A lot of money flows from the 99% to the executive officers of companies. For privately held companies, the process of deciding how much to pay the CEO and the other executive officers is simple: the CEO, as the principal owner, just decides on his or her own. Which is reasonable given that very often it’s the CEO who has provided a lot of the money and/or entrepreneurial or managerial skill which has created the revenue from which the CEO’s salary is paid.
For publicly held companies, the story is more interesting. We should first note that, depending on who is doing the counting and how, CEO’s are paid something like 420% more than the average worker in the country. Conservatives and the 1%, including CEO’s claim this happens because they work harder and are smarter than everyone else.
Obviously, American workers work very hard, often at 2 or 3 jobs, just to try and maintain their lifestyle or just get by. CEO’s don’t work 420% harder than that. And they are not 420% smarter than everyone else. In fact, in general, they often aren’t very good at their jobs. For those who doubt this, I suggest you visit the Harvard Business School (or a lot of other business schools for that matter) and read the numerous case studies that have been collected over the years showing considerable incompetence on the part of CEO’s and other executive officers of publicly held companies. Clearly, something else is at work in setting CEO income. To understand what is going on, it helps to look at the process by which CEO compensation is set.
Under the corporation laws of the states of the United States which laws control how corporations are run, at least in broad outline, the Board of Directors is responsible to the shareholders for how the corporation is run. Thus, it’s the Board of Directors who sets the compensation of the CEO. Usually, the Board is composed of people a majority of whom are not employed by the corporation. As a practical matter, the Compensation Committee of the Board makes a recommendation to the Board on CEO compensation, which recommendation is almost always adopted by the Board.
The Compensation Committee exists because the Securities and Exchange Commission (SEC) requires that publicly held companies tell shareholders if the company has a compensation committee of the board of directors, who is on that committee and which members, if any, are employees of the company. The company must also tell shareholders how the compensation committee has determined what the CEO’s compensation should be. However, the SEC is permitted by law only to require disclosure by publicly held companies; it cannot tell them how to run their business. (The New York Stock Exchange and NASDAQ have adopted similar disclosure requirements under pressure from the SEC for companies listed on those exchanges.) As a practical matter, however, publicly traded companies want to look good to their shareholders, so they all have these arrangements.
On the face of it, this arrangement looks reasonable. And if you read through the long report from the compensation committees in these companies’ proxy statements, it seems even more reasonable. Oddly, though, the outcome of this process is that CEO’s of publicly traded companies are often paid tens of millions of dollars, much to the dismay of the companies’ shareholders, both large and small. Indeed, almost everyone outside of the Board and the CEO’s think the system is broken. So what goes wrong?
What causes CEO compensation, and that of other executive officers to be so out of proportion to that of all other workers is that the Directors are selected and paid by the CEO’s. Not directly, of course, but indirectly. Boards of Directors have Nomination Committees of non-employee directors who nominate Directors for election each year. But those committees never nominate or re-nominate people to be Directors whom the CEO doesn’t want on the Board.
Further, being on the Board of Directors of a publicly held company is a good deal, and the bigger the company, the better the deal. The Directors get to set how much they get paid to be directors. It’s a nice piece of change. Then they get paid for attending meetings of committees and for their expenses in attending meeting. And for Board meeting, they don’t stay in the local Motel 6 nor do they eat at Outback Steakhouse. Sometimes Boards decide that they should have a retreat at a nice resort, which has a nice golf course. Sometimes Boards decide that they should visit a plant or office in a foreign country (and not a third world country), so they stay in an expensive hotel overseas and eat at expensive restaurants. And what do they care: it’s not their money they are pocketing and spending. It’s the shareholders’ money.
In this cozy world, no sane Director would annoy the CEO and risk not getting re-elected next year by suggesting no annual raise for the CEO or even worse, cutting his or her pay merely because of poor performance. Furthermore, most of the non-employee Directors have a good reason for voting to raise the CEO’s pay by significant amounts each year: it provides justification for the companies where they work raising their pay.
Directors of public companies are often CEO’s of other companies. One of the matters which Compensation Committees consider when creating an annual pay package for the CEO is comparing the pay packages of CEO’s of other companies. The argument is that if company A doesn’t pay its CEO in line with what companies B and C pay their CEO’s, then it won’t be able to keep its CEO. Obviously, this attitude creates an upward spiral of CEO compensation as each company’s Compensation Committee chases the CEO pay package of other companies. By sheer coincidence, there are executive pay consultants who are paid quite well by Compensation Committees, using the shareholders’ money, to produce reports showing why the company in question should raise the pay of the CEO to meet the alleged “market” standard.
All of this is bad enough in terms of hurting shareholders, including those who only have an indirect interest in public companies through their various retirement or pension plans, but there is a bigger problem that affects all of the 99%.
In order to try to justify completely unjustifiable compensation for CEO’s, compensation committees and their consultants create elaborate explanations of how the CEO’s compensation is actually “pay for performance” and not just a salary grab. Further, the payouts from bonus plans, stock option plans, restricted stock plans, etc., etc. all are based on the CEO reaching set “performance” targets. We’ll ignore the fact that when something bad happens that causes the company to have a bad year or two, the Board will lower the strike price for the options and the performance targets, and just look at how this system works when it plays by the rules, which admittedly the CEO has indirectly set up.
In all compensation plans for CEO’s performance means some combination of increased stock price and income. This would work fine for the economy if publicly held companies operated in an actual market economy. However, as all economists know, the US is not a market economy either as a whole or in any part of it. First, we should note that CEO’s of big companies don’t actually do much to affect the financial performance of their company. As John Kenneth Galbraith pointed out in his The New Industrial State, modern businesses are too complicated for the CEO’s to actually make decisions. Those are made by one, or more likely a group, of mid-level employees who have the technical expertise and information to make the decision. By the time the decision gets to the CEO for review, there is no way for him or her to actually redo the work of the multiple people who have worked on the decision based on their expertise. And when the CEO decides to override the decision or make one all on his or her own that is when we end up with a business school case study of bad decision making.
Second, the ideal way for a business to improve its income (and the way Econ 101 tells you things work), and hence its “value”, however you define that word, is to sell more product. However, for large companies this is hard and gets harder each year because those companies so dominate their markets, which are divided between 2 or 3 big companies, that just selling more widgets each year is very difficult. Which leaves two actual ways in which to increase income: raise prices for the company’s products or reduce costs or, preferably, both.
We’ll all familiar with how the prices of everything keep going up. Another way to do this is seen in the grocery store every day: keep prices for items the same but reduce the size of the cans or packages they come so less costs more. Since the CEO’s of the big companies who have divided up the markets in the US all have the same goal of getting richer by ripping off consumers, there is very rarely any price competition. If one CEO raises prices, they all do it because it’s found money for all of them.
Cutting costs in Econ 101 theory involves making production more efficient, but this really involves 2 processes not described in that course. Production can be made more efficient by making things cheaper, thus cheating customers. That’s why products don’t last as long and fall apart more easily than they used to: CEO greed. You can see this at work in any store.
The other cost cutting method is to cheat workers. Over time, CEO’s have moved the costs of medical insurance, pensions and numerous minor things onto the workers. By saving a little on each worker, CEO’s save themselves a lot of money. (None of this affects CEO’s because they get their Boards to pay for their medical costs, pensions, cars, airplane trips, etc. presumably because CEO’s are so bad at handling their own money they need help from the shareholders.) Obviously, the best way for CEO’s to save money on workers is to keep wages low, even if this means sending the jobs overseas to places where workers can be paid less. A subset is to pay women less and replace older workers with younger workers and to discriminate in hiring against older workers, who have to be paid more than younger less productive workers. Another subset is to fire the company’s workers and replace them with “contract workers” who are paid less by a theoretically independent third party.
In summary, what we have done in this country is to create a system where the CEO’s who control the largest companies are paid under a structure in which their greed can be fed only by ripping off customers, consumers, workers and taxpayers. They have no incentive to make better, cheaper products or to pay workers good wages and benefits. Put another way, the system under which CEO’s set their own pay based on incentives to screw everyone else is one of the big drivers of the income and wealth inequality.