Executive Compensation in the US

Executive Compensation in the US

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Rising year on year, seemingly irrespective of company performance, US executive pay is eye-watering. For decades now, its increase - the small blip following the financial crisis aside - has been rapid. As their wallets have bulged, however, CEOs’ standing in the public eye, has fallen precipitously - plotted on a graph the relationship between the two would make a big X. And this is a significant shift. It wasn't long ago that the American entrepreneur was heralded as an almost mythical figure: the embodiment of all that was good about the country; the opportunity it afforded; the work ethic it rewarded; the fact that with the right attitude anything was possible. They were the American Dream in action; evidence that it could be made real. Fast forward to 2019, however, and a cocktail of  increasingly unethical business practice, rank inequality, and precarious work have put paid to this reputation. Celebration has been replaced by suspicion, and where reverence was once felt there now exists resentment. It’s hardly surprising either: in a country where medical debt is approaching $81 billion, is it really possible to justify a $129.4 million salary like which was recently paid to Discovery Inc. CEO, David Zaslav?

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Free-market logic?

Many rail against such incomes, branding them a symbol of all that’s wrong with the current economic and political systems. A smattering of others simply can’t make sense of them, the figures, somewhat perversely, too large to hold any value. And then there are the fundamentalist free-marketeers who wonder what all the fuss is about. While conceding that yes CEO pay may sound excessive, they defer to the authority of the market, in all its infallible glory, to explain that incomes are, in fact, exactly where it should be, and merely a reflection of CEOs’ worth. If a boss receives 300 times more pay than their average worker, it because their contribution adds 300 times more value to the company. And with that, typically, the conversation is over. Pushed for more detail, and they’ll likely bristle, accusing the questioner of engaging in unsavoury acts of envy and spite, which, by anyone’s standard is not a good look. ‘Work harder’ the more sassy among them sometimes like to part with, ‘maybe one day you can make it too’.

But is this explanation really good enough? And are these ‘market-designated’ earnings actually fair? Suggestion that a CEO contributes 300 times more value to a company than a worker does sound, on first hearing at least, rather outlandish; they remain a human being after all. Is any one individual really that valuable? On investigation, and using the same free-market logic defenders of CEO pay rely on, the answer looks like a resounding no. In fact, three key reasons emerge - discussed below - that reveal exec pay to be far from natural and point instead to it being profligate, unjust, and sometimes even corrupt. 

Executive compensation in the USThe great divergence

American CEOs today earn approximately 10 times more than their predecessors of the 1960s and 70s, despite overseeing companies that are, in relative terms, far less successful. During this time, the ratio of CEO compensation to the average worker has also majorly distorted. In the 60/70s, it lay somewhere in the region of 30-40 to 1 - already excessive in some people’s eyes. By the 2000s, owing to rapid rise in the 80s, it had reached a whopping 300-400. Worker wages, on the other hand, were estimated by the Economic Policy Institute (EPI) to have grown just 13% between 1973-2006. 13% in 33 years: that is less than half a percent per year; essentially, that is stagnancy. Provided with these statistics, a free-market enthusiast’s only available conclusion would be that CEOs became ten times more productive in a period in which workers’ productivity remained almost exactly the same. Give that a second; let that supposition sink in.

A common justification for this steep rise is that as companies have got bigger in size, the importance of the CEO has grown commensurably: shrewd decisions made by the CEO of a billion dollar company, the argument goes, could easily increase company earnings by a few million. Also, to ensure the best candidate is secured, top dollar must be paid, lest they be poached by a rival company. With this in mind, surely it makes sense that these factors are reflected in the size of the pay packet? Well, no, not exactly. Although, there may be some small kernel of truth to the growing importance of the CEO, it doesn't account for the magnitude or manner of wage increase that we’ve seen. For one, it overlooks the fact that wages increased most rapidly in the 80s, even though company size had been growing for some time before. And more importantly, it doesn’t explain why, as bosses lined their pockets, workers’ pay flatlined. By the argument’s own logic, workers, too, should have experienced significant wage increase, as, owing to the complex cooperation and divisions of labour customary in large institutions, they also assume greater importance as a company grows. How else can you explain HR departments?

America the anomaly

Observations made by Cambridge Professor, Ha-joon Chang, further undermine these justifications. He posits: if ‘the increasing importance of top managerial decisions is the main reason for CEO salary inflation why are CEOs in Japan and Europe running similarly large companies paid only a fraction of what American CEOs are paid?’ Are Americans bringing something priceless to the party simply by virtue of being American? The EPI, again, provide reliable statistics on the matter, showing that in the 2000s German CEOs were paid 55% of what their American counterparts received, the Dutch just 40%, and the Japanes an almost unbelievably low 25%. Notably these figures do not include stock options granted to CEOs, which, in the US, are typically much higher. Chang has estimated that when stock options are included, Japanese CEOs’ compensation totals just to 5% of their US counterparts. More recent data compiled by Harvard’s Forum of Corporate Governance and Financial Regulation has shown that US CEO pay has continued to increase into the 2010s, whereas in Europe pay has been far more volatile, and across the region as a whole has fallen each year since 2015.

It’s not that American CEOs are running their companies any better, either. To the contrary, Chang highlights that in many cases they are actually being outperformed by their European and Japanese equivalents. He also discounts American CEOs enjoying better wages because wages, generally, are higher in America, for outside of highly skilled employment, it simply isn't true - wages are, in fact, rather similar. Japanese workers make around 90% of Americans, while in comparison with German workers, Americans actually receive less.

Insulated from market forces

Their legitimacy aside, there is the question of whether we should even care. If a company are silly enough to pay their CEO fiendish amounts, let them. Thriftier outfits with more sensible compensation packages will eventually outperform, and then eliminate them - market forces will see to it. Unfortunately, history has shown this function cannot be relied on, for two main reasons. First, the process of eliminating excessive CEO pay is incredibly slow: one need only remember the decades prior to General Motors’ bankruptcy, during which top managers continued to receive huge salaries and bonuses even as the business was collapsing - nothing done to check the blatant injustice. The second reason, which partially accounts for the first, is the power the managerial class have acquired, both within their own companies, thanks to their pay, and politically, also thanks to their pay. This phenomenon is particularly acute in the US, where the line between business and politics is so blurry it’s practically invisible - the revolving door connecting Washington and Wall Street now an accepted reality. So close are ties, many private CEOs actually end up heading government departments, and lobbying influence, often funded by those very same CEOs, has never been greater. Wielding such enormous power has allowed them, rather easily it should be said, to insulate their pay from both market forces and governmental regulation. The result: the average salary of a US CEO is $15.6 million,

The aftermath of the financial crisis was the clearest demonstration of this in action. Despite known criminal behaviour and major malpractice among the managerial ranks, few of those implicated lost their jobs, even less took a pay cut, and there was high-profile resistance (ultimately successful) against attempts made by the US congress to cap the pay of managers of financial firms. Rarely, if ever, has there been such a public display of how unfair the system really is - it’s supposed to punish inefficiency and mismanagement. Instead, it rewarded them, and in doing so, confirmed what the above also argues: that exec pay isn't natural or deserved, and its existence alone is not evidence of its legitimacy. Rather, it’s the result of greed, a lack of regulation, and foul play. It must be changed.

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