That’s why they make the Big Bucks

May 25, 2007, 4:32 PM UTC

A rather churlish article in today’s New York Times outlines a new trend in executive compensation — the #1 guy making exponentially more than his immediate subordinates. The immediate reaction, both from those who work for the Big Dog and those who work for the L’il Dogs who work for the bigger mutts who work for the Big Pooch, is to question why, say, the CEO of Omnivore makes $5 million a year while his direct subordinates earn only $2 million or, in dire cases, only high six figures.

As always in the world of business, there is a rational explanation for what seems to be an arbitrary scenario. A close analysis shows, in fact, that bigtime CEOs are generally worth the money they make, due to the extreme requirements (both operational and psychological) of their jobs. Even though our level of need may be the same or even higher, those who work for them are under far different burdens and are therefore worthy of less. Let me show you what I mean.

Let’s take a CEO I’ll call Big Bob. He makes $5 million a year and gets an $8 million bonus plus long term compensation that will pay him $18 quadrillion by the time he’s 106, which is the mandatory retirement age for ultra-senior executives. Standing next to him for our demonstration is a fellow we’ll call Forbisher, who works for Bob, He makes $400,000 per year, gets a bonus of $250,000 and stock options that will help him pay off his son’s bicycle when they vest around the time that global warming destroys what’s left of the planet.

Both compensation packages are fair and rational, and here’s why:

Take CEO Bob’s base pay of $5,000,000. After Federal, local and state income taxes, medical and retirement withholding, alimony from two failed marriages and child support for not only his own children but also the six his second wife adopted from Sri Lanka immediately prior to their separation, and you’ll find that Bob’s take-home pay comes to slightly less than $850,000 per year. For this he must support an executive persona that places him in the room with guys whose investments throw off twelve figures. On that money, he is also expected to be a philanthropist, since nobody worth a lick these days isn’t giving away big blocks of income to Bono.

Forbisher works hard, plays hard, and almost makes ends meet living in midtown Manhattan, Chicago or Santa Monica on take-home pay of about $200,000 a year. He has two kids in private schools, a house or apartment that costs $5000 a month, all-in. Once a year, he and his wife Barbara take a vacation at someplace nice. She also contributes income, of course, but finds it hard to work a 60-hour week with two kids to transport to and from school, ballet, piano and shiatsu classes.

So both CEO Bob and senior executive Forbisher are just scraping by on their paychecks. Now let’s look at bonuses, which is what both of them live on, really. Big Bob’s pays for his self-image, long, tormented and virtually sleepless nights, and the fact that every move he makes is chronicled in 10Qs, 8Ks and the gossip and business pages. He also takes out a house every summer in some terrific location where he can see other parade balloon-sized moguls perambulating on the beach. He lives with the constant knowledge that, given the vagaries of Boards, SEC regulations and predatory journalists, it could all be over five minutes from now. At this moment, he has enough in the bank to pay for his lifestyle for the next year or so, but he would really miss the front table he now enjoys at his restaurant of choice more than anything else.

Forbisher spends his bonus on upgrades to his house. By the end of the year, he’ll have a new patio and barbecue to show for it. He’d like the bonus that’s paid to his boss Bob, sure, but the last time he had his name in the paper, it gave him diarrhea for a week.

As for long-term comp – stock options, restricted stock units, etc. – if they both make it for another ten years, they’ll each be fine at their perceived level of self-worth. Forbisher will probably get his payout when he’s ready to kick back and live the remainder of his life in somewhat reduced circumstances and increased happiness. Bob the CEO will most likely get it in the back of the neck when he least expects it, in one lump sum that could amount to, say, as much as a hundred million dollars. And how far does that go these days?

See? Business is rational, right?