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Wednesday, December 7, 2016

Executive compensation is soaring while workers and taxpayers feel the squeeze. A new Roosevelt Institute white paper explains why.

Americans hate the fact that CEOs of big corporations keep raking in millions while the incomes of most American households are sinking. Now a new Roosevelt Institute white paper by University of Massachusetts economist William Lazonick adds to the growing case that soaring CEO pay is not just unfair, but harmful. It’s bad for businesses, workers, and taxpayers, and it’s one of the reasons that the economy remains sluggish.

Lazonick details the myriad ways by which CEOs pump up their wages, painting a picture of crony capitalism in the boardroom and at the SEC. CEOs pad their boards of directors with other CEOs, who are all eager to hike each other’s pay. They hire from the same pool of compensation consultants, who then recommend to all of their boards why each of them deserves to be paid more.

Almost all executive pay, which was back to its pre-recession average high of $30 million a year by 2012, is delivered in the form of stock. This exploits a policy loophole that taxes compensation of more than $1 million unless it falls into the category known as “performance pay.” Meanwhile, the CEOs and their teams of lobbyists and lawyers have gotten a compliant SEC to issue a host of rulings that invite stock price manipulation. The resulting higher prices are considered proof of better performance, and also instantly deliver millions to the CEOs through their stock options. Very neat.

Lazonick explains that corporations’ favorite method of boosting stock prices is buying back their own stock. While a firm is required to notify the public of its intention to buy back its stock, it doesn’t have to say when it will do so, which fuels price-boosting speculation and allows the firm to time its repurchases to maximize the CEO’s gains.

The justification given by economists for stock-based performance pay is that corporations should be run to maximize shareholder value, and paying CEOs in stock aligns their performance with the purpose of their firm. But as my business school finance professor told a shocked classroom of my fellow students, the economic purpose of the firm does not have to be maximizing value for shareholders. The firm could just as easily be dedicated to maximizing the value for workers or communities or society at large.

Lazonick’s version of this fundamental critique of corporate capitalism is that it is not only shareholders who have an investment in a corporation. Taxpayers invest in corporations through the public infrastructure and educated workforce corporations depend on. Workers invest through their contributions to corporate innovation. Taxpayers and workers lose if the corporation’s core economic performance – as opposed to the price of its stock – declines. The result is fewer people working, less tax revenue, and diminished community life. But CEO pay just keeps going up regardless.

Lazonick argues that the CEO focus on stock buybacks has distracted them from investing in innovation to sustain their companies over the long run. It may also be true that in the absence of consumer demand, the CEOs see no better use for excess cash than to reward themselves and shareholders. But in fact, the stock market focus of U.S. industrial corporations, which has eroded middle-class wages and employment, is a big reason for lower domestic consumer demand. In contrast, Lazonick points out that Apple, which did minimal buybacks from 1994 through 2011, found no lack of consumer demand for its innovative products.

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