----- 1st Tournament theory slide -----

An alternative explanation for high CEO pay is the impact it has on other workers in the firm.
Tournament theory suggests that CEO pay is not based on their individual performance, rather
that their pay is predetermined and used to incentivise hard work from other workers in the firm.
According to this theory workers are promoted based on their relative performance when
compared to others in the firm, rather than on their absolute performance which is often very
difficult to quantify. If pay increases in discrete intervals between levels of management then this
will encourage workers to put in extra effort to achieve the higher salary, with more effort being
exerted for a larger pay gap.

----- 2nd Slide (Problems) -----

A cap on executive pay levels limits the extent to which high salaries can be used to encourage
hard work from workers. Even worse, a low cap could result in equal wages between employees
on different levels within a firm, totally removing any incentive for further promotions once the
salary cap has been reached. This could have huge implications for a firm's productivity as the
aims and interest of managers become more detached from those of shareholders, where
managers who have no stake in the company are encouraged to exert the bare minimum
amount of effort to maintain their current position, while shareholders are looking to maximise
the profit from their investment which requires very high levels of effort from executives.

An argument made against high executive pay is that it could be lower and still provide the
same level of incentives to workers, as promotions lower down in the firm hierarchy are
accompanied by much smaller pay rises than those that occur higher up the firm. However,
workers further down in the firm are incentivised by the prospect of further promotions while the
only incentive left for those at the top is a large pay packet, which would be prevented by a pay
ceiling for executives. On top of this, the marginal cost of inducing extra effort from workers
rises with the levels of effort already exerted. As an example, a worker is far more likely to take
on extra hours if they work part time than if they are already working well over standard full time
hours, or at least they may not demand as much extra pay for doing so. So assuming those who
are high up within a firm got there because they worked the hardest, theyll likely want more
money than those lower down if they are to work even harder, which may not be possible when
pay is capped.

----- 3rd Slide (More Problems) -----

Now going back to my earlier point about differing goals for executives and shareholders. If
executive pay is not performance related then CEOs are encouraged to only strive for
acceptable levels of growth within the firm rather than the maximum they could achieve. A
common way to work around this problem is to align the interests of executives with those of the
shareholders by rewarding them with stakes in the firm. This way executives are directly
rewarded when the firm does well and lose out when it does not, providing a clear incentive for
hard work. In effect this shifts executive pay more towards piece rate style pay, where the CEO
gets a clearer indication of the return they will get from additional effort. A cap on pay limits this
by restricting the stocks that can be given to executives, limiting the financial reward they
receive from the firm being successful, further discouraging them from working in the best
interests of the firm.

The last point I want to make is in regards to firm mobility. Today we live in a more integrated
world than ever before, trade deals allow goods to be freely transported and sold all across the
world which means firms have greater choice over where to locate themselves. This allows
firms to base their headquarters in countries with less regulation, benefitting from the more
lenient laws. This isnt a new concept either, weve seen many firms moving abroad to dodge
high american tax rates, Coca Cola moved their headquarters from Atlanta in the US to london
to benefit from the lower corporate taxes, while just last year American pharmaceutical giant
pfizer moved their headquarters to Ireland. so theres no reason to believe the same couldnt
happen following an executive pay cap, if the individual company believes it will serious harm
their profitability.

So overall, while capping executive pay may seem like an easy answer to rapidly rising
inequality it can have serious implications beyond just the bank balance of executives. Slower
growth in large firms leading to a weaker stock market, slower creation of new jobs and
restricted economic growth are just some of the possible drawbacks to implementing a cap on
executive pay.

----- Switzerland Case Study -----

The next case study were going to look at is the 2013 swiss referendum on laws limiting executive pay.
The bill, which ultimately failed to pass with a 65% no vote, aimed to limit executive pay to just 12 times
the wage of the lowest paid full time worker within the firm, ban severance packages for executives and
give more power to shareholders. This approach differs from the failed US attempts to curb executive pay
in that it places a hard cap on salaries, which is in theory more enforceable and less subject to loopholes.
However in practice this approach has its own set of problems.

First off it creates huge variance in the maximum salary that can be paid to CEOs. For example a small
law firm hiring only university graduates will pay a much higher salary to its lowest paid worker than a
company like mcdonald's. This means the salary that can be paid to the CEO of the law firm will be much
higher, despite them overseeing a much smaller company.

Another issue is this creates an incentive to remove low paying full time jobs and replace them with more
part time staff. This will increase the lowest full time wage within a company allowing them to pay higher
salaries to executives at the expense of workers who could lose out. On top of this, going back to the
point I made earlier about offshoring, a number of swiss firms may simply have left the country had the bill
passed, meaning those same workers would have lost their jobs.

Even after putting these problems aside, any benefits from capping CEO pay would likely be very small,
with the bill impacting only very large swiss firms. All in all, the arguments for introducing a maximum ratio
between executive and worker pay seem to be largely political rather than economically based, fueled in
no small part by the backlash to some of the huge payouts given to swiss CEOs in 2013.