For bystanders who couldn't understand the credit default swaps and collateralized mortgage obligations that upended the economy or the implications of the 451-page final Senate bailout bill designed to address it, one piece of this whole mess appeared clear: The CEOs of freefalling companies seemed to be making an awful lot of money for their failures.
Of that much — and only that much — many taxpayers were sure.
There was the guy at Home Depot who walked away with $210 million, the Merrill Lynch exec who was given about $160 million on his way out, and the CEO at Lehman Brothers who made $34 million in the year leading up to his company's bankruptcy. The top executives of S&P 500 companies last year brought home an average total compensation of $10.5 million, according to one survey.
Those pricey figures, combined with dire forecasts for what a looming recession would mean to the average worker, have cast a harsh light on CEO pay in Congress and around the kitchen table.
Same Old Story, Different Ending?
While it's not the first time in our history that CEO pay has been scrutinized, scholars are split over whether this time around the system will actually change — or, even after the last two months, if it should change.
"Looking at the way things have gone historically, I'm very skeptical that somehow this time it's going to be different," said Jesse Fried, a University of California, Berkeley law professor and co-author of the 2004 book Pay Without Performance.
"We have seen this pattern happening repeatedly where the markets crash: People get upset about executive pay; there's some legislation that's passed that attempts to deal with the problem; and it's often very poorly designed and doesn't actually have much of an impact."
That story goes back to the stock market crash of 1929, which prompted an early round of the now-familiar congressional hearings on executive pay.
While some legislation since then has forced greater disclosure of CEO compensation, nothing has altered what Fried views as the fundamental flaw in the model: Board directors set CEO pay using someone else's money. Shareholders — the people who put up the money — have no seat at the negotiations.
"I think those who didn't think it was a problem are still convinced it's not a problem," said Charles Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. "It's pretty hard these days to say it's not a problem."
Randall Thomas, a law and business professor at Vanderbilt University, counters that the problem is with outliers in an otherwise effective market-driven system. In that view, $50 million is a drop in the bucket for the billions of dollars some CEOs do help generate for their companies.
"Who's to say these guys aren't worth what they're paid?" Thomas asked.
"I would say there are broadly two schools of thought on executive pay. One is that the boards of corporations are corrupt and in the back pocket of CEOs, and basically they give CEOs whatever they want," he said. "The other is pretty much the opposite, that corporations and boards are doing the best they can in the situation, striking contracts which they view as in the best interest of shareholders."
Much of the debate comes down to a somewhat unanswerable question: How do you decide what someone is worth?
Is a CEO's value tied directly to the company's raw stock price? Is it simply the next dollar amount larger than whatever someone else is willing to pay? Or is it a measurement, through incentives, of just how much risk a CEO will assume responsibility for?
"When we see executives in these financial services companies get 8, 10, 20 million-dollar severance payouts when companies have been destroyed, it reminds us that a lot of people's pay is not only not tied to their own contribution to firm value," Fried said. "It's not even tied to the firm's value."
Chuck Collins, a senior scholar at the Institute for Policy Studies, argues that incentivizing CEOs to take risks for short-term gains at the expense of long-term vision is one of the factors that has landed the economy in today's position.
Fried, too, draws a link from the current CEO pay model to the economic meltdown, among other factors (excessive CEO pay, however, is not what encouraged many people to take on mortgages they couldn't afford).
"If you're working for one of these banks," Fried said, "you think, 'OK, my expected lifetime here is four or five years, most of my pay is in the form of an annual bonus, all of which is in cash. I'm going to try to do things to generate a lot of profit now even if it may come back to bite the firm four or five years from now.'"
After those four or five years, the CEO is gone, but the taxpayer is picking up the bill.
What Might Government Do?
General public anger at the prospect of a $700 billion government bailout found voice in the issue of executive compensation, and as a result the final bill did include provisions on CEO pay.
In its most severe form — for firms seeking the greatest government bailout — the bill bans all payments to departing senior executives and requires companies to ensure that incentive compensation does not "encourage unnecessary and excessive risks that threaten the value of the financial institution."
Collins feels an actual dollar-amount limit on executive pay would be more effective than that ambiguous language. (The Institute for Policy Studies calculated that the nine major banks set to take bailout money collectively paid their CEOs $289 million in 2007.)
And today, only the companies participating in the bailout are subject to new restrictions. Fried predicts that after the bailout has served its purpose, not only will the experiment not win any converts, but even its participants will go back to their old ways.
What long-term changes could be implemented in the midst of a politically favorable climate to eventually outlast the crisis and apply to everyone? The most radical ideas involve government regulation of CEO pay, either by setting a cap or tying CEO pay to a ratio of the company's lowest-paid worker.
U.S. Rep. Barbara Lee, D-Calif., last year introduced a bill that would tie tax-deductible CEO compensation to 25 times the company's lowest-paid worker. Want to pay the CEO $25 more? Then that bottom-rung worker gets another dollar. (Federal law currently caps deductions for "non-performance based" pay at $1 million and $500,000 in the bailout bill.)
Beyond the philosophical arguments against government intervention, Thomas chimes in with a warning favored by his camp: "You'll see most talented people leaving and moving into positions where they can get higher returns on their skills" — in other words, leaving for the unregulated sector.
"That's the way our system works, and we think it's efficient."
A recent (and yet still pre-Lehman Brothers collapse) Cato Institute policy analysis concluded that CEO pay has in fact closely tracked performance, and that the market can best regulate itself in the case of outliers. Opponents often point to the fact that American CEOs make considerably more than their foreign counterparts. But both the Cato study and Thomas argue that American CEOs are paid more for making larger contributions to much larger companies.
Thomas concedes, though, a couple of changes that he thinks both camps (at least in academia) could agree to. He would like to see greater disclosure of total CEO compensation.
"I don't see how it harms the companies' relationships with executives to tell investors this is what we're paying them," he said.
Columbia University law professor Jeffrey Gordon proposes going a step further and requiring a "Compensation Discussion and Analysis" document that would itemize compensation, provide justification for it and then be signed by all members of the compensation committee. Such public disclosure — with individual names attached — would force directors to accept responsibility for CEO pay rates and any public backlash that comes with it.
Thomas' other point of agreement is "say on pay," a movement that's already become law in England giving shareholders a nonbinding, advisory vote on executive pay packages. "Say on pay" and further disclosure requirements would create an atmosphere of greater transparency and feedback without giving shareholders a direct veto. Aflac earlier this year became the first publicly traded American company to voluntarily adopt say on pay.
Inequality Not Restricted to Corporations
Fried, though, said no change will be effective until the basic relationship between boards and shareholders is restructured, with shareholders being able to replace directors they don't like or nominate those they do. Otherwise, Fried feels, CEOs effectively wield influence over the directors who pay them, and by extension their own pay packages. In this setting, pay is decoupled from performance, CEOs' interests are detached from shareholders' interests and CEOs have evolved to making more than 300 times the pay of the average worker.
That ratio, which has increased dramatically over the years, has become the rallying cry for excessive CEO pay opponents. The disparity should offend us, Collins said, as indicative of a system where executives have become disconnected from the companies they're supposed to lead and where labor has become a cost to be outsourced instead of a partner in production.
"The leadership model of the '50s and '60s was that the uplift of all is what is going to build a healthy company," Collins said. "We had companies with a very different management ethos."
That widening ratio also suggests that in an economic collapse, average workers will be hit disproportionately harder than CEOs, while Collins believes the actions of those CEOs put us here.
Thomas, though, suggests something else is at work in the statistic.
"Inequality of income and inequality in wealth distribution has clearly changed in our country in the last 25 years, so let's not get too obsessed with CEOs," he said. "Let's talk about the bigger reasons behind that. Part of it is the skills gap between highly skilled and lowly skilled workers. The returns to skills have increased dramatically."
That means that if you don't have skills, your job can probably be done in India. And if you do have skills that can't be outsourced, the market will now pay a lot more for them. That changing face of the economy is what gives Collins hope that out of this current crisis will come permanent change. Unlike Fried and Thomas, Collins doesn't think things will go back to the way they used to be — not the high times for everyone, or the high pay rates for CEOs.
"I think there's a populist moment about to break open," he said. "There's going to be demand for an economy that works for everybody, not just the top 5 percent."
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