I have suggested that one can think of firms as taking marketable inputs and producing non-marketable outputs. These non-marketable outputs ultimately contribute to marketable outputs. It is the non-marketable outputs that bind the firm together. If instead all outputs were marketable, then you could unbundle the firm and arrive at marketable output using market transactions among many firms.
I have also suggested that non-marketable outputs have an indeterminate value. This in turn makes the compensation paid to workers indeterminate.
Apply this to CEOs or other top executives. A CEO produces non-marketable output. The CEO’s “output” consists of key decisions with regard to strategy and personnel. It also includes intangible effects on employees, customers, and other firms.
Non-marketable output is, by definition, mostly valuable within the firm. The value of firm X’s CEO to firm X is likely to be quite a bit higher than the value of firm X’s CEO to firm Y. Thus, the CEO’s opportunity cost easily could be low relative to the value that the CEO provides. Whereas for low-level positions, it is plausible that competition serves to narrow the range of potential compensation, the same is not true at the level of CEO. It would seem that the range of indeterminacy in CEO pay ought to be especially high.
Observers on the left have argued that the rise in CEO pay in recent decades reflects changes in social norms rather than an increase in CEO productivity. Although there may be other explanations, I would think that the range of indeterminacy is sufficiently high that one should not dismiss the social-norms story out of hand.
There seems to be a missing step in your argument. As you wrote elsewhere, even when producing non-marketable output,
So, because there’s a deep market for accountants, there isn’t going to be much “wiggle room” regarding salary. So the question becomes – how deep is the market for CEOs?
Implicit in your argument seems to be some idea that top executives at firm X need deep and unique insight into that firm (hence why their value is so much higher than at firm Y). But it is equally plausible that being an executive is a generally transferable skill-set, rather like being an accountant. In fact, senior executives hop from company to company, often in only vaguely related fields. For instance, when Tesco wanted a new CEO, they poached a senior executive from Unilever. It’s really hard to argue that they chose Dave Lewis because of his deep knowledge of Tesco, or running a supermarket chain, or anything like that. Instead, they chose him because he was (perceived to have) demonstrated really good executive-y skills in his previous job, in terms of cutting costs and driving sales, and they thought these skills were generally applicable.
I think the real change is in this perception of the executive. It used to be the case that the senior executives of a company really did have deep knowledge of the company, having worked their way up the ranks. And this knowledge was perceived as necessary. Consequently, they had few outside options for this non-marketable output (because they couldn’t just jump to another firm), whereas the company had lots of middle-managers it could choose to promote, and so executive pay was at the bottom end of this “range of indeterminacy.” But nowadays being an executive is perceived to be a transferable skill, so the increased depth in the market has pushed pay upwards to a more determinate value.
This also explains why executive pay is lower in countries such as Japan, which still do expect executives to have worked their way up the ranks.
This sounds more plausible to me.
I just find it really hard to picture a typical penny-pinching board of directors dropping millions on a cEO not because it yields a better CEO, but because it seems like the normal thing to do. The (indirect) interaction I’ve had with boards of directors of private companies is that they are extremely motivated by the bottom line.