What does ChE theory have to do with CEO pay?

Chief executives in 35 of the top Fortune 500 companies were overpaid by about 129 times their “ideal salaries” in 2008, according to a new type of theoretical analysis proposed by chemical engineering professor Venkat Venkatasubramanian as a means of determining fair CEO compensation.

The ratio of CEO pay to the lowest employee salary has gone up from about 40-to-1 in the 1970s to as high as 344-to-1 in recent years in the United States. However, the ratio has remained around 20-to-1 in Europe and 11-to-1 in Japan, according to available data, he says.

Using the new analysis method, Venkatasubramanian estimates that the 2008 salaries of the top 35 CEOs in the United States were about 129 times their ideal fair salaries. CEOs in the Standard & Poor’s 500 averaged about 50 times their fair pay, raising questions about the efficiency of the free market to determine fair CEO pay, he says.

You might ask why a chemical engineer is concerned with economics and CEO salaries,” Venkatasubramanian says. “Well, it turns out that the same concepts and mathematics used to solve problems in statistical thermodynamics and information theory also can be applied to economic issues, such as the determination of fair CEO salaries.”

A key idea in his theory is the economic interpretation of the concept of entropy. “Just as entropy is a measure of disorder in thermodynamics and uncertainty in information theory, what would entropy mean in economics?” he says.

Venkatasubramanian identifies entropy as a measure of “fairness” in economic systems, revealing a connection between statistical thermodynamics, information theory and economics.

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