A New York Times piece on soaring CEO pay at one point noted how attaching most CEO pay to stock options is supposed to align CEO pay with shareholder interests:
“Executives at publicly traded companies receive most of their compensation in stock, an arrangement intended to align pay with the performance of a company’s share price. When the stock price goes up, the theory goes, investors and executives alike share in the gains.”
This would only be true if shareholders are able to determine the number of options and the structure of the package. The package could, for example, cap the amount of money that CEOs and other top executives get from options, or it could have the returns from options linked to the performance of other companies in the same industry. Tying pay to options in a context where CEOs and other top management largely control the boards that set their pay does not mean there is an alignment between CEO pay and shareholders’ interest.
If this is difficult to understand, imagine that cashiers at McDonald’s got paid in stock options, and the cashiers got to determine how many options they were awarded. By the theory described in the NYT piece, cashier’s pay would then be allied with shareholders’ interest. The piece actually provides evidence of this misalignment when noting that Starbuck’s shareholders voted down their CEO’s pay package, but since the vote was non-binding on the board of directors, the CEO’s pay was not affected. There is no shortage of examples of CEOs getting high pay that is in no obvious way related to returns to shareholders.
This matters because if CEOs are ripping off the companies that employ them, then shareholders should be allies in the effort to bring down CEO pay. The vast majority of the rise in inequality over the last four decades has been due to wage income being redistributed upward, not a shift from wages to profits. Soaring CEO pay is a big part of this story. When the CEO gets $20 million, the chief financial officer and other top execs are likely to be getting close to $10 million, and even third tier execs can be earning $2-3 million. This also affects pay in the non-corporate sector, where is now common for presidents of major foundations and universities to be paid well over $1 million a year. And, as fans of arithmetic know, more money going to the top means less money for everyone else.
The story would be very different if CEOs were paid 20 to 30 times the wages of ordinary workers, as was the case in the 1960s and 1970s. If shareholders can be empowered in ways that make them more able to control CEO pay, this could be a large step towards reducing income inequality.