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Executive Pay

John Quiggin writes about executive compensation and says corporate honchos make more than market considerations can justify. It's something I've heard frequently from liberals and occassionally from The Economist, and I'm more than convinced. What I've never quite heard is what we should do about it. I've got enough libertarian friends at this point to recognize that merely pointing out that a market failure exists isn't enough to demonstrate that a regulatory intervention would be better -- we've got "government failures" as well. If you get to assume a perfectly operating regulatory apparatus, then you can build a solid case for a planned economy. But you can't, any more than you get to assume a perfectly operating market system and then build a case for an unregulated economy.

Executives rig the system and get themselves compensation packages that are more than they deserve. What legal changes would improve things?

December 11, 2004 | Permalink


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Tracked on Dec 11, 2004 2:29:42 PM


I don't want the government involved in deciding how much executives can get paid! But it's fun to think of a maximum wage bill, isn't it?

The real correction here has to come from the shareholders and the company directors. They won't do anything if stock value is high. And when it drops for a length of time, the executive often leaves. It's also difficult for shareholders to organize outside of lawsuits, which I don't think are the right vehicle. Perhaps the sole remaining corrective source are the market analysts. I'd like to see them challenging companies for executive pay in the same way they do for acquisitions, business strategies, etc. But I wouldn't hold my breath for any of these options.

Posted by: Kathy | Dec 11, 2004 12:33:27 PM

"What legal changes would improve things?"

1.) Increase the marginal rate of taxation on incomes over, say, $1 million/year, to 50+%. The marginal rate was once as high as 70%, and the country prospered. A high marginal tax dampens the rewards to excessive greed.

2.) Regulate and limit deferred compensation in various ways. E.g. Require full public disclosure; require full financial accounting reporting (including the notorious options). Bar companies from creating "special" pension plans for one or a few employees -- corporate pension plans must apply universally -- there cannot be a fully funded, defined benefit plan for top executives, while the underfunded, defined contribution plan for everyone else plan is sent south. [Pension plans are already regulated and, to some extent, government guaranteed, so this is just policy tweaking).

3.) Loosen the restrictions of stockholder-control. Allow major stockholders, like pension plans and mutual funds, to nominate and elect Boards of Directors. Boards of Directors and other fiduciaries, including the company's outside auditors, should not hold their positions by the grace of the CEO, as is now the usual case. [Theoretically, a real libertarian, if there were such a thing, would not object to this approach.]

Posted by: Bruce Wilder | Dec 11, 2004 12:41:28 PM

This is supposed to be the province of the corporation's nominal owners, its shareholders. Diffuse ownership means no effective oversight, however - and if you really want to be discouraged, look at the fate of recently-fired CALPERS president Sean Harrigan.

Harrigan represented one of the few examples of a shareholder with clout ($177 bn in assets) trying to make management more accountable. So, of course, he was labeled a left-wing activist, targeted by the right, and dumped.

The only other market-based sanction is for shareholders to sell stock in under-performing companies. That's fine, but it really only punishes the worst management teams - who are generally able to reward themselves regardless, aided by friendly and hand-picked boards. Look at Disney: Michael Eisner has done a terrible job for the last decade, has obviously been there far too long, faces a well-organized shareholder revolt - led by a Disney! - and still cannot be dislodged.

And yet, I shudder at the thought of a legal remedy. In fact, I don't think there is one; all the attempt would accomplish would be to shift the form of compensation.

In my dreams, I imagine aggressive, independent boards casting their talent-search nets more broadly. In fact, why not consider outsourcing? Surely there are ambitious, over-achieving Indian managers who would jump at the chance to run a large American corporation for relative peanuts!!

Posted by: Dave L | Dec 11, 2004 12:41:29 PM

Corporate boards of directors are disproportionately made up of CEOs of other corporations. This is the real problem. Those CEOs feather each others nests. So, a non-regulatory fix would be a SEC rule that boards of directors may not have as members any CEO of another corporation. And, any member of a board of directors may not be hired as a CEO for any corporation for X years after being on a board. That alone would go far towards reducing the excessive CEO pay.

In addition, stock options should not be allowed as compensation for any corporate employees. Failing that, such stock options should be charged as business expenses at the current market value of the options. This would be to stop the rewarding of CEOs for raising stock prices as opposed to increasing corporate profits. Stock prices should reflect profits or profit potentials and not just a directed effort to raise stock prices.

Posted by: Vaughn Hopkins | Dec 11, 2004 12:46:45 PM

Not only the Economist, but also Business Week has written extensively on the subject of executive over-compensation for as long as I've been reading BW -- over 15 years.

More than legal regulation, the important thing is to get it out there in the minds of consumers and shareholders over and over and over again. Shame at having a bright light shined upon him was what prompted Jack Welch to give up his free-toilet-paper-for-life retirement deal with GE, although he still got to keep an unconscionable amount of scratch, relative to his value to the company.

What got Welch outed was his divorce, and even then he wouldn't have been outed if he hadn't tried to cheap out on his soon-to-be ex-wife. The main area where regulation would help is if the SEC were a lot tougher about forcing companies to reveal the details of their god-like offerings to their top management. But don't hold your breath waiting for anything like that to happen in an administration that believes the rulers should keep the ruled in the dark.

Posted by: S. Anderson | Dec 11, 2004 12:50:04 PM

It is a really, really, really, difficult problem, and anybody who puts forth facile solutions without extensively detailing what the unintended negative effects of those solutions might be is merely deceiving themselves or attempting to decieve others. For instance, the suggestion of re-instituting high marginal rates completely ignores the political dynamic of such an approach. Why does one think that credit card debt was once fully deductible, and real estate investing was once mostly a tax-shelter device ? Because people subjected to high marginal rates have a pronounced capacity to lobby elected representatives to create economically destructive tax provisions to avoid such rates. What's next, prevent rich people from voting, or more campaign finance reform, with it's excellent track record?

This is a great question, and I think the solution lies in getting shareholders to have more input over corporate boards, but I'll be damned if I have an easy way to do it.

Posted by: Will Allen | Dec 11, 2004 12:57:53 PM

But it's fun to think of a maximum wage bill, isn't it?

This is the problem, actually -- wage compensation to CEOs is limited to $1 million. They make most of their money in stock options and perks. The way to begin to solve the problem is to repeal the wage compensation laws and force companies to list stock options as liabilities so that executives' pay is more clearly available.

After that, I dunno. I think the mutual funds have to start protesting that they're getting shafted.

Posted by: Kimmitt | Dec 11, 2004 1:00:42 PM

The easiest solution, of course, is 95% tax bracket. Worked just fine in the 30s, 40s, 50s and 60s.

Posted by: abb1 | Dec 11, 2004 1:17:36 PM

> It is a really, really, really, difficult
> problem, and anybody who puts forth facile
> solutions without extensively detailing what
> the unintended negative effects of those
> solutions might be is merely deceiving
> themselves or attempting to decieve others.


But the people shooting down proposed solutions also need to very directly and honestly address why German (and to a lesser extent British) executives managed to achieve results equal to or better than those of their American counterparts at 1/10 or in some cases 1/100 the compensation.


Posted by: Cranky Observer | Dec 11, 2004 1:35:25 PM

Pierce the corporate veil. Make CEOs and the executive staff subject to prison when their company murders someone, defrauds someone, etc.

It won't reduce the compensation, but it will justify the compensation AND improve corporate behavior.

Posted by: jerry | Dec 11, 2004 1:40:27 PM

How about an "electoral college" type solution? A certain portion of board members have to be elected by shareholders- not by share number, but by investor number- and seperate each type of stock.

Posted by: TJ | Dec 11, 2004 2:13:09 PM

The best way to keep management in line is a healthy market for corporate control. The federal government and several states have actually made the problem of unaccountable executives worse by trying to discourage hostile takeovers.

Most of the comments here (especially Bruce Wilder's) seem to ignore the fact that the rules of corporate governance are a contract between the corporation and shareholders. If shareholders don't like the way executives are compensated, they are free to invest elsewhere. If shareholders care enough about these issues, corporations will be forced to forced to change their governance systems in order to attract investors. Allowing the government to interfere with the terms of a corporate charter is hardly a libertarian solution.

Posted by: Xavier | Dec 11, 2004 2:31:02 PM

One fairly simply (and commonly proposed) solution would be to simply disallow the deducting as a business expense any executive compensation over a certain amount. The amount could either be a flat number (presumably adjusted for inflation) or -- better in my view -- a percentage of the lowest-paid worker for the corporation (i.e. no compensation over x20 what the lowest paid worker receives can be deducted as a business expense). "Compensation" would have to include bonuses, stock options, perks, etc, and not just salary or the whole thing would be meaningless.

This wouldn't seem like excessive Government interference in the market; it'd simply be the Government refusing to abet certain market solutions -- which would still be perfectly legal, of course. I have no idea (and I don't know whether or not anyone has any idea) to what degree this would fix the problem: would corporations simply pay the extra taxes? But it seems like an easy first step to try -- no big new regulatory agency, just a comparatively minor change in the tax code.

I personally would second several other solutions proposed above -- higher upper-income tax rates, forbidding executives to have benefit-defined pensions while workers get contribution-defined pensions, etc. But in terms of the direct issue here I think the tax-change is the most on point and simple approach, at least to begin with.

Posted by: Stephen Frug | Dec 11, 2004 2:46:26 PM

One thing that would help would be a refocusing of investor attention away from capital gains and towards dividends, which could be quickly (if not easily, or even realistically) achieved via a significant relative tax increase on share price gains.

Such a change would have the additional salutary effects. First, it would restrict astronomical PE ratios to firms with realistic expectations of increased future profitability. Second, it would help to condition the public to think of stocks as investments rather than gambling chips. Third, it would help to focus company analysis on balance-sheet fundamentals instead of buzz and "momentum." Finally, it would focus stockholders like a laser on company profits. A board of directors that proposed to divert from shareholders' pockets "between 25 and 50 percent of aggregate corporate profits" to a corporation's top 5 executives had better have a damn good reason for doing so.

Posted by: David Yaseen | Dec 11, 2004 3:13:17 PM

The rise of undeserved executive compensation tracks closely with the collapse of the labor movement in the private sector...the best way to deal with this is to give working people the freedom to hold their own employers responsible for this nonsense. The could restore the balance by negotiating better compensation for the people who actually do the work.

To do that, we would have to restore Americans' freedom to form a union without interference from their employer. The right to form a union no longer really exists because federal labor law is so weak.

Posted by: Carter Wright | Dec 11, 2004 3:23:40 PM

But here's my question--why aren't shareholders making demands about this now? Or are they? Is there some reasonable way to facilitate shareholder power through policy?

Posted by: DJW | Dec 11, 2004 4:05:37 PM

What Stephen said. There are so many tax loopholes which simply end up creatimg the CEO lifestyle (corporate jets, condos, ski retreats, etc.) at taxpayer expense.

I would call for transparency of compensation for the top 10 employees or a corporation, and that it be posted publicly in each of their locations. That would help bring back the labor movement.

Clicked by a show about corporate jets last night. Burned me up to think that my tax dollars are paying for them. (Why doesn't my sister-in-law who goes on about people on welfare sitting on their ass think about these planes?)

Posted by: Contary Mary | Dec 11, 2004 5:29:42 PM

Some shareholders are making demands, but a lot of stock is held indirectly (by retirement funds or mutual funds) on behalf of investors.

Not that many individuals own big enough blocks of stock to get the attention of an entrenched management backed by cronies on the board and a lot of the funds don't want to get too closely involved in company politics - CALPERs is an all too rare example of a fund that exercised its theoretical management rights to try to improve their gains by improving the management of the companies they are invested in.

Posted by: Butch | Dec 11, 2004 5:37:07 PM

One fairly simply (and commonly proposed) solution would be to simply disallow the deducting as a business expense any executive compensation over a certain amount.

Again, this is the law, and it's an ongoing problem. It shifts expenses to relatively untrackable areas, such as stock options (which are set low enough in order to guarantee big money), golden parachutes, and weird perks. I say bring back the base compensation so people know what they're paying for when they get it.

Posted by: Kimmitt | Dec 11, 2004 7:46:18 PM

Talk about a straw man. The proposal for a modest additional piece of government regulation is enough to raise the spectre of a "planned economy"?

First, regulation is not the same thing as planning. Laying down certain ground rules in the way businesses and markets must conduct themselves is not the same thing as telling them what to produce and sell, or how much. The rules govern the structure of the market game, but the decisions are still up to the players in the market.

We obviously have a mixed and regulated economy, like every other developed nation. Every day, we make decisions about where to regulate and where to de-regulate. Why not just evaluate any proposed piece of regulation on its merits, by doing our best to estimate its likely costs and likely benefits, without turning it into a grand philosophical dispute between libertarianism and the advocates of fully socialized planned economies.

The obvious proposal to consider is requiring companies to limit their top salaries to some fixed multiple of the lowest salaried employees. Personally, I would favor about 20 to 1, although I know that will sound dreadfully draconian to many people, accustomed as they have become to ratios that are so obscene as to make merely outlandish ratio like 100 to 1 seem "modest" by comparison.

By the way, no getting out of the twenty to one deal by hiring an army of part-times. A formula can be used to project an annual salary from the lowest hourly wage paid.

Posted by: Dan Kervick | Dec 12, 2004 2:10:44 AM

I hate to think that you are claiming that certain people making more than others - a lot more, in this case - is a market failure. It's not. It's an issue of equity and fairness.

What should we do about it? Well, we could always do some sort of raising of the minimum wage and/or expansion of tax credits. We can shift more of the burden of the tax revenue to those making the most. As Mark Kleiman, among others, I hope, pointed out, Wesley Clark's tax plan was pretty damn desirable (though revenue neutral), as it only raised taxes on those making more than a million dollars a year, simplified the code considerably, and other things of that nature. It was so good, in fact, that Brad DeLong suggested Howard Dean steal it when the former governor was the frontrunner.

Posted by: Brian | Dec 12, 2004 4:50:43 AM

Most egregious pay is the result of stock options. A step in the right direction would be to remove some government barriers to a market solution. Specifically, assume that a CEO is paid Xmillion when the stock goes up, and pays 0 million when the stock goes down. Now, the loss of a job is non-zero, but after a certain point (certain accumulation) it's effectively zero -- this is not true for most workers, including most corporate officers when corporate charters began to be granted. Therefore the resulting skew can be thought of as a hidden effect of poorly devised regulations (e.g. those regulations that limit liability) that assumed that loss of a job would be enough incentive to keep decision makers' utility functions in line with those of stock holders.

So repeal this protection for CEO's, or any high officers of a company that are also stock holders, make them personally liable for the success or failure of the company -- so that a share of corporate lossess are first recovered from their assets, just as a share of corporate gains are added.

You'd see much more modest compensation packages, as CEOs decide to limit their exposure, and less government interference to boot. Common sense suggests this approach is only fair.

Posted by: mno1 | Dec 12, 2004 6:54:11 AM

Corporate boards of directors are disproportionately made up of CEOs of other corporations. This is the real problem.


It's vital to reform remuneration committees. Otherwise, it's just a merry-go-round of exec and non-exec directors voting each other ever-more ridiculous pay increases.

why aren't shareholders making demands about this now?

Because many de facto major shareholders are actually corporate executives (in investment and banking) who sit on remuneration committees as non-executive directors.

I'd like to see a return to some kind of sane ratio between CEO pay and the lowest-paid employee.

Posted by: ahem | Dec 12, 2004 12:33:59 PM

"Wage compensation to CEOs is limited to $1 million" (kimmit). No, compensation to CEOs in excess of $1 million is not deductible. This provision has had no discernable effect on the obscene spectacle of disgusting greed called CEO compensation.

Posted by: lee | Dec 12, 2004 2:20:47 PM

This provision has had no discernable effect on the obscene spectacle of disgusting greed called CEO compensation.

Sure it had. It shifted their compensation from wages to stock options and perks.

The only solution (in the absence of strong unions) is to tax the shit out of them bastards.

Posted by: abb1 | Dec 12, 2004 2:37:09 PM

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