Why Financial CEOs Earn So Much More Than Real-Economy CEOs

Robert B. Reich, Marketplace October 31, 2007

Look at the highest paid one half of one percent of Americans, and who do you find? According to a study by University of Chicago professors Steven Kaplan and Joshua Rauh, more than twice as many Wall Street financiers as corporate executives.

Why do you imagine there’s such a huge disparity between executives in the financial economy and those in the real economy? If you believe pay is a measure of someone’s economic value, you might think that Wall Street’s top brass is just plain smarter. I mean, consider the inventiveness and daring required to create collateralized debt obligations, structured credit derivatives, credit default swaps, and all the other financial innovations over the last few years – some of which, although no one seems to know how much of which, have rested on sub-prime loans.

Well, you might want to think again.. Last week, Merrill Lynch stunned investors by announcing a $7.9 billion write-down of bonds backed by sub-prime mortgages – billions more than the company had forecast earlier this month. Then earlier this week, Merrill’s top gun, Stanley O’Neill, was sacked. But don’t cry for him. He’ll get a $140 million good-bye gift – far higher than the golden parachutes of most CEOs in the real economy who flame out. Even when it comes to being fired, it seems Wall Street’s top brass do better than regular CEOs.

Other Wall Street heads may be on the chopping block soon. Despite all the hype about each big bank having its own unique expertise, the fact is they’ve all used similar techniques for highly-leveraged and largely unaccountable speculation. Which means their balance sheets are likely to have similar credibility problems. With their fiscal years ending in November, and their auditors requiring that assets reflect market realities, expect other big write-downs. Citigroup could be next.

In other words, there’s no reason to believe Wall Street executives have been smarter than executives in the real, non-financial economy. They’ve been paid more because they’ve been smarter at creating schemes that have only appeared to create value, while keeping investors in the dark.