Why CEOs are paid so much more than workers.
A popular reason given for CEOs receiving 351 times the pay of their lowest-paid worker is that they bring so much value to the company. However, executives are often compensated egregiously regardless of their performance or how the company does. JC penny executives awarded themselves 10 million dollars in performance bonuses, including 4.5 million for the CEO, by changing the benchmarks to meet shortly before filing for bankruptcy. A month after laying off thousands of employees, Hertz paid 16.2 million to its executives.
These stories are common, like GNC paying 4 million in cash bonuses before filing for bankruptcy. In cases like this, boards commonly rewrite rules to ensure the executives are awarded the amounts that they’re accustomed to. One justification is that navigating the company through bankruptcy is so very hard, the executives have to be paid extremely well. This infers that they are of such poor character that solving the problems their job entails would not be possible without a largesse worthy of a feudal lord.
Incentives are a popular justification, executives have to be paid well to incentivize them to do the demanding work of running a company that someone else founded. The work must be the height of torturous prostitution to demand such exorbitant rates as an incentive. Working at dollar tree is difficult because of the low wages which bottom out at 8.32 an hour, placing over 7,000 of their employees on government assistance like food stamps. The company made 1.2 billion in profit in 2021 and awarded their CEO roughly 11 million in total compensation. This occurred while they raised prices from 1.00 to 1.25 without even bothering to change the name. Considering how little is given to dollar tree retail employees to incentivize them, the life of the CEO must be a grueling slog to necessitate such incentives.
CEOs do work long hours. It’s not as long as someone being paid minimum wage would have to work to survive. Nor is it as demanding on the body as agriculture work or mining. It’s drudgery that can be equivalent to the work of lawyers or bankers. Why do corporate executives and CEOs specifically make so much more than even the most successful lawyer? Why are [CEOs making 10s of millions] as overall compensation, while the most successful lawyers make that over their whole career? Why is the work of corporate executives rewarded more in the marketplace than engineers, lawyers, scientists, physicians, or presidents?
In 1950 the wealthiest people in America, people with over 2 million dollars, were taxed at a rate of 91 percent. The GDP grew at a rate of 8.7 percent, which the country hasn’t seen since then. The government taxed stocks as income until the 1950 revenue act, which allowed stock options to be sold at the capital gains rate of 25 percent, making stock options an ideal tax shelter. For the following two decades, stock options were predominantly executive pay, reasoned as a means to incentivize executives to really care about the stock price. Otherwise, they simply couldn’t bring themselves to care about the share price of the company they were hired to run, the reasoning goes.
The use of stock options as executive compensation proliferated, from 18 percent in 1951 to 50 percent in the 1960s. The government noticed the use of qualified stock options to avoid taxes and banned them In 1976, making them taxable as ordinary income again. Ronald Reagan heroically restored qualified stock options and their capital gains tax rate and cut the top income tax rate down to 28 percent over his tenure. “Incentive stock options” is what they were now called, formalizing the reasoning of this executive tax avoidance measure with Orwellian language.
Stock options are a boon for employees but are awarded to executives in enormous amounts, well beyond anything that could reasonably be thought of as an incentive. Performance shares are another element of executive compensation, a reward given for increasing the stock or production to a specific target in a short time frame. Tying the reward directly to stock price makes this a popular incentive, though many things which drive up the stock price aren’t especially good for a company; such as stock buybacks, cutting corners on safety measures á la Boeing, and keeping labor compensation at subhuman levels wherever possible.
Performance shares are the innovation of compensation consultants. Companies hire management consultants to make tough decisions like to justify mass firings or build systems that facilitate insurers denying more claims; companies hire compensation consultants to make sure the executives don’t make any less money than any other executive. Duff McDonald deftly summarizes the influence of consultants on CEO pay in his book The Golden Passport.
General Motors hired McKinsey consultant Arch Patton in 1951 to conduct a survey of executive compensation across industries. Harvard Business Review published the results showing that from 1939 to 1950 hourly workers’ compensation had doubled while the administration’s pay had only risen 35 percent. The news of underpaid corporate executives presented in academic language was a great success; the survey of executive compensation became a yearly affair and was moved to McKinsey Quarterly after a decade in HBR.
Impressed with the simultaneous advertising of the value of business education and advocacy for executives to get more money, Juan Trippe of Pan American World Airways brought Patton in to study stock options as compensation for his executive team. Mr. Patton was so popular for his assessment of executive pay that at one point he personally accounted for almost 10 percent of McKinsey billings. He went on to write books like “What is an Executive Worth” and “Men, Money, And Motivation”, as well as publishing over 60 articles on the subject, 26 published in HBR alone.
Stock options and ideology alone don’t explain ballooning CEO pay. Corporate boards have oversight of CEO pay. Compensation committees are often a part of deciding executive pay, compensation consultants always are. The consultants contribute information about what other boards decided to pay at other companies to ensure that the compensation package is not insulting in its modesty. Should the compensation package be insufficiently robust, the executive may not be properly incentivized to maximize shareholder value. As Duff McDonald describes it, “It’s one of the most intricately designed circle jerks in business history”. This is a community that is working together to drive up what they pay to themselves, a shining example of the power of collective action.
It’s precisely this power that has motivated the legal obstacles to labor organization, like the Taft Hartley act. The kind of coordinated wealth extraction described in this essay is precisely the kind of thing that a well-functioning free-market legal system ostensibly exists to prevent. US law has precedent for dictating wages, like the federal law dictating restaurant workers can be paid $2.13 per hour. So, why is the power of the federal government absent on the subject of this long-term wealth extraction from the country?
Lobbying is commonly discussed in this context, but the problem is more inherent to the system. A company only has to petition for something if it’s not what the politician already wants. What’s creating the issue is that everyone involved in regulating, from the SEC to congress, is trading stocks to enrich themselves. There is nothing free about this market. Many judges don’t see the need to recuse themselves when they’re judging the case of a company they’re invested in.
There’s a revolving door between the public and private sector, allowing lawyers to flip between prosecuting banks and defending them; for bureaucrats to pivot from working for the SEC to working for a bank. When enforcing regulations or crafting the law, many people are being mindful of their future employment prospects. Stock trading at the SEC and within congress operates similarly in giving regulators a reason to privilege the subject of the regulations. This is nothing new at all, the government has long made people rich by awarding contracts and often decided to do so by personal connection. Dick Cheney and Halliburton is a famous example, when Cheney awarding his former company the spoils of war. It’s the revolving door that opened up the use of Halliburton. Cheney didn’t retire from public life after he was secretary of defense, he acted as CEO of Halliburton and then came back into office as VP.
In this environment, lobbying is much less necessary. The interests of the CEO holding gobs of stock and getting more for driving up the price are right in line with the interests of the politician holding stock for that same company. An invested politician is naturally more inclined to care about stock price than making sure the employees at the bottom have good wages.
There is a long history of the enmeshment of business and politics in America. We eschewed a feudal aristocracy in the founding of the country, leaving a void that was filled with a business aristocracy. The law is absent from acting on this coordinated wealth extraction because they’re participating in it.
This is wealth extraction, not just enrichment. The Panama Papers in 2016, the Paradise Papers in 2017, and the Pandora Papers in 2021 successively and robustly illustrated the use of offshore tax avoidance by business leaders, politicians, and transnational corporations. This is the most direct way of contributing to rising inequality and the financial degradation of a society. Money isn’t a store of value, as the Ruble is currently showing. It’s a ticketing system for the things that actually have value. All modern economies are essentially complex token economies.
In this context, I’m using token economy in the behavioral modification sense. A token economy is a means of incentivizing behavior through reinforcement, using tokens as rewards to reinforce desired behavior. The tokens can later be exchanged for objects or privileges of real value. Token economies are among the most successful means of behavior modification in history.
A subway system is an example, where the money you exchange represents labor, the tokens you get represent currency, and the subway ride represents the thing of value. A concert using a beer ticket system is also a token economy, you exchange money (labor) for tickets (currency) which you can exchange for beer (value). Token economies can be used to get anything you want if they’re established successfully, whether it’s another currency, labor, or changes in behavior. In the real world, our labor and production is the currency we exchange for USD tickets which can be exchanged for goods, services, and to pay taxes.
Corporate executives are acting like alcoholics hoarding beer tickets. Rather than invest in anything of benefit to the community like education or infrastructure, money is predominantly invested to become more money; or gets socked away overseas or in assets like real estate, driving up prices. McKinsey released a report about the worldwide bubble of asset prices across the world economy over the past 20 years, directly pointing out how poorly wealth is used. Which is a bit like getting your asthma inhaler from Marlboro.
What are the solutions to this problem?
We need a clearer division between the public and private sectors. Maybe legislators and regulators should get paid more, to apply the Arch Patton mindset, if the work is so unappealing to do without conflicts of interest. Investing from regulators acts as a natural disincentive to do the work with integrity. Similarly, it’s too much to expect a person to float back and forth between regulation and profit-seeking and keep the motivations of roles distinct. The effect is undermining the capacity of regulation to act in the public interest.
A report published in the Economic Policy Institute by Dean Baker, Josh Bivens, and Jessica Schneider recommends taxation of the worker to CEO pay ratios. This is an appealing approach to a taxation solution, focusing on the central issue, the disparity itself. They also advocate boosting shareholder power with changes to corporate governance, like having worker representation on corporate boards.
The ideal worker to CEO pay ratio is 7 to 1, according to a study from Harvard Business School. At a minimum wage of 48k a year, this would put CEOs at a respectable 336k. This is enough to appeal to all the needs of one’s vanity in a world where people don’t treat money like they need enough to use it as construction material should they ever get lost at sea. In our increasingly digital world, money doesn’t even have the value of its material, the fed marks bank accounts up and down with the stroke of a keyboard.
There is no reason for the gross wealth disparities in this country, no pragmatic reason, no rationality or logic to it. At this point, it’s simply habit.