Posts Tagged ‘ marginal product ’

Executive Compensation Part II: Spoiling the Good Child

Aside from the objectively huge¬†effect that executive decisions can have on a firm’s bottom line, there is at least one more compelling reason to pay top executives more than their own marginal product (in a sense). A professor once suggested to me that a CEO’s full marginal product includes not only the value of his policy, branding, and motivational actions, but also his motivational inactions. Basically, by over-compensating a CEO in terms of what he actually does, a firm presents a big carrot to anyone within shouting distance of the position. Of course, this practice shouldn’t begin or end with a company’s top man; indeed there are gains to be had from over-compensating employees at every level, even the ground level (consider a firms desire to attract the best entry-level applicants).

Obviously, this practice will always scale with the classical value of the positions in question; how big is the spread between the median dishwasher and one who performs in the 95th percentile? It will also compound towards the top, each supervisor is paid to increase the output of those beneath her, both explicitly and implicitly; the more supervisors and the more tiers beneath you, the great the ripple effect of your desirable salary.

I don’t think this theory is far-fetched in the least. As I’m not so well versed on the subject, it may even be common knowledge in relevant circles. What I do find very interesting are this strategy’s applications outside of the hierarchical firm.

All of this came very keenly to mind when talking to my 24 year-old friend who still lives quite amicably off the trough of her parents. The interesting thing is, her 21- year old brother is being cut off. My friend’s justification for her disproportionate compensation? She stays out of trouble, got through college in a reasonable amount of time, and does errands upon request. Her brother is hardly a degenerate; he does poorly in school, but still attends regularly, he stays away from hard drugs, doesn’t run in criminal or otherwise dangerous circles and is usually home at a decent hour. He is more impulsive, serially lazy, and temperamental, but you can squeeze a favor out of him now and then.

Basically, children are always better compensated, often into their twenties than the services they provide to their parents would ever warrant. But why the disparity in the case of my friend? She does provide more than her brother, but not nearly to the degree (and length of time) that she’s been better taken care of. My leading hypothesis is that my friend is enjoying the spoils of implicit motivational compensation. Just by being a relatively good child next to a less well behaved sibling, she enjoys the fruits of being a vegetable (carrot), that she likely wouldn’t if her wayward brother wasn’t around to, perhaps, learn his lesson.