Capitalism and Western Civilization: Compensation

Jun 07, 2012 | 

William H. Young

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Capitalism and Western Civilization: Compensation

Jun 07, 2012 | 

William H. Young



On April 30, 2012, The New York Times (Brian Stelter, “Seacrest Assembles TV Empire”) celebrated that  Ryan Seacrest had “signed a new contract with NBCUniversal that will have him contribute to the “Today” show, Olympics coverage, election coverage, and other special events….He will remain at Fox Broadcasting, hosting “American Idol”…and, most likely, at ABC, hosting the New Year’s Eve special….Already, Mr. Seacrest makes well more than $50 million a year from his current jobs.” A college dropout, Mr. Seacrest became a success when, at age 27, he was named the host of “Idol.” 

On April 19, 2012, AFL-CIO Executive Paywatch condemned “soaring CEO compensation”: “the CEO of a company in the S&P 500 Index, on average, received $12.9 million total compensation in 2011.” That’s “380 times the average worker’s pay. In 1980, CEOs made 42 times the average wages of workers.” A breakdown of that 2011 compensation shows that 75 percent is in long-term corporate and stock performance awards. Let’s examine the history of CEO compensation. 

During the acclaimed economic times after World War II and into the 1960s, shareholder-owned public corporations made profits of 9‒10 percent a year. Executive salaries were modest compared to worker pay. Stock shares were largely owned directly and held by individual households. Beginning in the 1970s, however, corporate profits steadily deteriorated, ultimately to a low of 5 percent in 1992. See my previous article “Finance”. Concurrently, pension and mutual funds became large corporate shareholders, gathering and investing the savings of half of households. The funds, on behalf of Main Street, pressured Wall Street, corporate CEOs, and boards of directors to increase corporate profits and share values. (Joe Spiers, “The Myth of Corporate Greed,” Fortune, 15 April 1996) 

In the 1980s, a wave of leveraged buyouts, hostile takeovers, and other restructurings began, to improve corporate profitability and link CEO compensation to stock price performance. Corporations, particularly high-tech companies, also sought an ownership role for newly important human capital—to attract, motivate, and reward scarce high-skill talent. The method chosen, called the “Silicon Valley model,” (Gretchen Morgenson, “Stock options are not a free lunch,” Forbes, May 18, 1998) was the granting of stock options. 

Options are shares of stock awarded to an employee with a designated price; the shares can be sold at some later time, at a profit if the market value of the stock increases. This is intended to align the interests of managers and shareholders and spur long-term stock price growth. But options have hidden costs and dilute the value of shares held by outside shareholders; their use has declined. (Gretchen Morgenson, “Enriching a Few At the Expense of Many,” The New York Times, April 9, 2011) 

In what was called the “new economy” of the 1990s, the enormous number of options granted, combined with a strong bull market, caused CEO compensation to skyrocket. The 1999 average pay of CEOs of new economy companies was $27.5 million; the average pay for CEOs of old economy companies was $7.1 million. (David Leonhardt, “In the Options Age, Rising Pay (and Risk),” The New York Times, April 2, 2000) 

A critical view of CEO compensation is offered by Nell Minow, a board member of GMI Ratings, which specializes in corporate governance: 

The astronomical sums commanded by CEOs are the culmination of a decades-long trend….This accumulation of wealth of a small group of individuals came about for a number of reasons….The roots of elevated CEO salaries lie in the mergers and acquisitions and leveraged-buyout frenzy of the 1980s plus the dot.com explosion of the 1990s, which made twerpy twentysomethings into billionaires overnight. I am a captain of industry, CEOs said to themselves and their boards. Those kids should not be paid more than I am…

The pay-consultant industry came up with new ways to justify higher salaries…Boards of directors set the pay for CEOs, who set the pay for directors….Something like the Lake Wobegon effect took place: In measuring performance, all CEOs were above average….The Dodd-Frank financial reform bill included a watered-down version of a ‘say on pay’ measure, granting shareholders the ability to voice dissatisfaction with CEO salaries, but only in a nonbinding fashion.

(Nell Minow, “Executive Decisions,” The New Republic, February 8, 2012)

The Dodd-Frank Wall Street Reform and Consumer Protection Act of July 21, 2010 is beginning to have some effect. Hudson Institute economist Irwin M. Stelzer writes:

Good news for those of us who know that only a reformed version of market capitalism can survive current unhappiness with its performance. Citigroup’s shareholders have told their executive employees, and most especially CEO Vikram Pandit, that it is the owners of the business, not the hired hands who run the show….A majority of the shareholders turned down a plan that paid Mr. Pandit almost $15 million last year…despite less-than-stellar performance. This is important because it addresses one of the discontents with capitalism. 

(“Shareholders of the World, Unite,” The Weekly Standard, April 23, 2012) 

Business is reforming itself. “CEO pay during 2011 was more firmly correlated to how well companies fared in the stock market….On average, for every additional 1% a company returned to shareholders between 2009 and 2011, the CEO was paid 0.6% more last year….For every 1% decline in shareholder return, the CEO was paid 0.6% less.” (Scott Thurm, “CEO Pay Moves With Corporate Results,” The Wall Street Journal, May 20, 2012) This does not address the difference in compensation between high-skill executives and lower-skilled workers, who may not be shareholders; both are in global competition.

The most extreme business incomes are those of Wall Street and hedge fund financial traders or involve large stock awards (such as $376.2 million in Apple stock to Timothy D. Cook, Steve Jobs’s successor). In 2011, “the median chief executive pay among 100 big American corporations was $14.4 million.” (Natasha Singer, “In Executive Pay, a Rich Game of Thrones,” The New York Times, April 7, 2012) “Corporate executives… are far from a majority of the superwealthy. Robert J. Gordon, economics professor at Northwestern and Ian Dew-Becker at the National Bureau of Economic Research estimated that executives accounted for 20 percent of the income of the top 0.01 percent of the scale. Others put their share lower—around 8.5 percent.” (Eduardo Porter, “More Than Ever, It Pays to Be the Top Executive,” The New York Times, May 25, 2007)

The base period used by critics to show that CEO pay growth has caused unfair inequality is again the 1970s, when stocks were in the tank and cash compensation was king. The Dow Jones Industrial Average was flat between 1965 and 1982. After CEO pay was aligned towards increasing shareholder value, corporate performance improved markedly. Between 1982 and 2007, the Dow Jones Industrial Average rose by a factor of eleven, enriching not only CEOs, but millions of investors in pension and mutual funds, including those of unions.

We live in an age of what Robert H. Frank and Philip J. Cook called The Winner-Take-All Society (1995). Ironically, the earnings of most CEOs are less than those of star entrepreneurs, lawyers, and doctors and sports, entertainment, and media celebrities (such as Mr. Seacrest) and come through application of scarce, extraordinary talent in increasingly larger corporations and global markets.

Arguably, CEOs generate far more societal value in creating jobs and wealth for ordinary Americans. But CEO greed—pay beyond that justified by performance and excessive severance packages and perks—should and can be corrected by shareholders, as those of Hewlett-Packard did in rejecting the company’s executive compensation and severance plan in March 2011. (See Singer reference above.) Rather than demonizing capitalism and its executives according to a priori ideological assumptions (see my article “Inequality), higher education can best address inequality by improving the abilities of college students to compete for higher-skill and better paying jobs in the global economy, as NAS advises.

Next week’s article will examine Joseph Schumpeter’s views of capitalism.

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This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.

The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).

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