Professor Bainbridge...on law, politics, religion, culture & food

Unions, Executive Pay, and Management Entrenchment

Unions have been among the most prominent critics of high executive compensation. The AFL-CIO, for example, has devoted an entire website - Executive PayWatch - to the issue. A casual observer might assume that union campaigning against executive pay is simply class warfare. In fact, however, I think something much more subtle is going on here.

We know that entrenched CEOs - i.e., executives of companies with strong takeover defenses and other forms of insulation from capital market and shareholder pressure - tend to get much higher salaries than non-entrenched CEOs. This makes sense, because if the latter's performance doesn't justify his pay, an unentrenched CEO is more vulnerable to a disciplinary termination.

Interestingly, however, a recent survey finds conclusive evidence that entrenched CEOs also pay their workers more!

Based on a two-million-observation panel dataset that matches public firms with detailed data on their employees, we find that entrenched managers pay their workers more. For example, our estimates show that CEOs with more control rights (votes) than all other blockholders together, pay their workers about 6%, or $2,200 per year, higher wages. Because cash flow rights ownership by the CEO and better corporate governance are found to mitigate such behaviour, we interpret the higher pay as evidence of agency problems between shareholders and managers affecting workers' pay. ... These results are consistent with an agency model in which managers pay high wages because they come with private benefits for the manager, such as lower-effort wage bargaining and better CEO-employee relations, and suggest more broadly an important link between the external corporate governance of large public firms and labour market outcomes.

So if high CEO salaries are correlated with management entrenchment, which is correlated with higher employee wages, why are the unions so upset?

In a very real sense, unions and managers compete to offer benefits to employees. If managers are voluntarily paying workers more, with concomitant "lower-effort wage bargaining and better CEO-employee relations," the firm's workers may be less likely to unionize. After all, under such conditions, they may perceive the benefits package offered by management to be superior to the package promised by the union. (Plus, of course, there would be a bird in the hand aspect to the decision.)

In sum, union opposition to high executive compensation may reflect a union recognition that highly compensated CEOs tend to be more effective competitors for worker loyalty. ... Or it could just be plain old class warfare after all.