Thursday, May 29, 2008

Income inequality and the NFL

Steven Malanga over at Realclearmarkets.com actually makes a solid case for income inequality in society by comparing it to the situation in the NFL (I am only quoting part of the article below. I fully recommend reading the whole thing at the link above. It is short.):
I took a look at the salary structure of the team with the biggest payroll in 2007, the Washington Redskins, who paid $123 million in salaries to 59 players, including those on the practice squad, over the course of the year. That’s a rich pot, but what I found was that the top quintile, or 20 percent, of the roster took home 63 percent of the money, and the top two quintiles earned 85 percent. The Skins’ aren’t an anomaly, even though they are one of the richest teams. The other teams at the top of the salary scale—the Pats and the Saints—devoted 62 percent and 60 percent of salaries, respectively, to a fifth of their players.

It was only slightly different at the bottom. The team with the lowest payroll in 2007, the Super Bowl-winning New York Giants (talk about value for your dollar), paid 59 percent of wages to the top 20 percent, and 78 percent to the richest 40 percent of players.

Malanga goes on to show that numbers for other sports leagues, as well as the U.S. in general, are similar.

One place where Malanga fails in his comparison (even though his conclusions are correct) is in completing his comparison.

In the NFL, how many players are responsible for a team's financial success? The top 40% of the team may see the field most of the time, and may win games and draw fans. But in a market where players can change teams, and do so frequently, the cream will rise to the top of the salary scale, either through free agency or fear thereof by the team.

The real world operates similarly. When a company sees an employee outproducing other employees, a company must quickly recognize this, and reward it, or risk losing the employee to another company which does recognize the employee's abilities.

But where do CEO's fit into this comparison? Truth be told, CEO's tend to be like a starting quarterback. A starting quarterback can have a bad day and the rest of the team can still pull out a win, or even a successful season (do I need to mention Trent Dilfer won a Super Bowl?). A bad CEO is similar in that a company can only cover his shortcomings for so long.

On the other hand, if a CEO or a quarterback is REALLY bad, they will actually make their company/team worse. Even in these situations, both will probably make a lot of money in comparison to their workers/teammates, but both will end up getting fired in the end.

In the long run, good CEO's will tend to make more than bad CEO's, just as good quarterbacks will make more than bad quarterbacks. But that doesn't explain why CEO's and quarterbacks should make significantly more than the lowest paid employees or the team's lowest paid players.

For that, you have to look at their impact. If a quarterback is making $10 million per year, and a backup player makes $500,000 per year, should the backup make more at the sacrifice of some of the quarterback's salary? With salary cap considerations, this is the question an NFL team faces. The logical answer is "of course not". The quarterback has a far greater impact on the team's success, so he naturally makes significantly more.

Just like an NFL team, companies have a salary cap: it is called the free market. Specifically, a company which spends more than it can afford on a CEO, regardless of how good the CEO may be, runs the risk of putting itself out of business (although there are times when that can be a good strategic maneuver, but those are exceptional cases).

But what value does a good CEO bring to it's company? The best example of CEO value comes from Roberto Goizueta, former CEO of Coca Cola. While he is best remembered for the "New Coke" debacle, he also was the CEO who introduced Diet Coke. In addition, it should be remembered that Goizueta was not so headstrong he couldn't admit his mistakes, bringing back Coke Classic after New Coke flopped.

My point is the New Coke debacle could have crippled Coca Cola under a more headstrong CEO. Instead, Goizueta brought the company back and made it one of the most profitable companies today. Was Goizueta worth the high salary he was paid? Most certainly (according to Wikipedia, he "[b]ecame the first CEO to gain billionaire status from a company which he did not found"). Instead of costing the company thousands of jobs, he instead allowed it to expand.

Was Goizueta worth a $1 billion more to Coca Cola than their lowest paid worker, who may have done more of the "sweaty" work? Absolutely. Ideas move companies. Anybody can do the manual labor, but not everyone can come up with ideas that make money in the free market.

Certainly there are plenty of examples of CEO's who make more than they deserve. The CEO who made $100 million in a year when their company tanked is almost a cliche. But companies that do that all the time tend to go out of business quickly, unless the CEO is much better than the public realizes. But is that situation so much different than a rookie quarterback who gets a huge contract based on his potential?

Actually, it is. If a rookie quarterback fails, he is the one who gets fired. If a CEO fails, there can be tens of thousands or even hundreds of thousands of jobs lost due to his incompetance. So who is REALLY more important?

Of course, income inequality isn't about comparing quarterbacks and CEO's. Considering the size of modern corporations, and all the responsibility sitting on the shoulders of CEO's, it would be foolish to pay them "a little more" than their lowest paid worker.

2 comments:

daveja vu said...

I also might add that rookie quarterbacks are normally groomed and brought in gradually, allowed to make some mistakes and grow. Rookie CEO's are normally expected to start making a difference IMMEDIATELY. Or at least draw up a plausible plan for success.

EdMcGon said...

Good point Dave.