One Way to Control Executive Pay: More Unions

Unions are not the favorites of efficiency-seeking economists (or executives or investors). The argument goes like this: a union's demand for higher wages restricts the C.E.O. from deploying his (or her) resources in the best profit-enhancing way possible, thus depressing the company's stock price.

Still, unions can serve another purpose, say Rafael Gomez and Konstantinos Tzioumis of the London School of Economics: keeping executive compensation in check.

(Source)

There are two main channels, direct and indirect, through which this can happen.

First, the collective bargaining process allows unions to act as a counterbalancing force to management. If an executive wants a large pay package, the union could see that as a sign that the company's financial health is in good shape and demand higher wages themselves. And in some countries, namely Japan and Germany, it's not uncommon for a union rep sit on the board of directors.

Second, financial markets have historically taken a dim view of companies with a union presence. This translates into a lower stock price, and, in turn, a lower value for the C.E.O.'s stock options.

Collecting data on union and non-unionized firms between 1992-2001, Gomez and Tzioumis found that, on average, union presence lowered C.E.O. compensation by 10 percent. And this effect was more pronounced higher up the compensation ladder: union presence lowered total compensation by 25 percent for C.E.O.'s whose pay was in the top 10 percent. The union-effect resulted in 5 percent lower compensation for the bottom 10 percent of C.E.O.s.

(Compensation here is the sum of salary, bonus, benefits, restricted grants, long term incentive plans, and stock options.)

They also found that the stock option effect is much stronger than the collective bargaining effect. In fact, unions may actually boost a C.E.O.'s base pay. The reasoning for this is that to attract qualified executives to a position with a compensation package that has less upside, the minimum guaranteed pay has to be higher.

The most surprising part of Gomez and Tzioumis' findings is that the manner in which C.E.O. compensation changed when the company's performance changed was very similar across union and non-union firms. This last point suggests that unions may not be crimping efficient decision making by C.E.O.s.