Executive Pay and "The Market Economy"

It's pretty hard these days to justify astronomical executive pay. In 2007, the average CEO's pay of $10.5 million was 344 times higher on average than the average worker's wage, according to Executive Excess 2008, a joint report from the Washington, D.C.-based Institute for Policy Studies and Boston-based United for a Fair Economy. The top 50 private investment fund managers each took home more than 19,000 times the average worker's earnings.

But never fear, Jack and Suzy Welch -- the former high-flying CEO of General Electric and his wife, the former editor of the Harvard Business Review -- are willing to defend high executive pay by return to first principles and invocation of "the market economy."

In a recent issue of Business Week, they write, "Yes, most CEOs make a ton of money, and sometimes they make too much, but in a market economy salaries are set by supply and demand. We also live in a market economy where companies that field the best teams win, and, because of global competition, the best teams tend to be expensive."

There are several decisive rebuttals to this claptrap.

First, there is no plausible market-based story why executive pay should have been bid up so much over the past quarter century. Are executives working harder now? Making better decisions? Has the CEO supply and demand equation changed?

Second, executive pay is not set by the market, but by boards of directors, who frequently are CEO cronies and excuse their behavior by relying on conflicted compensation consultants.

Third, the most super-high compensation packages are typically based on performance standards, with executives cashing in on stock options as share values rise. But this is a system easily gamed, with those same shares sold before short-term thinking leads to medium-term losses. By way of example, consider the massive pay packages obtained by the ousted CEOs of the now-floundering Wall Street firms.

And now comes a new analysis that further debunks the market-based rationalization for ridiculous CEO compensation levels. Executive Excess 2008 shows how taxpayers are helping foot the bill for these outrageous compensation packages.

Executive Excess 2008 highlights five distinct U.S. tax subsidies for executive pay. These are actually market distorting, in that they let top executives and investment fund managers take home more than they would if they played by the same tax rules as regular people. Altogether, Executive Excess 2008 reports, the five tax loopholes heap $20 billion in subsidies on the corporate and hedge fund honchos.

* The hedge fund manager loophole, involving what is called "carried interest," enables investment fund managers to treat most of their salaries as capital gains, and to pay taxes at the capital gains rate, rather than the ordinary income tax rate. Annual cost to taxpayers: $2.6 billion.

* The pensions for the rich loophole. While regular people can place a maximum of $15,500 in 401(k) plans -- deferring taxes until they withdraw the money -- CEOs can place unlimited amounts in deferred pay plans. Annual cost to taxpayers: $80 million.

* The offshoring loophole. Although companies cannot deduct the expense of executive compensation in deferred accounts, this is no problem for businesses registered in offshore tax havens. Set up an offshore subsidiary, and you can deduct the deferred income from revenue. Annual cost to taxpayers: $2 billion.

* The greed loophole. Money spent on wages and salaries are deducted from corporate revenues, and is not taxable. For top executives, however, U.S. tax rules impose a limit: corporations cannot deduct salaries and compensation that is more than "reasonable." An effort to define reasonable as $1 million has been entirely circumvented -- and corporations can, in effect, deduct whatever they pay CEOs. Annual cost to taxpayers: $5.2 billion.

* The double-standard loophole. Stock options -- the right to buy stock at a preset value, at a later date -- are now a huge component of executive pay. For their internal accounting, corporations value stock options using the value of the stock on the date of the option grant. For tax purposes, however, they can deduct the generally much higher value of the stock on the date the options are exercised. In other words, they can deduct more than they list as their expense. Annual cost to taxpayers: $10 billion.

Not long ago, it was possible to argue that executive pay was an important but symbolic issue. But then it became clear that ever-escalating executive pay is creating a culture of greed that is fueling income and wealth inequality. And now it has become clear that executive pay schemes are contributing to corporate practices harmful not only to workers, consumers, communities and the environment, but to corporations themselves, and even to the functioning of the economy.

The foolish and inexcusable housing-related investments by Wall Street firms, Fannie Mae and Freddie Mac resulted in no small part from executive compensation-driven efforts to drive up short-term stock values. These decisions were so bad, and of such enormous scale, that they have endangered the functioning of the financial system itself, thereby necessitating government intervention and massive taxpayer expenses -- an indirect but even more expensive taxpayer subsidy for executive compensation.

A "market economy" indeed.

Comments

[BBackSoon]

My problem with stocks going up is that in the quest for the all mighty dollar the employees get the shaft. We have a culture that tells us that as long as the company does well we will all do well. That does not seem to be the case. I work for a major Manufacturing Corporation. My company does fairly well year after year. Big Dogs get big money with bonuses along with all of the other pay package perks that this brings, but we are constantly moving manufacturing out of the states, employing offshore IT contractors and call center employees. They have also diminished raises to the point that they will not even cover the yearly increases in Health Insurance Premiums. All of this ads up to a better bottom line with more profit and therefore bigger bonuses for the Executives.

I am no economist but when my CEO gets his 10+ million a year, that money never does trickle down to me. If he buys a new top of the line Benz, that does not help me. If he buys a new yacht, still no help. I guess if he buys into a sports team and I give a $hit, that might affect my life but it really doesn’t help me heat my house.

Perhaps we are approaching our own Bastille Day?

[Aaror]

Tax number 6, the poor choices tax.
High executive compensation creates motivation to try to reach the top for greed, rather than merit. This means that someone who wants to enrich themselves will have more motivation than someone who wants to help the company. Also, it may be financially advantagous to sabatoge co-workers to climb the corporate ladder, even though it harms the company. Big business seems to have an efficiency problem that small businesses don't, could this be the reason? In any case, this problem depresses corporate earnings, costing taxpayers billions, and causes layoffs that the taxpayer has to pay unemployment for.

[bugdog]

Stock options as compensation should be banned.

Capital gains should be taxed at 50% unless they are management compensation; then it should be 75%.

All deferred compensation should be capped at the 401k level.

And people who offshore should be executed.

[Yvan]

Quoting from University Of Chicago studies on Executive pay:

http://faculty.chicagogsb.edu/workshops/AppliedEcon/archive/pdf/FrydmanSecondPaper.pdf

Prior to World War II, average compensation of top executives was about 63 times higher
than average earnings This ratio fell significantly during the war years,
so that by 1945 the remuneration of top executives was 41 times average earnings.

This compares to 344 times the average pay now days, as stated above.

Executive pay is directly related to tax laws. When tax laws are very progressive then pay is lower. When it is regressive as today, then pay is very high.

You want to fix the problem ? Then just change the tax laws.

[proreality]

Class warfare?!

[PacificGatePost]

You might review your number of 2 billion as the total cost to taxpayers for all the "offshoring." That may be for deferred compensation, but not for the total loss from capital sitting offshore.

The total held in offshore accounts is in the hundreds of billions, so the real cost or "loss" to the national economic basket is much greater than 2 billion dollars.

There is also the unrecorded benefit to CEOs of getting in on brokerage deals of other companies. Once the brokerage firm slices them in, they are "bought." From that point on they will do their broker's bidding. This creates peculiar deals that shareholder don't underderstand.

[PacificGatePost]

ROBERT,

Well done.

Welsh is hardly an example of a principled and fiscally diligent executive. The media made him a hero, but the fact remains he was lucky, and abused the system to his own advantage. On top of that, he was worshiped for it.

"You get away with what you can get away with."

The whole system should be reorganized so that CEO's report to Boards of Directors, and not to themselves. The capitalist system is broken and badly needs repair at the top.

Abuse holds no pretty end games.

[Aaror]

I recently read an article called "Level 5 Leadership," by Jim Collins. It discussed how the small minority of companies which achieve greatness are led by leaders who do not seek the spotlight or talk about how great they are. The opposite of the Donald Trump/Lee Iacoca model. Those CEO's seek what is best for the company, even going so far as to seek a successor who is good for the company. By contrast, most of the "big name," leaders seem to choose a successor who crashes the company, coincidentally making them look great by comparison.
This is like paying a quarterback on the basis of how good his trash talk is, even when he refuses to let the second string quarterback practice with the team. It is great for the quarterback, but lousy for the team both when he is playing, and when he is replaced.
Now that we know that the best results are from quiet, modest CEO's who put the company before their own fame, we may not want to pay so much for loudmouthed CEO's who don't put the company first. But until Wall Street learns this, expect the CEO's who want big bucks to keep grandstanding to hide their mediocrity.
I mention all this because it explains both the high pay, and the low performance. These CEO's are looking out for themselves, not the company. If you can get shareholders to seek better leadership and appropriate pay, stocks will go up.

[MajorKong]

These guys all sit on each other's boards of directors and vote each other pay raises. It's like a big corporate circle jerk.

[Paul]

Too bad the leadership of American business is not guided by what is best for society.

I guess its all about cashing in your stock options before the company goes belly-up.

Can Mr. Welch put a cost on that?

[itolduso]

I remember a time when 'intent to defraud' was a criminal offence, and the Justice Department would actually investigate & prosecute... nowadays, the more 'criminal' the intent, the more they're admired. I must be getting old.

[JBS]

Yeah, but that was back before the Justice Department itself became the country's largest criminal conspiracy.