Executive pay in public U.S. corporations has evolved into an out-of-control racket. Left unchecked, the resulting huge and growing income gap between the elites and the shrinking middle class will soon resemble typical third-world patterns.
According to a widely referenced Congressional Budget Office statistic, since 1979 the income of the top 1 percent grew 275 percent, while that of the middle 60 percent grew only 40 percent. The U.S. owns the highest gap in the developed world, according to New Republic.
The trend is continuing unabated. In 2011 the top 500 CEOs of publicly traded companies received 16 percent increases in compensation, while the average American worker received 3 percent, according to Forbes Magazine.
The historical income gap charts show an arc from 1915 (the peak of the Gilded Age just prior to U.S. entry into World War I) to present, as shown here and here. In 1915, the top 1 percent’s share of income was over 18 percent, while today it is over 20 percent. The 1950s, 60s and 70s represent the bottom of the arc, during which the top 1 percent’s share of national income was approximately 10 percent.
History has shown that great countries, and empires, derive strength from a broad middle class, and fail over time when wealth is concentrated at the top 1 percent. But often the cures prescribed are worse than the disease.
Indeed, Lenin’s post-World War I-income-gap solution in the Russian Empire had some bad side effects, to put it mildly. And the U.S. solution from the 1950s through the 1970s were based on draconian top-bracket tax rates. From 1950 to 1963, income above $400,000 was taxed at rates over 90 percent. From 1965 through 1980, the top bracket was lowered to $200,000, and taxed at rates above 70 percent. These statistics are a good reminder of where the term “Reagan Revolution” came from.
Before prescribing a cure to today’s runaway income gap, it’s necessary to understand the main cause.
The situation is simpler than one might expect. Executives of publicly traded companies by and large make up the top 1 percent of income earners. The executive compensation in these companies is paid by shareholders.
However, the executive compensation level is not set by shareholders. Instead it’s set by corporate boards. These boards of course are made up of fellow corporate executives belonging to the same top 1 percent of income earners.
In other words, the top 1 percent of income earners is a closed club where members assign astronomical income packages to each other, which the common shareholders then have to pay.
For example Jamie Dimon, the CEO of JP Morgan Chase Bank, ranks No. 19 on the 2011 Associated Press Survey of Highest Paid S&P 500 CEOs. JP Morgan’s Board has 11 members. With one exception, all the members are or were chairmen, CEOs or presidents of other S&P 500 companies.
The head of the compensation committee, a board member since 1987, is Lee Raymond, the recently retired CEO of ExxonMobil. Another board member (since 2005) is William Weldon, who as chairman & CEO of Johnson & Johnson is ranked No. 18 on the Associated Press highest-paid list.
Yet another JP Morgan board member is David Cote, whose day job is chairman and CEO of Honeywell Corp. He’s No. 6 on the highest-paid list.
Apple’s Tim Cook enjoyed $378 million total compensation in 2011, widely considered a record. That’s 7,560 times more than the average household income in America.
Clearly the shareholders of Apple grossly overpaid Mr. Cook. If Apple had paid him only 5 percent of this amount — $18.9 million – would he have worked less hours, or have been less creative, or delivered lower-quality work? Of course not.
Would he have been more prone to quit his job? Only if some other company’s board acted more irresponsibly with shareholder capital and offered him tens of millions of dollars more. That’s the fear-mongering technique the One Percent Club uses to justify the spiraling compensation packages they award each other.
Executive compensation in publicly traded companies does not conform to democratic principles, as the shareholders have no real input on how their money is spent for compensation. Nor does it confirm to free-market capitalist principals, because in a truly open market, qualified people would gladly provide executive services for a fraction of the current compensation packages. It’s a racket that’s at the heart of the spiraling income gap.
This problem can be solved by introducing a regulation for publicly traded companies that requires an absolute shareholder majority approval for each executive pay package that exceeds a certain threshold. The threshold should be a multiple of the average employee compensation within that company. Setting the multiplier to 100 seems reasonable.
For example, if the average employee at Apple earns $100,000 annually, then the board could set Cook’s compensation as high as $10 million at its discretion. If it wishes to offer him a higher compensation, then Apple’s board would be required to attain more than 50 percent of shareholder votes in favor of the compensation package. Or the board could increase average employee compensation.
Almost certainly, other major economic blocs would follow the U.S.’s lead in implementing such a scheme. By and large, the rest of the world in general is vexed by out-of-control executive compensation in U.S. corporations.
It’s time to bring capitalist and democratic representation principles to executive compensation governance. Government must empower shareholders to solve this problem.