The rich and the super-rich are getting richer. We all know that. The question is why? Every economist on the planet has a theory. Some blame waning productivity gains or workers' losing their war with the robots. Others argue that the "offshoring" of jobs has suppressed wages, still others that lower taxes on capital gains have benefited the investing class.
Thomas Piketty, the suddenly famous French economist whose bestselling book, Capital in the Twenty-First Century, has fired up the wealth-gap debate around the world, argues that the inequalities in income distribution have risen sharply because of enormous corporate pay packages. He's generally right (even though the Financial Times found fault with some of his historical data) but what he does not do in any detail is break down those packages into their component parts. He and his research colleague, Emmanuel Saez, use U.S. Internal Revenue Service data, which lumps all pay together as "salaries." But salaries make up only a tiny portion of the haul for top executives. The biggest single component is stock-based pay: the realized gains from exercising stock options and the vesting of stock awards.
How did stock-based pay turn into a monster? The simple answer is that no one–not shareholders, not employees, not regulators–has been able to stop the executives from rigging the game in their favour. What seemingly started out as a reasonable idea–handing executives some shares so they would have an extra incentive to boost shareholder value–has tipped so far into the executives' favour that the richest bosses are gaining oligarch status. Through the repricing of options and ever-rising stock awards, many executives have been able to ratchet up their pay even when their company's share price falls.
The problem, of course, is not new. More than 20 years ago, U.S. compensation consultant Graef Crystal, who has been in the game since 1959, published In Search of Excess: The Overcompensation of American Executives. The book noted that "In the last 20 years the pay of American workers has gone nowhere while American CEOs have increased their own pay more than 400 per cent." The book would be doubly relevant today. Crystal, bless him, is still at it, lately going after Leslie Moonves, CEO of CBS, for a $32-million cash payout last year that Crystal said was 19 times higher than a boss running a company of that size should receive. (All currency in U.S. dollars.)
Data compiled by William Lazonick, of the University of Massachusetts Lowell, builds on Crystal's work. Lazonick's research papers report that in 1992, average total compensation of the 500 highest-paid American executives named on proxy statements was $8.9-million (in 2012 dollars), of which 59 per cent came from gains on stock options and 9 per cent from fair-value stock awards. In 2012, their average compensation was $30.3-million, with 42 per cent coming from stock options and 41 per cent from stock awards. Even in 2009, when the financial crisis threatened to sink the global banking industry and dozens of industrialized countries were in recession, executive pay, adjusted for inflation, was still almost twice the level it had been 15 years earlier.
The executive pay system is so well organized, and so sublimely immoral, that it has taken on a racketeering flavour, all in the slick guise of aligning the interests of management and shareholders. Executives pad their boards with yes-men and –women who wouldn't dare suggest their boss is overpaid; compensation consultants are happy to recommend that the CEO's pay should fall in the peer group's top quartile; and the regulatory climate has been benign, thanks to the lobbying power of the companies.
The regulation that came as a godsend for executive pay was the Securities and Exchange Commission's Rule 10b-18, born in 1982, which essentially legalized stock manipulation by allowing companies to repurchase shares amounting to 25 per cent of their average daily trading volume over the previous four weeks. Since then, stock buybacks have exploded. From 2001 through 2013, the S&P 500 companies spent $3.6-trillion on buybacks. The buybacks of some companies, among them Cisco Systems and Hewlett-Packard, routinely exceeded their net income. The effect was to pump up share prices, all the better to turn stock-based pay awards into cash gushers for executives. At the same time, the diversion of income to buybacks deprived companies of the healthy R&D budgets that would have created the winning products and services that could have benefited all stakeholders, including employees.
The AFL-CIO calculated that the ratio of CEO pay to that of the average worker went from 40:1 in the early 1980s to more than 300:1 in recent years. Piketty's book deserves its bestseller status. His suggestion for a global wealth tax to reduce income inequality is a good idea, if an unworkable one. It would be far easier for regulators to clamp down on stock-based pay and the buybacks that feed them.
Eric Reguly