News Journal: Are CEOs worth that much? Not by a long shot

On Aug. 5, the Securities Exchange Commission approved a rule that will require major public companies to regularly disclose the ratio of their CEO’s pay to the median of the annual total compensation of the company’s employees.

The SEC was instructed to propose such a rule by the Dodd-Frank Wall Street Reform Act of 2010. Why did it take five years for it to happen? Led by the Chamber of Commerce, big business lobbyists have made opposing it one of their top priorities.

Earlier this year, Scientific American published an article entitled “Economic Inequality: It’s Far Worse than You Think.” Citing a 2014 study in Perspectives on Psychological Science by Michael Norton and Sorapop Kiatpongsan, the article reports, “They asked about 55,000 people from 40 countries to estimate how much corporate CEOs and unskilled workers earned. Then they asked people how much CEOs and workers should earn. The median American estimated that the CEO-to-worker pay-ratio was 30-to-1, and that ideally, it’d be 7-to-1. The reality? 354-to-1. Fifty years ago, it was 20-to-1. Again, the patterns were the same for all subgroups, regardless of age, education, political affiliation, or opinion on inequality and pay. ‘In sum,’ the researchers concluded, ‘respondents underestimate actual pay gaps, and their ideal pay gaps are even further from reality than those underestimates.’”

The SEC rule requires no action by any corporation to close any pay gaps. It merely says the corporation must tell its stockholders what the ratio is. Clearly, the Chamber and business lobbyists fear that when Americans know the true numbers they may be provoked into doing something about it.

We’ll see. Certainly, the new rule will have many people wondering just how the ratio of CEO versus average worker pay has gone from 20-1 50 years ago to over 350-1 today. Is it because today’s CEOs are that much more effective?

I guess some of them would argue that, but the real reasons are not too difficult to identify. I’ll spell out the two I think are most important.

First is what you might call the Lake Wobegon effect. That’s where “all the children are above average.” Corporate boards across America insist their CEOs are above average too. So all of them must be paid to reflect that. Since any one company CEO has to be paid more than the average of his or her fellow CEOs, they all keep getting pay hikes. Which means the average keeps going up, year after year, in an unending cycle.

The assumption behind much of this escalation is that corporations must pay their CEOs more than the average or they will lose them to another company. Charles Elson, the Edgar S. Woolard Jr. Chair of Corporate Governance at the University of Delaware, has done research that brings that theory into question. Along with Craig Ferrerre, he found that in a study of 1,500 companies over 30 years only 27 CEOs left for another job. They concluded that, “If executive talent is not transferable, the whole theory of peer groups collapses…It’s a market based on false assumptions, and until you address that false assumption, you’re not going to change compensation.”

The second important cause of the explosion in CEO compensation is that it is now the norm to link it to a rise in the value of a company’s stock. This seems eminently reasonable, except for the fact that CEOs and complacent boards have found a way to pump up the price of their stocks without doing anything to increase the real value of the corporation.

They do this with stock buybacks, and the results have been destructive on many levels. As Harold Meyerson pointed out in the Washington Post, “Getting your company to use its earnings to buy back its shares might reduce its capacity to do research or expand, but it’s a sure-fire way to boost your own pay.”

A Harvard Business Review article by William Lazonick, Professor of Economics at the University of Massachusetts, Lowell, found that stock buybacks are one of the major causes not only of income inequality, but also wage stagnation. He found that from 2003 to 2012, the publicly listed companies in the S&P 500 “used 54 percent of their earnings – a total of $2.4 trillion – to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37 percent of their earnings.”

That means that, in this period, only 9 percent of the profits of S&P 500 corporations were left to be invested in the future of the companies. Hardly any money was left at all for things like new plants and equipment, research and development, or – no surprise – raises for employees.

Keep stock buybacks and the Lake Wobegon effect in mind when your next annual report tells you the ratio of your CEO’s pay to his or her average worker. Maybe the Chamber of Commerce is right to be worried about what you might want to do about it.

Ted Kaufman is a former U.S. Senator from Delaware.