How CEO Pay Skyrocketed To Over 300 Times Worker Pay

There's a new proposed tax on corporations that overpay their executives and underpay their workers, but we also need to address the core causes.
President Ronald Reagan’s Cabinet, 1981 (Official White House Photo)

President Ronald Reagan’s Cabinet, 1981 (Official White House Photo)

  • Executive pay often exceeds 300 times median worker pay
  • Each year that gap increases
  • The media have been exposing this inequity since the 1990s to absolutely no effect

In his international best-selling book, Capitalism in the 21st Century, French economist Thomas Piketty startled the world with a statistical picture of the grim state of our increasing inequality that would soon return us to pre-World War I levels. The greatest contributor to income inequality: sky-high executive pay. In an interview, Piketty summarized the problem this way:

“In the US, between two-thirds and three-quarters of primary income growth since 1980 has been absorbed by the top 10% income earners, and most of it by the top 1% income earners.”

For decades prior, newspaper headlines had blared about the obscene level of CEO pay that continued to rise despite voter outrage and politicians’ attempts to rein it in. According to a 2013 study by the Economic Policy Institute, “from 1978 to 2012, CEO compensation measured with options realized increased about 875 percent, a rise more than double stock market growth and substantially greater than the painfully slow 5.4 percent growth in a typical worker’s compensation over the same period.”

Now, new legislation, introduced November 13 by Senator Bernie Sanders and Representatives Rashida Tlaib and Barbara Lee, is designed to stop this executive pay gone wild by directly taxing the gap between CEO and median worker pay.

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How CEOs Set Their Own Pay

In theory, the corporate form is a democracy, but in practice, it is a monarchy - the emperor CEOs set their own pay packages. They do this through the “proxy” system. A proxy allows a nominee to vote on behalf of a shareholder.

Before the Annual General Meeting, management sends out a proxy circular containing a proxy form with a suggested nominee. Many shareholders routinely sign the form and send it back.

The CEO has the power to hire and fire the person who drafts the circular. So, as self-preservation dictates, that employee obeys and writes in the CEO’s choice. The CEO’s choice votes for the directors whom the CEO wishes (and keeps his job). In short, the CEO hires and fires the people who decide his comp.

Many shareholders are mom-and-pop investors. They buy their shares because they hope to make money either by dividends or capital gains. They have listened to advisors and have a diverse portfolio of shares in corporations in widespread industries ranging from manufacturing, banking to medical research. They know nothing about running any of them– and have no interest in the elections. They often sign the proxy form to be nice or ignore it.

Over 30 years ago, some small shareholder power groups began a “say on pay” movement to curtail the rising CEO pay. It slammed into an impenetrable stonewall because the Board of Directors, who depend on the CEO controlled votes for their lucrative directors’ fees, refused to even put the CEO comp item on the agenda.

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Why the Hedge Funds Are No Help

That is a short, easy answer: They don’t care. They only want a CEO who will do their bidding: distribute amounts that should be retained for future development immediately by way of dividends, or sell off profitable subsidiary businesses and distribute the bounty by dividends. If the CEO does that, the big guys - the institutional investors, hedge and equity funds - will vote to approve anything that CEO wants.

Why the Dodd-Frank Reforms Are of No Help

Because the small shareholder groups couldn’t even get CEO pay on the agenda of the Annual General Meeting, one of the Dodd-Frank (S951) reforms required corporations to put this item on the agenda - but only for a voluntary vote. That has been happening since 2011.

That reform did nothing to cure the proxy problem. This CEO’s nominee can still vote the shares by proxy to approve the compensation. So, no doubt, the shareholder votes at most of the annual meetings will still approve the CEO’s compensation package–and by a wide majority. Journalists who naively report the amazing approval rate will not investigate how many shares were voted by the CEO’s employee by proxy.

Laws Can Do the Opposite of What is Claimed

During the 1990s when the voting public’s outrage at the escalating executive pay was forceful enough to force politicians to act, President Bill Clinton (1993–2001) successfully campaigned on a promise to put a lid on it. As promised, he immediately changed the tax code so that only $1 million of high-end executive pay could be deducted from income. That should do the trick, Clinton believed.

As a result of the Clinton measure, total CEO compensation exploded into stratospheres even higher than before this attempt at restraint - and hasn’t stopped since.

This is why: his advisors advised an exemption.

Exemptions should be noted as a red flag. They sometimes completely undo what the politicians say the legislation is supposed to do.

This crippling of legislation does not come about by accident. The advisors and drafters of potential legislation come from the civil service which corporations and, especially bankers, learned to populate with their alumni quite some time ago. Many times, the politicians themselves don’t realize the cunningly deceptive advice they are given. I certainly don’t believe Clinton intended the result - but his advisors did.

We have former Labor Secretary Robert Reich to thank for exposing how this subverting exemption was inserted. Reich tells us in his documentary Saving Capitalism that then-Treasury Secretary Robert Rubin insisted on the exemption. Rubin was an ex-CEO of Goldman Sachs and well understood the potential for helping corporate America.

In his first 100 days, Obama vowed to stop the banker bonus culture, “For top executives to award themselves these kinds of compensation packages in the midst of this economic crisis isn’t just bad taste - it’s a bad strategy - and I will not tolerate it. We’re going to be demanding some restraint in exchange for federal aid - so that when firms seek new federal dollars, we won’t find them up to the same old tricks,” However, the pay party rolled on. Human-like, he did not learn from history, but repeated the same Clinton strategy that inflated bonuses. CNN reported: “Under Obama’s plan, companies that want to pay their executives more than $500,000 will have to do so through stocks that cannot be sold until the companies pay back the money they borrow from the government.”

Creating Corporate Cocaine

This exemption permitted compensation for performance to be deducted. Thus, if a company paid a bonus, that reward would meet the test. And here’s the rub: the bonus could be in stock or stock options. (So, when you read that a CEO’s pay is $20 million, it will likely be $1 million in salary and 19 in ‘performance pay’, i.e., stock or stock options as Eddie Lampert’s at Sears was.)

“Great!” The promoters of the exemption cried. Executives would have skin in the game. This would motivate them to do better for the corporation, right? Of course, wrong.

A Geek Interlude: A stock option gives the executive the right to buy stock in the company at a fixed price. Let’s say the CEO gets up bonus stock option of stock worth $1 million in their 2015 pay called the strike price. They have the right in, say, 2018 to buy that stock, selling now at the 2018 price of $1.5 million, for the lower 2015 price of $1 million.

So, by now any student of human nature has seen the problem. The executives are motivated to increase the short-term price of corporate shares on the day they exercise the option - and at the same time, or as soon as possible - have their corporation buy the shares from them for an immediate cash bonanza. Buy-backs became corporate cocaine.

And, we will not forget, that as the ultimate insiders, the executives not only know if that day’s price is inflated - they have the means to make it so.

The many ways of unaccountable accounting would, and has, filled books. One of the simplest ways here would be to defer expenses for one quarterly earnings report giving a short-term boost to profitability that in turn raises the share price temporarily. On this golden day, the executives exercise their options and sell back to the corporation.

Because executives are in a position to so easily manipulate the market before having the corporation buy back its own shares, corporations were once absolutely prohibited from doing so. But in 1982, President Reagan deregulated that prohibition and permitted corporations to buy back executive shares as long as the purchase met four completely arcane conditions - which the SEC said were impossible to police.

The Trump tax cuts went primarily into buybacks not into creating new jobs or better employee wages. For more on this see my article: Stock Buybacks are a Parasite on the US Economy.

Economist Bill Lazonick wrote a hard-hitting piece exposing executive buyback abuses for the Harvard Business Review  -  which won the HBR McKinsey Award for the best article of the 2014 Harvard Business Review. The title captures the effect on wealth inequality perfectly, “Profits Without Prosperity”. Lazonick explains that contrary to the interests of the corporation, stock buybacks were done when the stock price was high. The reason is obvious. In Lazonick’s words: “Because stock-based instruments make up the majority of executives’ pay, and buybacks drive up short-term stock prices.” He confirms these firms are engaged in “what is effectively stock-price manipulation.”

Also, CEOs have the ability to determine which shares the corporation buys back. Additionally, the broker, who acts on behalf of the corporation to do the buybacks, may also hold the executives’ shares in a dark pool. The details of the transactions would never see the light of day.

Another Geek Interlude: A dark pool consists of the many and various shares held by an investment bank on behalf of all its clients. So, if a client wants to buy shares in Apple, the broker does not go directly to the stock market, they first check if any of the bank’s other clients want to sell Apple shares. Given the size of the major investment banks, that is a highly probable coincidence of events. The transaction is done within that one investment bank and nobody but the broker knows any of the details. Often the clients don’t know how it was done.

Prime Pay for Poor Performance

Now comes the salt in the wage earners’ wound: the highest-paid CEOs run some of the worst-performing corporations. Companies that gave their CEOs higher stock incentives had below-median performance according to research by Ric Marshall of Morgan Stanley Capital International. As Marshall summarized his findings: “Has CEO pay reflected long-term stock performance? In a word, ‘no.'”

At this point, let’s recall that in banking, executive pay generally is largely based on fake profits from synthetic derivatives. Here’s how Warren Buffett explained it in that legendary 2002 letter to Brookshire Hathaway shareholders: “I can assure you that the marking [valuing] errors in the derivatives business have not been symmetrical. Almost invariably, they have favored either the trader who was eyeing a multi-million dollar bonus or the CEO who wanted to report impressive “earnings” (or both). The bonuses were paid, and the CEO profited from his options. Only much later did shareholders learn that the reported earnings were a sham.”I will note, nothing is done to reclaim the bonuses.

Taxing the Corporations is Questionable

Back in the early 1900s, J Pierpont Morgan said that executive salary should never be more than 20 times the average worker pay. That was the ratio until about 1965 when the gap started to widen.

An obvious solution that should invoke support from both Republicans and Democrats is that there should be no entitlement to government grants, subsidies or tax breaks unless the executive/worker pay gap is acceptable. Otherwise, these corporate welfare benefits are subsidizing executive pay.

While I applaud the efforts of this dedicated team from the Senate and House for introducing legislation to tax the corporation for the pay gap, I question why they want to tax the corporation. The executives don’t care how much the corporation pays in tax. Why isn’t this tax directed right at the executive compensation so that if any executive makes more than, say, 20 times the median worker salary, that excess is fully taxed - no exemptions, no loopholes? Everything extra would be gripped from their greedy grasps.

Opinion // Business / CEO Pay / Economy / Stock Buybacks