Why your boss is overpaid

My friend has a huge problem with her boss.

She claims that she works like a dog while he sits all day and purrs like a fat contented cat behind his rosewood altar, drinks herbal tea and swivels aimlessly in his leather chair. His daily ritual is to rearrange the post-its on his computer and send mails to the lesser-paid mortals asking for updates or demanding that they justify their existence. And when the cat is in a particularly foul mood, whoever comes into his line of fire gets skewered. 

She has figured out his apathy: His mind is either on permanent vacation, or worse still, has already retired but the company just refuses to let his body follow suit, for a reason she cannot fathom.

Her biggest grouse is that while she and her colleagues work their backs off to add to the bottom line, he is at the receiving end of a bloated salary and inflated bonus.

Before I continue, let me set the record straight. This post is NOT about my bosses, who, incidentally, all read this blog hence my urgency to clear the air. All my bosses (that's right, I have more than one) sit at work stations identical to the rest, no plush leather seats or polished wooden desks - be it mahogany or teak or rosewood. None of them use post-its or, to my knowledge, drink herbal tea.

Back to my friend. While I do (silently) admit to the possibility of exaggeration on her part, the point is hard to miss. Are our bosses really overpaid?

Years ago, economist Tim Harford tackled this issue in his book The Logic of Life and presented a downsized version in Forbes titled Why Your Boss is Overpaid. According to him, there is a logic to bosses making obscene sums of money while the downtrodden cubicle slaves toil. The ugly truth is that your boss is probably overpaid because of you. He isn't being paid for the work he does but, rather, to inspire you. So you work your socks off in your underpaid job in the hope that one day you will become an overpaid fat cat yourself.

Economists (bless that breed of individuals!) have a name for this: Tournament Theory.

According to Tournament Theory, workers are frequently ranked relative to each other and promoted not for being good at their jobs but being better than their rivals. For instance, Andy Murray was paid $1.9 million for winning the US Open. He was not paid to work hard. He was not paid to play objectively brilliant tennis. He was paid to beat his opponent - Novak Djokovic. And not in his backyard or anywhere else, specifically at Flushing Meadows. Harford goes into great detail about “tournament theory” and “promotion tournaments” in the office space, which I don't have the patience to delve into.  

This very month when the Occupy Wall Street movement completed a year, The Economist tackled the issue of overpaid bosses. With Steven Kaplan’s help, The Economist challenges three propositions:

• CEO pay just keeps on going up
• CEO pay is not tied to performance
• The Boards are not doing their job of holding fat cats’ paws to the fire

Kaplan questions the notion that CEO pay always goes up and argues that CEOs are paid for improving the performance of their company’s stock and provides data to back his claim. But according to a much earlier article in The New Yorker, overpaid CEOs are not just expensive, they are even destructive. And, you guessed right, they have data to back their claim too. 

The New Yorker ends with the conclusion that in the long run companies that do not balance pay with performance will suffer on the stock market. The Economist concludes by saying that CEO pay packets are determined by demand and supply. 

So basically, scarce good talent is heavily in demand but the supply is drastically limited. Hence the steep premium. Companies pay what it takes to woo the best bosses and show them the door if they falter. Whether the boss delivers due to his business acumen or intelligence or because he possesses the ability to attract great talent and drive them like slaves is another issue altogether and meaningless to some extent, at least to the Board. The results are what they look at.  

Back to my friend. She has rubbished all of the above. But the thought of sitting behind that rosewood desk in soft leather has got her pulse racing.