Eric Rasmusen has an interesting proposal on how to pay CEOs. I think the underlying ideas is right, but I see one danger in his proposal, and one aspect of motivation that he is missing.

His proposal is that CEO’s bonuses should be at the discretion of directors. This will make bonuses more of a recognition of real achievement.

Where I think the danger lies is that boards will tend to have an interest in inflating their CEO’s pay. It will be a comparator for both their compensation as directors, and for directors pay in general. This is especially true when the directors themselves are CEOs of similar companies.

This would still be an improvement on the current situation, as and would increase motivation, but shareholders are likely to (as now, in my opinion) pay management too much.

What I think Eric misses is an insight from management theory, that I have mentioned before. The most important motivators are those intrinsic to a job, not extrinsic factors like pay. A CEO benefits hugely from these.

The conclusion I draw from this is that executive pay in general could be much lower with little or no harm. Even if it fell severely, what other work could they find that paid as well as being a CEO? Some might start their own businesses: well,a few extra entrepreneurs never harmed the economy. As for the rest, the most important factor is their pay relative to other CEOs.