When the winner takes all, people will pay through the nose.
Carlos Tevez, the much-travelled Argentinean footballer, is still a Manchester City player after his transfer to the Brazilian club Corinthians broke down at 4am this morning when the transfer window closed. Another club may make a bid, but in any event Tevez is likely to want something close to £10 million a year for his services.
Whilst the massive salaries paid to people like Tevez and the Chief Executive Officers (CEOs) of large companies attract plenty of complaints, there are sound economic reasons for their employers to pay such large amounts. Although the benefits for fans are somewhat intangible, and often unpredictable, for shareholders the payoff for hiring a top CEO can be seen in the share price.
These people are paid a lot because they are at the top of a profession where the benefits produced by hiring someone who is excellent at their job, rather than just being very good, can be worth many times what they are paid.
Big money for small differences
What Tevez and the CEOs have in common is that they work in occupations where very small increase in ability can easily translate into far better results. In Tevez's case it's usually a goal which can be the difference between winning and losing, whilst for top CEOs it's quite common for tens of millions of pounds to turn on a single decision.
As a result those with the best skills in these professions tend to command far higher salaries than everyone else. This produces "winner-takes-all" markets, some of the more obvious of which are seen in individual sports. For example, so far in 2011 the top ranked women's tennis player has won $3.1 million of prize money; twenty-three times what the 100th best player has received.
Most job markets aren't winner-takes-all, so the best dustman won't earn that much more than the average dustman. But the top actors usually earn vastly more than the average ones, most of whom have to work other jobs to make ends meet (unless they get lucky).
Pay up for proven talent
Contrary to popular opinion there aren't too many people with the experience and ability to successfully run a multi-billion pound multinational company. Since the CEO can have a substantial effect upon a company's performance, for a company with a turnover in the billions it's worth paying a few million to hire a superior CEO.
Bob Diamond, the boss of Barclays (LSE: BARC), was paid £9 million in 2010. Barclays' pre-tax profits for the same period were £6.1 billion so Diamond was paid less than 0.15% of this amount. If he could increase Barclays' profits by just 1% more than the average CEO then that would mean some £61 million of additional profit that the company would earn for paying out only a few million more in salary and bonuses.
So the price for the top CEOs tends to be bid up, much like top footballers' salaries.
Naturally there are some exceptions such as Warren Buffett who gets $100,000 a year for running his company. Relative to what other CEOs are paid this is on par with my local pub team hiring Tevez for the national minimum wage!
It's much harder to hide on the pitch
If you're a professional sportsman it's pretty easy for everyone to see when you're having a bad day. Last Sunday, Argentina lost the penalty shootout in the quarter-final of the Copa America because Tevez missed a penalty. On live TV. There's no hiding from that.
But it's a different matter in the corporate world and this provides some justification for criticising the high pay packets of CEOs. Mistakes often take time to appear because of the nature of the business and many a good set of company results has had vastly more to do with external influences, such as an economic boom, than the CEO's skill.
After all, a rising tide lifts all boats.
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