a free agent in 2007, signed the (then) largest contract in history for a pitcher: $126 million over seven years.
After inking that contract, times have been rough for "Z," to say the least. After losing more games than he won in 2007 and going 0-8 to start the ‘08 season, Giants manager Bruce Bochy relegated the former ace to the bullpen. Poor Z's been vilified by the local media and lampooned by the national baseball press ever since.
Here's an example from a recent ESPN.com article*:
"We also asked high-ranking officials of two clubs what they would do if they had a big-buck disaster like Zito on their team. The first replied: ‘I'd cry.'"
"The second had a more innovative proposal. ‘Here's what (the Giants) should do...take the whole contract, defer it over 30 years with no interest and then…release (Zito), to let (him) start fresh somewhere else. You're better off paying him $3.7 million a year to not pitch than having him go out and do what he's doing.'"
So how did the Giants front office get in such a pickle? Simple. They needed to win more games for their fans. Management went out and found the best available free agent at the moment for a position they needed to fill and paid the market price.
Corporations select their senior executives almost identically. Instead of wins, corporate boards and shareholders want earnings. They hope to fill their roster with the highest-caliber performers to lead their organizations and drive their share prices up.
Today's publicly traded companies compete in a vastly different world than 50 years ago. Competition is global, business lines are international, information transfer is instant and financial markets are far more sophisticated. Over the last 20 years, the total market capitalization of the companies within the S&P 500 increased nearly eight times over from $1.8 trillion to $14 trillion.**
Viewed differently, today's large company CEOs directly impact a meaningful percentage of a larger, more global economy; whereas the median worker, while very intelligent and productive, impacts little past his or her small circle of influence. Compensation is adjusted accordingly.
Big business now competes for a limited supply of management talent capable of leading them to earnings success in this environment. CEOs are free agents in a market just like professional athletes.
Major League Baseball also operates in a vastly different—and more global—market today than 50 years ago. Today's big leaguers come from all corners of the globe—truly the best of the world's best. Pro leagues now have merchandise, television and other revenue streams internationally too, bringing in more money than ever before.
Should we then be so surprised to see C-level executives receive bloated compensation packages? Is our anger justifiable when we read of the fired CEO who walks away with a multimillion dollar severance package? Perhaps only as much as the frustration San Francisco fans feel about Barry Zito (and believe me, they are frustrated). Putting dollar envy aside, it shouldn't be just about the compensation, but rather the results—wins and losses, earnings and share price.
If your stock's CEO is winning, the pay is probably justified whatever the level. You should demand the board of your investment seek the best executives they can find and pay them whatever it takes to woo and keep them without mortgaging the company's future.
Just like baseball, not every signing works like you hope. Some CEOs are bums, cheaters, get fined and suspended, or even retire unexpectedly. Often CEOs foolishly extrapolate boom times too far into the future only to see things whipsaw in a down cycle. But for every deadbeat, a plethora of All-Stars is consistently winning and worth every penny.
As executive pay levels increase, so has public discontent. People fume after hearing what CEOs earn, especially after they're dismissed. But it would be very dangerous to enact legislation to stifle compensation—that would amount to a price ceiling causing market distortion and hampering economic growth. Such "salary caps" might even push the brightest business minds overseas.
Instead of wasting our days fretting over what CEOs make, let's accept they will probably continue to earn far more than the average Joe, just like professional athletes. They are a niche bunch. All we can expect is that our team signs more winners than losers. And for Pete's sake Barry Zito, strike some people out! (The local fans are all secretly rooting for you.)
* Source: http://sports.espn.go.com/mlb/columns/story?columnist=stark_jayson&page=rumblings/080501
** Note: salary and market cap data is not inflation adjusted