What the NFL Teaches Us About Executive Compensation

link here to article

Tom Brady had one of the best years ever last year as an NFL quarterback for the Patriots, and he was highly paid for his performance. Salary's in the NFL are based primarily on performance. This is exactly what everyone learns in economics 101. Individuals are paid for their marginal contribution to revenue. Some economists still use economics 101 to explain why US executives are paid many times more than executives in other parts of the world. For example, N. Greg Mankiw from Harvard, and former Bush administration Chief Economist, goes to the textbook and argues that the market has put a premium on their marginal contribution to revenue. The CEO of The American Enterprise Institute tells us a similar story that we posted below. The high wages of executives are based upon merit and if we raised their taxes we would destroy the economic system based upon merit.

This article gives a better explanation of executive compensation, and Tom Brady is fortunate that he is paid for performance and not in the way that we pay our top executives. CEO's in the US are paid on expectations and not on performance. Their compensation comes primarily from stock price appreciation which is based upon beating market expectations. They tell the market what to expect in earnings and the stock price will increase if they beat expectations. Consequently, the CEO is rewarded for setting expectations and then beating them. The total focus of the CEO is on the management of the stock price which is a function of expectations. This also means that the CEO behaves in way that moves the stock price in the short term, even if it means that longer term prospects might be diminished. This might be called expectations capitalism.

If Tom Brady were paid on meeting expectations, instead of by his performance, he would not have done as well. The expectations market in the NFL is based upon beating the point spread. The Patriots did so well in their first 8 games that expectations increased each game on the spread by which they would beat their opponents. Eventually, expectations got so high the the spreads became too large even for Tom Brady, and the patriots had a bad season relative to expectations. On the other hand, a quarterback from Cleveland earned a lot less than Brady because he did not perform as well, but he beat the point spread more frequently than Brady. The NFL represents the way capitalism is supposed to work better than it works today as a system of expectations about asset appreciation or depreciation.