The National  Memo Logo

Smart. Sharp. Funny. Fearless.

Monday, December 09, 2019 {{ new Date().getDay() }}

The Pay’s The Thing: How America’s CEOs Are Getting Rich Off Taxpayers

Income inequality will continue to rise unless we close the performance pay loophole and curb the growth of executive compensation. For more, see “Fixing a Hole: How the Tax Code for Executive Pay Distorts Economic Incentives and Burdens Taxpayers,” by Susan Holmberg and Lydia Austin.

It’s proxy season again, and we will soon be deluged with news profiles of CEOs living in high style as our ongoing debate on CEO pay ramps up. Last week, the floodgates opened when the New York Times released its annual survey of the 100 top-earning CEOs. Lawrence Ellison from Oracle Corporation led the list again with over $78 million in mostly stock options and valued perks, an 18 percent drop in pay from last year. Poor Larry.

Rising CEO pay has been a hugely contested issue in the U.S. since the early 20th century, particularly in the midst of economic downturns and rising inequality (these two often go together). Because the numbers are just so staggering, most of the current debate focuses on the rapid rise in CEO pay over the past four decades. While executive pay remained below $1 million (in 2000 dollars) between 1940 and 1970, since 1978 it has risen 725 percent, more than 127 times faster than worker compensation over the same period.

With any luck, ascendant French economist Thomas Piketty and the English-language release of his book Capital in the Twenty-First Century will build much-needed momentum in D.C. to institute reforms that address our CEO pay problem. This is a major driver of America’s rising income inequality, which is the central focus of Piketty’s magnum opus. One reform in particular that is critical to slowing down the growth of CEO pay and its costly impact on our economy is closing the performance pay tax loophole.

Inspired by compensation guru Graef Crystal’s bestseller on corporate excesses and skyrocketing executive pay, then-presidential candidate Bill Clinton elevated CEO pay as a core issue of his 1992 campaign with a pledge to eliminate corporate tax deductions for executive pay that topped $1 million. Clinton was successful only in part; his policy did become part of the U.S. tax code  as Section 162(m), but it came with a few unfortunate qualifiers, namely the exception for pay that rewarded targeted performance goals, or “performance pay.”

The logic of performance pay comes from Chicago-school economists Michael C. Jensen and Kevin J. Murphy, who published a hugely influential piece in the Harvard Business Review in the early 1990s that argued executive pay should align CEO interests with what shareholders care about, which is higher stock prices. Otherwise known as agency theory, this idea has profoundly shaped the executive pay debate and is arguably the primary reason the performance pay loophole made it into the tax code.

Once Section 162(m) became law, what do you suppose happened next? Predictably, companies started dispensing more compensation that qualified as performance pay, particularly stock options. Median executive compensation levels for S&P 500 Industrial companies almost tripled in the 1990s, mainly driven by a dramatic growth in stock options, which doubled in frequency.

Most of us think of skyrocketing CEO pay as simply a moral problem. However, economists like Piketty and my Roosevelt Institute colleague Joseph Stiglitz have been expounding about the havoc that rising income inequality wreaks on our economy (and democracy). When middle-class wages stagnate, consumer demand diminishes, which has tremendous spillover effects in terms of investment, job creation, tax revenue, and so forth. That particular set of problems relates to how much CEOs are paid. But there are also costly problems with the structure of CEO pay, i.e. what they’re paid with.

Performance pay can (and has) made executives very wealthy, very quickly, which creates incentives for shortsighted, excessively high-risk, and occasionally fraudulent decisions in order to boost stock prices. What kind of effect does this behavior have on the economy at large? Think mortgage crisis and subsequent global financial meltdown. Performance pay also diminishes long-term business investments. According to William Lazonick, in order to issue stock options to top executives while avoiding the dilution of their stock, corporations often use free cash flow for stock buybacks rather than spending on research and development, capital investment, and increased wages and new hiring.

All this and Americans get the bill. Beyond the innumerable costs we’ve borne from the recent economic crisis, the Economic Policy Institute calculated that taxpayers have subsidized $30 billion to corporations for the performance pay loophole between 2007 and 2010. According to a recent Public Citizen report, the top 20 highest-paid CEOs received salaries totaling $28 million, but had deductible performance-based compensation totaling over $738 million. Assuming a 35 percent tax rate, that’s a $235 million unpaid tax bill. The Institute for Policy Studies calculated that during the past two years, the CEOs of the top six publicly held fast food chains “pocketed more than $183 million in performance pay, lowering their companies’ IRS bills by an estimated $64 million.”

Congress is long overdue to close the performance pay loophole. The Supreme Court just made that harder. Thanks to Citizens United and now the McCutcheon decision, the same CEOs who are benefitting from the loophole are much freer to draw upon the corporate coffers to donate big money to politicians to maintain these loopholes.

Nevertheless, there is potential for getting it done. Senators Blumenthal (CT) and Reed (RI) have introduced the Stop Subsidizing Multi-Million Dollar Corporate Bonuses Act (S. 1476), which would finally end taxpayers’ subsidies to CEOs by closing the performance pay loophole and capping the tax deductibility of executive pay at $1 million. In the House, Rep. Lloyd Doggett (D-TX) has introduced a companion bill, HR 3970.

There are many policy ideas for how to curb skyrocketing CEO pay. Piketty and his colleague Emmanuel Saez argue for a much higher income tax rate for top incomes. (The growth rate of CEO pay was at its lowest when the U.S. had confiscatory tax rates for the very rich.) In the current political climate, a more viable step toward slowing the growth of CEO pay and the damage it does to our economy is to, at long last, close the performance pay loophole. It should never have been there in the first place.

Susan Holmberg is a Fellow and Director of Research at the Roosevelt Institute.

Cross-posted from the Roosevelt Institute’s Next New Deal blog.

The Roosevelt Institute is a non-profit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.

Photo: Sebastian Alvarez via Flickr

Show Your Invisible Hand: Why The SEC Should Make Corporations Disclose Political Contributions

Corporations are increasingly active in U.S. politics, and their investors deserve to know where the money is going. Click here to read Susan Holmberg’s new paper, “A Cost-Benefit Analysis of Corporate Political Spending Disclosure.”

A core assumption of the Supreme Court’s opinion in 2010’s troubling Citizens United case, which broadened corporations’ abilities to use their money for political purposes, was that shareholders could decide for themselves whether they agreed with the ways that money was being spent.

According to Justice Anthony Kennedy, who delivered the opinion for the Court, “With the advent of the Internet, prompt disclosure of expenditures can provide shareholders and citizens with the information needed to hold corporations and elected officials accountable for their positions and supporters. Shareholders can determine whether their corporation’s political speech advances the corporation’s interest in making profits, and citizens can see whether elected officials are ‘in the pocket’ of so-called moneyed interests.”

The problem with this particular assumption, which economists call perfect information, is that corporations are — surprise surprise — not legally obligated to share information on political spending with their shareholders or the public. In August 2011, a group of high-profile law professors filed a petition with the Securities and Exchange Commission, calling on the agency to require public companies to disclose what corporate resources they spend on political activities because “most political spending remains opaque to investors in most publicly traded companies.”

Why do companies spend money on politics? The answer seems obvious: they want to generate profits. They are seeking advantages like reduced trade barriers, government contracts, easier regulatory inspections, and lower tax rates. For more on this point, see my colleague Tom Ferguson’s recent paper with Paul Jorgensen and Jie Chen, which reveals how “Too Big to Fail” Wall Street firms and telecom companies have captured the GOP and the Democrats, respectively. (As an aside, isn’t it odd that the same companies orchestrating the expansion of the surveillance state are so concerned about their own privacy?)

But there is sufficient research to suggest there is another, more covert reason that has serious consequences for shareholders. In my recently published Roosevelt Institute paper on the costs and benefits of this disclosure rule, I cite several studies that show corporate executives frequently spend on politics for their own personal advantage rather than the company’s bottom line. These personal benefits include things like prestige, a future political career, star power, or assistance for political allies.

With these kinds of distorted incentives, the lack of information available to the public about corporate political spending puts shareholders and potential investors at enormous risk. Why would they want to invest in a company that is undertaking activities that are more likely to benefit its executives than its investors? Requiring corporations to disclose their political spending, on the other hand, would do the following:

—Enable investors to make informed investment decisions. Good information is always key to helping potential shareholders calculate the risk they are taking by investing in a company or helping current shareholders decide if they want to hold on to a company’s stock.

—Create the motivation for corporate executives to focus less on their own personal benefit and more on the political spending that would increase shareholder wealth. By disclosing their political activities, corporate executives would have less of an opportunity to waste company resources for their own advantage.

—Benefit corporations that already share their political spending information. Research suggests companies that already disclose SEC-required information enjoy a bump in stock returns when the particular rule is put in place.

Two years after the lawyers submitted their petition, File No. 4-637 is finally on the SEC’s official agenda and support for the disclosure rule is overwhelming. Recent polling finds that 79 percent of surveyed Republicans and nearly 100 percent of Democrats support the rule, and more than 600,000 public comments supporting the rule have been submitted to the SEC. Major institutional investors are also in agreement. Former Vanguard mutual fund CEO John C. Bogle, six state treasurers, CalPERS and other pension funds, and many more are also in support. The rule also has the endorsement of small-business owners across the country, as large companies have a competitive advantage over smaller businesses because of their ability to influence lawmakers and agencies through campaign contributions and lobbying.

The pushback against disclosure is typically about the costs of disclosure. But companies already have to document their political spending for the IRS, so the additional cost would be, at most, the few hours it would require an employee to copy and paste data from an internal file into a public one. Furthermore, companies already submit annual forms to the SEC. The political spending information would simply be a few additional lines of text added to these forms.

A more valid concern about this rule is that, if companies are required to disclose this information to the SEC, the information could be exploited by their competitors and harm the companies’ bottom line. But corporate political activities are already well known among industry competitors. In fact, sometimes political spending is even coordinated among industry groups. The people who are actually excluded from this information are the ones who need it most: investors.

At a briefing held this past Wednesday organized by the Corporate Reform Coalition, Senators Elizabeth Warren (D-MA) and Robert Menendez (D-NJ) called for the SEC to finally adopt this important rule. “There is no excuse,” said Warren, “There is no reason […] for saying a corporation wants to be able to spend shareholders’ money and not tell shareholders how that money is being spent.”

Susan Holmberg is the Roosevelt Institute’s Director of Research.

Cross-posted From The Roosevelt Institute’s Next New Deal blog.

The Roosevelt Institute is a non-profit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.

AFP Photo/Adek Berry