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We Don’t Need Washington to Fix Bloated CEO Pay

The outcome of the presidential election dashed the hopes of many people expecting measures to reverse the four-decade long growth of inequality. Few expect Donald Trump to be an ally in efforts to rein in incomes at the top and boost the income of ordinary workers. While there is always the possibility that we can be pleasantly surprised by the policies that Trump puts forward, efforts are probably best focused in other arenas.

One obvious target are the bloated salaries of top executives at major corporations. CEOs have always been well paid. This is reasonable given that they have demanding jobs that often require a wide range of skills. But corporate America seemed to have little trouble attracting talented top executives in the 1950s, 1960s and 1970s, when the ratio of CEO pay to that of ordinary workers was 20 or 30 to 1. Why do we now need ratios of 200 to 1 or even higher to get good help?

But corporate America seemed to have little trouble attracting talented top executives in the 1950s, 1960s and 1970s, when the ratio of CEO pay to that of ordinary workers was 20 or 30 to 1. Why do we now need ratios of 200 to 1 or even higher to get good help?

And the help often doesn’t seem that good. Wells Fargo CEO John Stumpf will walk away with a pay package that averages close to $15 million a year, even as the bank was involved in a massive phony account scandal under his watch. And according to some calculations, Marissa Meyer averaged almost $55 million a year for her four-year stint at Yahoo, a period in which she never managed to turn around the company’s fortunes.

The basic problem is that CEO pay is not subject to the same market discipline as the pay of most other workers. Most companies are constantly looking to lower costs by paying workers less. This is the point of producing goods in Mexico or China. If a company can get comparable quality labor at a lower price, they will shift production.

However the boards of directors who most immediately determine CEO pay rarely act the same way. It is unlikely that many directors ever ask if they could cut their CEO’s pay by 20 to 30 percent and still keep her, or alternatively, if they could get another CEO who is just as good at half the pay? These questions are likely to go unasked, even though this is exactly what corporate boards are paid to do, because the directors tend to be more closely tied to top management than to shareholders.

Directors often owe their positions to top management. Once on the board, which often includes the CEO, the directors typically ally themselves with top management. After all, it is a very cushy arrangement with directors getting hundreds of thousands of dollars a year for extremely part-time work. Why should they look to upset the apple cart by getting in a fight over the CEO’s pay? It is almost impossible for shareholders to dislodge even the most negligent directors. They are re-elected over 99 percent of the time.

In this context, it is not surprising that CEO pay keeps rising. There are no checks in place in the current institutional structure.

It is almost impossible for shareholders to dislodge even the most negligent directors. They are re-elected over 99 percent of the time.

The obvious fix is to put in place some real checks on CEO pay. Suppose that directors had a real incentive to reduce CEO pay. For example, the directors could split any savings from cutting the pay of the CEO and next five top paid executives, as long as the company’s stock did at least as well as a peer group for the next five years. This would give directors a real incentive to ask whether they could get away with paying less.

This sort of shareholder power measure is something that could be pressed by pension funds, university endowments or any other party with a substantial stake in a company’s stock. And if some companies could be pressed to reform corporate governance in this way, others might follow.

In addition to bringing down to earth the pay of some of the country’s highest earners, lowering pay for corporate CEOs would likely have a large spillover effect. It is not uncommon for the top executives at universities, foundations and private charities to earn more than $1 million a year. Pay at the top in these other sectors followed the pay of CEOs in the corporate sector on the way up. It is likely also to follow them on the way down.

And, as a simple economic matter, lower pay for those at the top will leave more money for everyone else. The university that pays its president $400,000 instead of $1 million has $600,000 to pay other staff or charge lower tuition.

There is also another route to attack CEO pay in the nonprofit sector. Nonprofits benefit from special tax treatment, most importantly the tax deduction for charitable contributions. This allows high-income people to write off 40 percent of their contributions against their income taxes. This effectively means that the government is giving a $400,000 yearly subsidy to a university president getting a $1 million annual salary. That’s a big taxpayer subsidy for people in the top 0.1 percent of wage earners.

There are clear channels that people can use to put downward pressure on the pay of those at the top in both the corporate and noncorporate sector that don’t require going through Washington.

While the largest subsidy is the federal income tax, most states also give exemptions from their income taxes for charitable contributions. They also often exempt nonprofit institutions from state sales and property taxes.

There is no reason that states or even cities could not put conditions on these subsidies. For example, they could say that to benefit from these tax subsidies, nonprofit institutions would have to cap the pay of any employee at $400,000 a year, the same as the president of the United States. While many universities and other institutions will insist that they can’t attract good help for this wage (roughly 10 times the annual pay of a typical worker), that is probably a good argument that they aren’t then the sort of institution that the taxpayer should be subsidizing.

There are clear channels that people can use to put downward pressure on the pay of those at the top in both the corporate and non-corporate sector that don’t require going through Washington. These are clear cases where incremental gains can make a big difference. Contrary to the warnings we got from TV shows when we were young, these are actions that the kids can do at home.

This article originally ran PBS Newshour.

More articles by:

Dean Baker is the senior economist at the Center for Economic and Policy Research in Washington, DC. 

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