Time to Rein in Grossly Overpaid CEOs

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Dean Baker
Al Jazeera, April 21, 2014

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Last week the New York Times ran an article on the pay of top corporate executives in 2013. It reported that the CEOs of major U.S. corporations continue to do quite well. At the top of the charts we find Oracle chief executive Larry Ellison, who pulled down $78.4 million; Roger Iger at Disney, who made $34.3 million; and Rupert Murdoch at Fox who received $26.1 million.

At this point most people have become used to hearing about these bloated pay packages at the top. We’re also used to hearing the rationale from these folks and their boosters about how they are paid what they are worth.

To the contrary, they are grossly overpaid. First, many CEOs were running large successful companies in the 1960s and 1970s for pay that in today’s dollars averaged about one tenth as much as the current crop of CEOs get. We can also look to Europe, Japan and China and find plenty of successful CEOs of large companies who work for a fraction of the price of American executives. And there are plenty of CEOs who get these outlandish pay packages even when they drive their companies into the ground.

The relevant question is not how much a CEO contributes to the company. That is not how economics works. After all, how much does the firefighter contribute who rescues three kids from a burning house? We don’t pay our hero firefighters multi-million dollar salaries. We pay firefighters based on how much it costs to hire another firefighter who can also do the job.

The question is how much does the CEO contribute compared to the next person in line for the job? Given the experience of large corporations in other countries, there is every reason to believe that there are lots of next people who could do the job as well or better, and for a fraction of the pay. (Anyone who believes that CEO pay actually reflects the CEO’s value to the company should read Lucien Bebchuk’s outstanding book, Pay Without Performance.)

The problem here is grounded in the corruption of the corporate governance structure. In principle CEOs should be treated like any other employee. Companies should be trying to ask if they can get away paying them less or getting a lower cost CEO of the same caliber in Germany or China.

Most companies, however, never ask this question. The reason is that the people who should be doing the asking, the corporate boards of directors, largely owe their jobs to the CEOs, not to the shareholders they are supposed to represent. Just as it’s difficult to organize large numbers of voters to unseat incompetent and/or corrupt politicians, it is very difficult for the shareholders of a large company to keep CEO pay in check and to dump incompetent CEOs.

The diffusion of stock ownership effectively allows the CEOs a free hand to line their own pockets. This is one reason that we are seeing so much hostility in elite circles these days to public pension funds. Major pension funds, such as the ones for public employees in California or New York, are one of the few entities with enough stock to actually put a check on CEO pay. If these pension funds can be taken out of the picture, the CEOs will have even less to worry about than they do today.

In order for CEO pay to be brought down to earth it will be necessary to change the behavior of the directors who decide their pay. In most cases sitting on a corporate board requires attending 4-8 meetings a year and walking away with annual paychecks of several hundred thousand dollars. Directors are usually prominent public figures such as former politicians or academics. They get their jobs because of their reputations; this means that the directors will not want their valuable reputations tarnished.

Many directors actually sit on multiple boards. For example, Erskine Bowles, a co-chair of President Barack Obama’s deficit commission, has collected millions of dollars sitting on corporate boards. He had the distinction of sitting on both General Motors board and Morgan Stanley’s boards in the years they needed bailouts from the government. Bowles has also sat on the boards of Krispy Krème, Norfolk Southern Corporation and now Facebook. It should be possible to shame people like Bowles to take their responsibilities as a director seriously and stop handing blank checks to CEOs regardless of their competence.

In this vein it is worth noting the “Say on Pay” provision of the Dodd-Frank financial reform bill. This requires that companies put their CEO pay packages to a non-binding vote of shareholders. Since this provision has been in effect, less than 3 percent of pay packages have been voted down. This reflects the difficulty of organizing among shareholders.

However it would be possible to have a minor modification to the Say on Pay provision that could make these votes far more effective. If the directors had to forfeit their own pay any time a CEO compensation package was rejected by shareholders it would likely help to focus the directors’ thoughts on constructing pay packages that were not excessive. This could put a serious constraint on CEO pay.

Reining in CEO pay is an important issue that goes well beyond the outrageous pay packages for a small number of top executives. The exorbitant pay at the top of the corporate ladder helps to set in place a pay structure that leads to bloated pay for those at the top in every sector, including universities and private charities, while leaving most of the rest of the workforce behind.

This is why it is so important to rein in CEO pay. And that means publicly humiliating all those prominent directors who pass out the blank checks.


Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.