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Executive Pay and the "Market Economy"

It’s pretty hard these days to justify astronomical executive pay. In 2007, the average CEO’s pay of $10.5 million was 344 times higher on average than the average worker’s wage, according to Executive Excess 2008, a joint report from the Washington, D.C.-based Institute for Policy Studies and Boston-based United for a Fair Economy. The top 50 private investment fund managers each took home more than 19,000 times the average worker’s earnings.

But never fear, Jack and Suzy Welch — the former high-flying CEO of General Electric and his wife, the former editor of the Harvard Business Review — are willing to defend high executive pay by return to first principles and invocation of “the market economy.” In a recent issue of Business Week, they write, “Yes, most CEOs make a ton of money, and sometimes they make too much, but in a market economy salaries are set by supply and demand. We also live in a market economy where companies that field the best teams win, and, because of global competition, the best teams tend to be expensive.”

There are several decisive rebuttals to this claptrap.

First, there is no plausible market-based story why executive pay should have been bid up so much over the past quarter century. Are executives working harder now? Making better decisions? Has the CEO supply and demand equation changed?

Second, executive pay is not set by the market, but by boards of directors, who frequently are CEO cronies and excuse their behavior by relying on conflicted compensation consultants.

Third, the most super-high compensation packages are typically based on performance standards, with executives cashing in on stock options as share values rise. But this is a system easily gamed, with those same shares sold before short-term thinking leads to medium-term losses. By way of example, consider the massive pay packages obtained by the ousted CEOs of the now-floundering Wall Street firms.

And now comes a new analysis that further debunks the market-based rationalization for ridiculous CEO compensation levels. Executive Excess 2008 shows how taxpayers are helping foot the bill for these outrageous compensation packages.

Executive Excess 2008 highlights five distinct U.S. tax subsidies for executive pay. These are actually market distorting, in that they let top executives and investment fund managers take home more than they would if they played by the same tax rules as regular people. Altogether, Executive Excess 2008 reports, the five tax loopholes heap $20 billion in subsidies on the corporate and hedge fund honchos.

* The hedge fund manager loophole, involving what is called “carried interest,” enables investment fund managers to treat most of their salaries as capital gains, and to pay taxes at the capital gains rate, rather than the ordinary income tax rate. Annual cost to taxpayers: $2.6 billion.

* The pensions for the rich loophole. While regular people can place a maximum of $15,500 in 401(k) plans — deferring taxes until they withdraw the money — CEOs can place unlimited amounts in deferred pay plans. Annual cost to taxpayers: $80 million.

* The offshoring loophole. Although companies cannot deduct the expense of executive compensation in deferred accounts, this is no problem for businesses registered in offshore tax havens. Set up an offshore subsidiary, and you can deduct the deferred income from revenue. Annual cost to taxpayers: $2 billion.

* The greed loophole. Money spent on wages and salaries are deducted from corporate revenues, and is not taxable. For top executives, however, U.S. tax rules impose a limit: corporations cannot deduct salaries and compensation that is more than “reasonable.” An effort to define reasonable as $1 million has been entirely circumvented — and corporations can, in effect, deduct whatever they pay CEOs. Annual cost to taxpayers: $5.2 billion.

* The double-standard loophole. Stock options — the right to buy stock at a preset value, at a later date — are now a huge component of executive pay. For their internal accounting, corporations value stock options using the value of the stock on the date of the option grant. For tax purposes, however, they can deduct the generally much higher value of the stock on the date the options are exercised. In other words, they can deduct more than they list as their expense. Annual cost to taxpayers: $10 billion.

Not long ago, it was possible to argue that executive pay was an important but symbolic issue. But then it became clear that ever-escalating executive pay is creating a culture of greed that is fueling income and wealth inequality. And now it has become clear that executive pay schemes are contributing to corporate practices harmful not only to workers, consumers, communities and the environment, but to corporations themselves, and even to the functioning of the economy.

The foolish and inexcusable housing-related investments by Wall Street firms, Fannie Mae and Freddie Mac resulted in no small part from executive compensation-driven efforts to drive up short-term stock values. These decisions were so bad, and of such enormous scale, that they have endangered the functioning of the financial system itself, thereby necessitating government intervention and massive taxpayer expenses — an indirect but even more expensive taxpayer subsidy for executive compensation.

A “market economy” indeed.

ROBERT WEISSMAN is editor of the Washington, D.C.-based Multinational Monitor, and director of Essential Action.

 

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