The 21st century has been a terrible century so far for US stock markets. Adjusted for inflation, all major stock market indices (Dow Jones, S&P 500, NASDAQ, Russell 3000) have been flat or down since the turn of the millennium.
Stock markets in general have been moving sideways since the 1990s. There’s been lots of volatility, but not a lot of gain. That’s a bit surprising, because for the past twenty years we’ve been living in the “shareholder value” era.
The idea that corporations should seek to maximize shareholder value – and nothing else – was born in the 1980s and rose to dominance in the 1990s.
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Before the 1990s, many people believed that corporations existed to produce useful goods, provide important services, generate meaningful employment and support vibrant communities. How quaint that sounds today.
After two decades of laser-beam focus on maximizing shareholder value, you’d think American corporations would be generating more value by now. They’re certainly generating lots of profit. Why no value?
One answer is executive pay. While shareholder value has been sliding sideways, executive pay has gone through the roof. The AFL-CIO reckons that the ratio of chief executive pay to median worker pay rose from 42-1 in 1980 to 343-1 in 2010. The average S&P 500 CEO now makes over $10 million a year, according to a report from the Institute for Policy Studies.
Investors are unhappy. According to the Wall Street Journal, a recent survey by executive consultants Towers Watson shows that “companies that give their CEOs high pay opportunities are more likely to receive lower levels of shareholder support.” You don’t have to be an Occupy Wall Street protester to be angry over CEO pay.
But is CEO pay such a problem? The average S&P 500 company is thought to have made around $2 billion in profit in 2011, so $10 million for a chief executive will hardly break the bank. It’s half a percent of the average company’s profit.
Put another way, though, that half a percent is a staggering sum. An S&P 500 company is an enormous organization with thousands (or in a few cases, millions) of employees. The fact that one employee could rake in one two-hundredth of the firm’s total profit is pretty extraordinary.
Take Walmart. Walmart made over $16 billion in profit in 2011. It paid its CEO, Michael Duke, just over $18 million. That’s just over 0.1 percent, or one one-thousandth, of its profits. It doesn’t sound like much, until you realize that Walmart has over two million employees.
Duke is a modest example. Take Robert Iger of Walt Disney. He made over $53 million in 2011. His company made $3.9 billion. Iger took home over 1 percent of Walt Disney’s profits for the year, and that in a company of 156,000 employees.
The problem isn’t the money. The problem is what these men – and 488 of the Fortune 500 CEOs are men – will do for the money. If history is any guide, they’ll do anything. It’s worth rolling the dice and risking bankruptcy for your company if the potential payoff is a multimillion dollar bonus.
Executives involved in many of the largest corporate collapses in American history were extraordinarily well paid. Richard Fuld (Lehman Brothers), Bernie Ebbers (Worldcom), Kerry Killinger (Washington Mutual), Kenneth Lay (Enron) and Stanley O’Neal (Merrill Lynch) all had seven-digit annual pay packages.
Moving beyond specific cases, research shows that high executive pay isn’t systematically associated with better (or worse) performance. Instead, it seems to be driven by broad cultural change. Call it the premiumization of society.
Those who believe that the rich always get richer will be surprised to hear that CEO pay hardly increased at all from the 1930s through the 1970s. Research published in 2010 in the Review of Financial Studies by Carola Frydman of MIT and Raven E. Saks of the Federal Reserve shows that the average American CEO in the 1970s earned about 4 percent more than the average CEO did in the 1930s (adjusted for inflation).
Between the 1930s and the 1970s average earnings of ordinary Americans more than doubled, but CEO pay remained about the same. It actually fell from the 1930s through the 1960s. The post-war economic boom was accompanied by declining real (inflation-adjusted) CEO pay.
Frydman and Saks report that, since the 1970s, CEO pay has risen by a factor of eight. Pay for ordinary Americans, by contrast, has been stagnant. It’s hard not to see a link.
Companies run by more highly paid CEOs don’t do any better or worse than companies run by less highly paid CEOs, but as CEO pay has risen over time the pay of ordinary workers has fallen.
The issue isn’t CEO performance; the issue is CEO greed.
In addition to their findings on trends in CEO pay, Frydman and Saks tracked the CEO “pay slice”: the proportion of total executive team pay that goes to the CEO. The average CEO pay slice reached a minimum in the 1960s and has been expanding ever since.
In other words, it’s not just that all executives are getting paid more. As I have reported elsewhere, between 1993 and 2006, CEOs at America’s top 1,500 public companies received average annual raises of 8.8 percent per year, while their corporate seconds in command received annual raises averaging 5.4 percent, thirds in command 5.2 percent, fourths in command 5.0 percent and fifths in command 4.6 percent.
This is greed at its most glaring. And it’s not just morally offensive. It’s bad for companies as well.
A 2011 paper in the Journal of Financial Economics by Lucian A. Bebchuk, K.J. Martijn Cremers and Urs C. Peyer found that the CEO pay slice is associated with lower profitability, lower stock returns and a range of other negative outcomes. Greed is not good.
When chief executives are earning tens of millions of dollars a year for doing the same job as executives at other times and in other countries have done just as well for a fraction of the price, it’s reasonable to ask “is CEO pay money well earned?”
Both morally and empirically, the obvious answer seems to be no.