I’m seriously behind in highlighting an article by Ryan Grim and Mark Gongloff on one of the key mechanisms by which CEO pay has risen to stratospheric levels: cronyism and backscratching among board members, many of whom are also CEOs. While this behavior is well understood by most people who know the workings of the top levels of large corporations, the general public is largely in the dark. In addition, it’s one thing to recognize on an anecdotal basis that this sort of favor-trading goes on, quiet another to have it proven in a more rigorous manner. As the Huffington Post article explains:
The rise in U.S. income inequality in recent decades is largely due to massive wealth accumulating at the top of the income scale. The press and popular culture treat this phenomenon almost as if natural forces were guiding it — an invisible hand dealing out different shares to different people.
But the hands doing the dealing are in fact quite visible. They belong to the directors of the boards of the major companies in the U.S. and around the globe. One key source of wealth at the very top is the pay of the executives of our largest companies. That pay is approved by corporate directors, who are themselves paid for their service. Many of those directors are also executives at other companies, meaning they sit on both sides of the arrangement…..
The system operates largely in the open, with corporate records filed publicly for shareholders to view. But there is little practical transparency around the issue. Based on research conducted by [Dean] Baker’s CEPR, which combed through Securities and Exchange Commission filings, HuffPost has built the first-ever interactive database of every director of every company in the Fortune 100.
The database is here, and the article names and describes how this corporate incest works, for instance, describing how as Erskine Bowles approved hefty pay increases for CEOs at underperforming companies.
And remember, even the board members who are not executives at public companies benefit over time from this largesse. As CEO pay zooms upward, board member pay is also reset higher, since the board members are of the same class as the corporate officers they are overseeing and need to be paid appropriately.
Gee, but don’t board members have a duty to shareholders and the corporation to make sure its assets aren’t squandered by paying top executives too much? How can they justify all this wink and nod overpayment? Not to worry, they have all sorts of procedures in place that both make it look legitimate but are guaranteed to keep compensation levitating to the stratosphere. We wrote in 2008 about the pay double standard:
While most commentators on CEO pay correctly focus on the role of options-based rewards in goosing pay from generous to stratospheric, the role of compensation consultants seldom gets the attention it merits.
One practice that I have seen get perilous little mention is where the pay targets are set. Based on their belief of what constitutes good modern practice (influenced in no small degree by the pay consultants) most boards set general target ranges for how they would like the CEO to be paid relative to peers. The comp consultant then helps define and survey the peer group’s pay ranges, setting a benchmark for how the CEO in question is to be paid.
That all sounds fine, right? Well, except just as all the children at Lake Woebegone are above average, no board likes setting a target below peer group norms. I have heard of numerous examples of targets being set somewhere in the top half (66th percentile, top quarter, top 20%), hardly any at the mean, and none I know of below average…
So with this mechanism in place, any CEO who has fallen below median pay who is targeted to be in a higher group will have his pay ratcheted up, independent of performance, merely to keep up with his peers. This increase raises the average and creates new laggards. The comp consultants have institutionalized a leapfrogging process that keeps them busy surveying competitor reward levels and keeps top-level pay rising relentlessly.
Oh, and it gets even better. The fact that CEO compensation has risen so much allows for all the service providers to charge higher rates too. In the days when I was at Goldman (a LONG time ago), the investment bankers were careful not to dress too ostentatiously (well, one broad-shouldered man over 6 feet tall did manage to pull off wearing fur coats) precisely so as not to rub the noses of the less well paid CFOs in the fact that the senior investment bankers made a lot more. Now that CEOs routinely make tens of millions of dollars, they want to engage someone they think is a top or at least a pretty good practitioner, and that means he needs to be well paid, since pay is assumed to be a proxy for quality. After all, an attorney that makes only $300 an hour, or a consulting firm that bills its top partners at a mere $500 an hour can’t be good enough to be doing top executive level work. So a whole raft of professionals gets to ride the slipstream of rising CEO pay (and you see that even more with the professionals who serve the even better remunerated top hedge fund and private equity firm managers).
And in case you missed it, if you aren’t part of any of these elite clubs, a similar process is being used to your disadvantage. From our double-standard post:
Consider the way in which views that are contrary to most wage earners’ interests have been internalized (or at least are promulgated in the media). One meme I have noticed surfacing in the debate over the automaker bailout is that UAW employees are paid more than average workers.
Now in and of itself, that statement is meaningless. You need to have an idea of worker productivity to see whether that it out of whack (and for some odd reason, the bloated and highly paid management cohort almost never gets mentioned in these discussions, nor do the massive state level subsidies to the foreign transplants). Perhaps I missed it, but I do not recall seeing any longitudinal work on labor costs (that sort of analysis would help bring some badly needed facts to the table).
But why is framing the discussion around averages alone dangerous? Let’s say we collectively want to bring car worker pay down to some sort of average. That has the effect of lowering the average. You will have groups that were formerly at the average that are now above it. And if you accept the implicit logic “above average pay is bad” (fill in the blank as to why), you have a race to the bottom due to pressure on the relatively better paid to take less which puts pressure on aggregate pay.
And it is not hard to see that that is precisely what is happening. Not all that long ago, people chose government jobs explicitly because they were lower risk/more stable employment in return for lower pay. They turned out to have made the right bet on the “lower risk” part. But the people who made the bad bet and took the riskier private sector jobs and have now seen pay levels outside a few select sectors (finance and the minions to CEOs and the 1%) have been encouraged, not to demand better pay or insist that the top brass also make sacrifices, but instead have had jealous of those government workers stoked very successfully. Demanding that their wages and benefits be lowered simply paves the way for further grinding down of ordinary worker pay.
As robber baron Jay Gould said, “I can hire one half of the working class to kill the other half.” Today’s uber rich have done Gould one better by getting the lower orders doing their dirty work by undermining each other for free.