New Study Finds Top Executives Pocketed a Huge Chunk of the Trump-Radical Republican Tax Cuts
By Dean Baker, Center
for Economic and Policy Research
The
basic point is CEOs and other top executives rip off their companies. The
officers are not worth the $20 million or more that many of them pocket each
year.
Again,
this is not a moral judgment about their value to society. It is a simple
dollars-and-cents calculation about how much money they produce for
shareholders. The piece suggests that it is nothing close to what they pocket.
This
is a big deal because it is yet another piece of evidence that executives are
able to pocket money that they did nothing to earn.
It is no more desirable to pay a CEO $20 million if someone just
as effective can be hired for $2 million than to pay an extra $18 million for
rent.
In
the case of these tax cuts, company profits increased because of a change in
government policy, not because their management had developed new products,
increased market share or reduced production costs. Some of them presumably
paid for lobbyists to push for the tax breaks, so their contribution to higher
profits may not have been exactly nothing.
There
is much other work along similar lines. An analysis of the pay
of oil company CEOs found that they got large increases in compensation when
oil prices rose. Since the CEOs were not responsible for the rise in world oil
prices, this meant they were getting compensated for factors that had little to
do with their work. A more recent study found the same result.
Another study found that CEO pay soared in the 1990s because it seemed that corporate boards did not understand the value of the options they were issuing.
A
few years ago, Jessica Schieder and I wrote a paper showing that
the loss of the tax deduction for CEO pay in the health insurance industry,
which was part of the Affordable Care Act, had no impact on CEO pay.
The
loss of this deduction effectively raised the cost of CEO pay to firms by more
than 50%. If CEO pay were closely related to the value they added to the
company’s bottom line, we should have unambiguously expected to see some
decline in CEO pay in the industry relative to other sectors. In a wide variety
of specifications, we found no negative effect. Bebchuk and Fried’s book, Pay Without Performance,
presents a wide range of evidence on this issue.
Ripping Off Companies
As
can be easily shown the
bulk of the upward redistribution from the 1970s was not due to a shift from
wages to profits, it was due to an upward redistribution among wage earners.
Instead of money going to ordinary workers, it was going to those at the top
end of the wage distribution, such as doctors and dentists, STEM [science,
technology, engineering and math] workers, and especially to Wall Street trader
types and top corporate management. If we want to reverse this upward
redistribution then we have to take back the money from those who got it.
If
top management actually earned their pay in the sense of increasing profits for
the companies they led, then there would be at least some sort of trade-off.
Reducing their pay would mean a corresponding loss in profit for these
companies. It still might be desirable to see top executives pocket less money,
but shareholders would be unhappy in this story since they will have fewer
profits.
But
if CEOs and other top management are not increasing profits in a way that is
commensurate with their pay, their excess pay is a direct drain on the
companies that employ them.
Money Thrown in Garbage
From
the standpoint of the shareholders, it is no more desirable to pay a CEO $20
million if someone just as effective can be hired for $2 million than to pay an
extra $18 million for rent, utilities or any other input. It is money thrown in
the garbage.
As
I have argued in the past, the excess pay for CEOs is not just an issue because
of a relatively small number of very highly paid top executives. It matters
because of its impact on pay structures throughout the economy. When the CEO
gets paid more, it means more money for those next to the CEO in the corporate
hierarchy and even the third-tier corporate executives. That leaves less money
for everyone else.
The
Ohrn study found that 15% to 19% of the benefits of the tax breaks he examined
went to the top five executives. If half this amount went to the next 20 or 30
people in the corporate hierarchy, it would imply that between 22% and 37% of
the money gained from a tax break went to 25 of the highest paid people in the
corporate hierarchy.
If
the CEO is getting $20 million, then the rest of the top five executives are
likely making close to $10 million; the next echelon making $1 to $2 million.
If
we envision pay structures comparable to what we had in the 1960s and 1970s,
CEOs would be getting $2 to $3 million. The next four executives likely would
earn $1 to $2 million. The third tier would be paid in the high six figures.
With the pay structures from the corporate sector carrying over to other
sectors, such as government, universities and non-profits, we would be looking
at a very different economy.
Arranging Their Own Pay
If
CEOs really don’t earn their pay, the obvious question is how do they get away
with it? The answer is they largely control the boards of directors that
determine their pay.
Top
management typically plays a large role in getting people appointed to the
board. Once there, the best way to remain on the board is to avoid pissing off
your colleagues. More than 99% of the directors nominated for re-election by
the board win their elections.
Being
a corporate director is great work if you can get it.
As
Steven Clifford documents in his book, the CEO Pay Machine, which
is largely based on his experience at several corporate boards, being a
director can pay several hundred thousand dollars a year for 200 to 400 hours
of work. Directors typically want to keep their jobs, and the best way to do
this is by avoiding asking pesky questions like, “Can we get a CEO who is just
as good for half the money?”
While
many people seem to recognize that CEOs rip off their companies, they fail to
see the obvious implication that shareholders have a direct interest in
lowering CEO pay.
For
example, a common complaint about share buybacks is that they allow top
management to manipulate stock prices to increase the value of their
options. (Editor’s note: Before 1982, buybacks were illegal,
deemed a form of manipulation.)
If
this is true, then shareholders should want buybacks to be more tightly
restricted, since they are allowing top management to steal from the company.
If shareholders actually wanted CEOs to get more money from their options, they
would simply give them more options, not allow them to manipulate share prices.
Yet, somehow buybacks in their current form are still seen as serving
shareholders.
Shareholders Losing Out
As
a practical matter, it is easy to show that the last
two decades have not been a period of especially high returns for shareholders.
This is in spite of the large cut in corporate taxes under the Trump
administration.
There
seems to be confusion on this point because there has been a large run-up in
stock prices over this period. Much of this story is that shareholders are
increasingly getting their returns in the form of higher share prices rather
than dividends.
Before
1980, dividends were typically 3% to 4% of the share price, providing close to
half of the return to shareholders. In recent years, dividend yields have
dropped to not much over 1%, with the rest of the return coming from a rise in
share prices. If we only look at the share price, the story looks very good for
shareholders, but if we look at the total return, the opposite is the case.
If
CEOs really are ripping off the companies they lead, then shareholders should
be allies in the effort to contain CEO pay. This would mean that giving
shareholders more ability to control corporate boards would result in lower CEO
pay.
As
with much past work, Ohrn’s study found that better corporate governance
reduced the portion of the tax breaks the CEO and other top executives were
able to pocket.
Reform Proposal
There
are many ways to increase the ability of shareholders to contain CEO pay, but
my favorite is to build on the “Say on Pay,” provision of the Dodd-Frank
financial reform law. This provision required companies to submit their CEO
compensation package to an up or down vote of the shareholders every three
years. The vote is nonbinding, but it allows for direct input from
shareholders. As it is, most pay packages are approved with less than 3% being
voted down.
I
would take the Say on Pay provision a step further by imposing a serious
penalty on corporate boards when a pay package gets voted down. My penalty
would be that they lose their own pay if the shareholders vote down the CEO pay
package.
While
a small share of pay packages get voted down, my guess is that if just one or
two corporate boards lost their pay through this route, it would radically
transform the way boards view CEO pay. They suddenly would take very seriously
the question of whether they could get away with paying their CEO less money.
I
also like this approach because it is no more socialistic than the current
system of corporate governance. It would be hard to make an argument that
giving shareholders more control over CEO pay is a step toward communism.
The
basic point here is a simple one: The rules of corporate governance are
unavoidably set by the government. There is no single way to structure these
rules. As we have now structured them, they make it easy for CEOs to rip off
their companies. We can make rules that make it harder for CEOs to take advantage
of their employers and easier for shareholders to contain pay.
Progressives
should strongly favor mechanisms that contain CEO pay because of the impact
that high CEO pay has on wage inequality more generally. And, shareholders
should be allies in this effort. There is no reason for us to feel sorry for
shareholders, who are the richest people in the country. They can help us
contain CEO pay and we should welcome their assistance.