Tuesday, 23 June 2015

The CEO Backlash

(Mark Wilson/Getty Images)
 
“Prosperity can’t be just for CEOs and hedge-fund managers” - Hillary Clinton.
 
It seems inevitable that the unfolding presidential campaign will also become a referendum on American capitalism and, in turn, that capitalism will be defined in part by lofty executive pay. 
 
This makes chief executive officers among capitalism’s worst advocates. They have constituted themselves as a new economic aristocracy, but in the process they’ve become an engine of inequality and sacrificed much public trust.

Lavish CEO pay is no secret. Reviewing the largest 350 firms, Lawrence Mishel and Alyssa Davis of the left-leaning Economic Policy Institute find that chief executive pay averaged $16.3 million in 2014. The New York Times, citing estimates from the consulting firm Equilar, reports that the 200 best-paid CEOs averaged $22.6 million.

To be fair, some qualifications.

Even Mishel concedes that CEO pay is below previous peaks in 2000 and 2007, mainly because the stock market has lagged (CEO compensation routinely includes large stock grants). Still, CEOs have far outpaced most workers. In 1965, the ratio of CEO pay to the pay of typical workers was 20 to 1, Mishel estimates. Now it’s 300 to 1.

Next: These wage gaps may apply only to the largest companies. A new study attributes most of the growth of wage inequality since the 1980s to differences between firms. Pay at the most productive companies (so-called “super firms”) rose much faster than average, but “within a given firm, wage inequality increased little,” says University of Minnesota economist Fatih Guvenen, a study co-author. There are 6 million U.S. businesses, he notes. What’s true of a few thousand huge firms doesn’t describe highly successful small and medium-sized companies.

Finally: CEOs and finance executives (bankers, traders, hedge-fund operators) aren’t the only super-rich. By one study, they represented 43% of the wealthiest 1% in 2005. Others included doctors (14%), lawyers (8%), engineers and computer specialists (4%), entrepreneurs (3%) and celebrities and athletes (2%).

What’s incontestable is that there’s been a revolution in how - and how much - top CEOs are paid. After World War II, executive pay (adjusted for inflation) barely inched ahead, according to a study by economists Carola Frydman of Boston University and Raven E. Saks of the Federal Reserve.

In the 1960s and ’70s, gains averaged about 8% and 12% compared with the previous decade. Most compensation, almost 90% in the 1960s, was paid in cash as salary and bonuses.

The Depression-World War II era managers were generally self-restrained. They didn’t want to reignite the ideological battles of the 1930s, when business was blamed for the economic collapse. They feared unions. But they also believed in the innate superiority of American management. CEOs were usually company insiders. They drew their public legitimacy by orchestrating national prosperity.

All this changed in the 1980s. The World War II-era managers retired. U.S. companies were besieged by foreign competitors in many industries: steel, autos, electronics. U.S. managerial superiority was a myth. The high interest rates deployed to suppress double-digit inflation threatened many firms’ survival. 

These pressures transformed the CEO’s role. More corporate outsiders were recruited. Pay was increasingly tied to stock prices to give managers incentives to improve firm profitability. By the 1990s, nearly half of CEO pay consisted of various stock awards and long-term bonuses, says Frydman.

Americans favor people getting rich; but to be socially acceptable, wealth needs to be earned. The trouble with some - though not all - CEO wealth is that it resulted from good luck or good connections, not good management.

From 1982 to 2000, stocks rose by a factor of 12 (in 1982, the Dow averaged 884; in 2000, 10,735). The huge increase mostly reflected the elevating effects of lower inflation and interest rates. CEOs had nothing to do with this, but they benefited enormously from the rising market. It was a huge windfall. Executive pay ascended to stratospheric levels from which it has not returned.

It would be nice to say there’s a simple fix for this. There isn’t. Having the government set executive compensation would create an administrative morass and invite political grandstanding. Nor will companies fundamentally rein in executive pay. Some incentives are desirable, though designing them is difficult. Executives believe they deserve what they get (who doesn’t?), and few firms will put themselves at a disadvantage in competing for managerial talent.

What remains is a politically vulnerable system. CEO capitalism creates incentives for executives to favor policies - reducing jobs or research and development - that boost stock prices for a few years at the expense of long-term growth. How much of this is a real problem as opposed to a rhetorical debating point is unclear. But the contrast between executives’ rich rewards and the economy’s plodding performance suggests why CEOs have become political punching bags.

No comments:

Post a Comment