Executive Pay Is Even More Outrageous Than We Thought!

The fact that executive pay at big corporations has been soaring over the past few decades while wages of almost everyone else have stagnated or fallen is well known.  What is less well known, are the various games corporations and executives can play to manipulate both the value of the compensation and the level of taxation.  Robert B. Reich included a chapter titled “The Hidden Mechanism of CEO Pay” in his book Saving Capitalism: For the Many, Not the Few in which he provides details.

“Anyone who still believes people are paid what they’re worth is obliged to explain the soaring compensation of CEOs in America’s large corporations over the past three decades….Overall, CEO pay climbed 937 percent between 1978 and 2013, while the pay of the typical worker rose 10.2 percent.”

One might assume that an individual receiving a lofty salary is a small perturbation on a large corporation’s balance sheet, but the CEO is not the only executive rewarded with large paychecks.

“The share of corporate income devoted to compensating the five highest-paid executives of large public firms went from an average of 5 percent in 1993 to more than 15 percent in 2013.  Not incidentally, this was money corporations could have invested in research and development, additional jobs, or higher wages for average workers.”

The compensation packages for executives are large enough to make a significant dent in corporate income.  Fortunately, corporations have friends in Washington who have helped them by making most executive compensation tax deductible.  Huh!

“….in 1993, the Clinton administration decided to allow companies to deduct from their taxable income executive pay in excess of $1 million if that pay was linked to corporate performance—that is, if it came in the form of stock options and awards linked to share prices.  Not surprisingly, stock options thereafter boomed.”

So, if you hear someone complaining about the ties between the Clintons and Wall Street, pay attention.

“Meanwhile, you and I, and other taxpayers are subsidizing all this….because corporations deduct CEO pay from their income taxes, requiring the rest of us to pay more proportionally to make up the difference.  To take but one example, Howard Schultz, CEO of Starbucks, received $1.5 million in salary for 2013, along with a whopping $150 million in stock options and awards.  That saved Starbucks $82 million in taxes.”

All those executives and all that money add up.  Their rewards are significant economy-wide.

“The Economic Policy Institute estimated that between 2007 and 2010, a total of $121.5 billion in executive compensation was deducted from corporate earnings.”

To put this in perspective, Reich points out that federal government expenditures in 2011 on the Temporary Assistance for Needy Families (welfare) program, school lunches for poor kids, and Head Start together added up to less than $50 billion.  Corporations seem to have been granted a welfare system of their own.

The move to stock options and awards for executive compensation is not without its own tax advantages: cashing in stock shares allows one to claim capital gains which are taxed at a lower rate than regular income.

Of more concern are the perverse incentives inherent in this system of reward.    The increased use by corporations of stock options or rewards as compensation has been coupled with a rise in the tactic of allocating income to the buying back of publicly-held shares.  Sometimes money is even borrowed for this use.

“This maneuver pumps up share prices by reducing the number of shares owned by the public.  A smaller supply effortlessly increases the price of each remaining share.  In recent years, such buybacks have become a major corporate expenditure.  Between 2001 and 2013, they have accounted for a whopping $3.6 trillion in outlays of companies in the standard & Poor’s 500 index.”

Companies must report the fact that a buyback has been authorized, but they do not have to announce when they are to occur.

“Buybacks are executed anonymously through the company’s broker.  So share prices can rise without investors having any idea that buybacks are the cause.  (If they knew of the artifice, they might be less willing to buy or hold the shares of stock.)  Yet CEOs can use their inside knowledge of when the buybacks will occur and how large they’ll be in order to time their own stock sales and exercise their own stock options.  Presumably, they’ll time them to coincide with the rise in share prices, which all too often is temporary.”

An incentive has been created to manipulate a company’s stock price to enhance the earnings of the company’s executives.  What could be wrong with that?

“If this sounds a lot like insider trading, or a conflict of interest with the CEO’s fiduciary duty to shareholders, it is no coincidence.”

The argument is made that share buybacks that drive up the value of investors’ shares is equivalent to giving shareholders income that can be taxed at the capital gains rate rather than as regular earnings in the case of a dividend.  However that only holds if the stock maintains the gain in value over the long term.  The argument falls apart completely if the buyback funds would have better spent in R&D or other investments, and company performance suffers in the future.  Reich has some thoughts to express on that matter.

The main point Reich wants to make is that the explosive rise in CEO pay has not been justified by improvement in CEO performance.  He—somewhat gleefully—reported the results of a study by three professors: Michael J. Cooper, Huseyin Gulen, and P. Raghavendra Rau.  They compared the performance of 1,500 large companies as correlated with CEO pay across various industries, and over three-year time periods covering the years 1994 to 2011.

“They discovered that the 150 companies with the highest paid CEOs returned about 10 percent less to their shareholders than did their industry peers.  In fact, the more these CEOs were paid, the worse their companies did.  Companies that were the most generous to their CEOs—and whose high-paid CEOs received more of that compensation as stock options—did 15 percent worse than their peer companies, on average.”

It is outrageous that corporate executive compensation is such a large component of our economy.  It is even more outrageous that corporations don’t seem to know what to do with their earnings other than to increase their executives’ salaries and to manipulate their stock prices.  That is no way to run an economy.  We will all suffer in the long run if companies do not spend wisely, including delivering some of that profit back to workers as higher wages.  The nation’s corporations cannot continue to grow earnings indefinitely when consumers don’t have growing incomes.