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CEOs Are Set to Make More Money Than Ever. Their Employees? Not So Much.

CEOs Are Set to Make More Money Than Ever. Their Employees? Not So Much.

Craig Donofrio

  Original image by Eli Miller

Original image by Eli Miller

Last year, the Securities and Exchange Commission approved a rule requiring public companies to disclose how much their CEOs make in comparison to the median worker.

Those figures are available now and surprise, surprise—CEOs make a lot more than the typical company worker. Take Live Nation Entertainment, whose CEO made about $71 million—nearly 3,000 times the company’s median salary of $24,406 as of 2017. The CEO of First Data Corp pulled in more than 2,000 times the salary of that company’s median worker, earning more than $102 million. Walmart faired marginally better; the CEO made a meager $22.8 million, only 1,188 times the median worker’s $19,177 salary.

How did we reach a point where CEO salaries so severely outpace their workers’ earnings?

The short history of big money

Worker frustrations around high CEO salaries hit a fever pitch during the Great Recession, when many were facing stagnant wages and the dreaded “last hired, first fired” syndrome, but big top brass benefits—and the outrage over it—aren’t anything new.

In 1930, at the start of the Great Depression, a lawsuit forced the CEO of Bethlehem Steel to reveal he received a $1.6 million bonus—equivalent to roughly $23 million in 2018 dollars. At the same time, a lawsuit against the American Tobacco Co. revealed that CEO’s compensation hit $1.2 million. 

Then there were the railroads. During bailout talks for the Depression-ravaged industry in which employment had fallen by 42 percent, railroads were forced to disclose the names of all executives making more than $10,000 a year. That list was large enough to lead to a government-imposed informal executive compensation cap of $60,000 for all railroad presidents.

Unsurprisingly the vast number of unemployed workers living in Hooverville shantytowns weren’t thrilled to learn of the lavish salaries—and neither was the federal government.

In the wake of a nationwide economic disaster, President Franklin D. Roosevelt enacted the New Deal, a series of government reforms aimed at providing relief and future economic security. Those reforms led to the creation of the Securities and Exchange Commission. Created in 1934, the SEC pretty much immediately set about requiring pay disclosure (including bonuses, stock, and stock options) for the top three executives of each publicly traded company, in part hoping that the spotlight would deter lavish payments. These disclosure rules have expanded over the years, such as with the new CEO-to-median-worker pay ratio.

Unfortunately …

“There’s absolutely no evidence that it kept down pay levels,” says Kevin J. Murphy, finance chair at USC Marshall School of Business and an expert in executive compensation.

While the SEC might have been hoping a public guilt trip would knock some sense into Great Depression-era CEOs, executive compensation kept rising for another six years. By 1940, at the end of the Great Depression, the median top executive made 24 times the average worker. But heading into the middle of the century, CEO compensation hit a sharp decline. By 1949, CEO earnings had dropped to 17 times that of the median worker, a trend that largely continued throughout the ’50s and ’60s.

The decline has been attributed to the “Great Compression,” a period of time between the 1940s and 1970s where the wage gap between high- and low-income workers became smaller, largely due to factors like World War II and new labor policies enacted under President Roosevelt’s National War Labor Board.

By the time we get to the disco-era, data on CEO pay gets murky. Recent research by UCLA and the University of Cambridge found that, at least in the early ’70s, “the $1 million executive was nowhere to be found.” The authors asserted that the first “Millionaire Club” was created in 1977 and was composed of the salaries of just five of the nation’s top-paid CEOs. A 1982 New York Times article backed this up—saying that Henry Ford II (who retired in 1980) was the first CEO to break the millionaire mark in recent times.

However, according to the Economic Policy Institute, in 1973, using “options realized” numbers—which includes salary, bonus, restricted stock grants, options exercised, and long-term incentive payouts—average CEO pay in America’s largest firms was $1.069 million, or 22.3 times that of the average worker. By 1989, the average CEO was making $2.724 million, or 58.7 times the average worker. The EPI study suggested that total CEO compensation had actually been rising rapidly throughout the ’70s and ’80s.

In fact, options, stocks, and long-term incentive payouts were increasingly making up larger chunks of CEO compensation. Research by Stanford University found from 1936 to 1969, CEO pay largely came from salary and cash bonuses. In the ’70s, CEOs started earning an average 11 percent of their compensation in the form of other incentives. By the greed-is-good ’80s, that number had jumped to 26 percent. But as the U.S. workforce headed into the ’90s, CEO compensation was poised to get far more complicated, and far larger, than ever before.

The pay gap explosion of the 1990s

Before 1993, businesses could deduct unlimited expenses like office supplies, employee wages, and CEO pay. As a result, hefty CEO price tags meant huge tax deductions for corporations. But in ’93, President Bill Clinton changed the tax code, imposing a $1 million cap for each company’s top five executives (that number is now down to four in our current tax codes). Anything over $1 million was suddenly taxable.

In theory, Clinton was putting pressure on companies to limit rocketing CEO pay. Except that cap only applied to direct cash compensation, not pay-for-performance incentives like stock options. Call it a loophole or an oversight, but the lack of limits on incentives catapulted CEO compensation beyond the pale. In 1995, the average CEO pay was $5.947 million, about 122 times the typical worker’s salary, according to the Economic Policy Institute. By 2000, it ballooned to $20.664 million, making one man’s pay 411 times that of the typical worker.

And that mega-inflation all comes down to a little thing called a stock option.

A stock option allows an employee to purchase a certain amount of company stock at its current value sometime in the future. Say a company’s stocks are trading at $5 a share when the option is granted. Six months down the line, the stocks are now up to $15 a share. You can buy the $15 share for $5, then sell it and make a $10 profit. The opposite is also true; if the shares drop to $2, you’re out $3 per share.

Now imagine you’re the CEO of a company, shares are trading high, and you have tens of thousands or hundreds of thousands in stock options—the profits can be in the millions. To use a current example, Netflix CEO Reed Hastings will make $700,000 in salary and get $28.7 million in stock options this year, according CNN Money. If Netflix stock goes up next year, he can turn around and sell those options for a hefty profit.

Between 1990 and 1999, stock options made up 32 percent of executive compensation, up from 19 percent in the ’80s and just 11 percent in the ’70s, according to the Stanford University research.

Yet CEOs weren’t the only ones benefiting from stock options—everyone was.

Free lunch?

At first glance, it might seem like the way to limit a CEO’s compensation is to get rid of the stock options and other performance incentives altogether. After all, between 2000 and 2005, direct cash salaries only accounted for 40 percent of the average CEO’s $9.2 million compensation package, according to Stanford University. But axing those stock options wasn’t so clear-cut, largely because companies saw—and treated—the practice as a “free lunch.”

Stock options aren’t really on the books, not in the traditional way that clearly impacts a company’s expenditures.

“The companies didn’t have to take any kind of accounting charge,” explains Murphy. “They didn’t have to pay the executive in cash, and when the executive exercises the option, not only do I get cash from the executive, but I also get a big tax break.”

It’s important to note that stock options are common for regular employees, too (only they get a lot less). They are also favored in startup businesses where funds are scarce but 100,000 shares could attract top-level talent. Stock options were crucial to businesses in the tech sector during the 1990s.

“We’re talking the growth of the internet. There are few people in the industry who know how to do this stuff and they demand high numbers,” says Mark Harvey, director of graduate business programs at the University of Saint Mary in Leavenworth, Kansas, and a professional consultant.

In fact, tech businesses were some of the most outspoken critics when the Financial Accounting Standards Board, an organization responsible for setting public company accounting standards, wanted to make stock options less “free.”

But even if the costs were off the books, there’s one glaring problem with churning out stocks for employees: “The more shares you give to somebody, the more it waters down every other share out there,” says Harvey.

But in the ’90s, many workers were profiting off this “free lunch.”

“We saw an explosion in stock options not only for CEOs, but for everyone. CEO pay was tripling but so was the stock market,” says Murphy. Stock options were so widespread that a compensation lawyer told Forbes in a 1998 article that “People just will not work for a company that won’t offer stock incentives.”

But alongside stock dilution, stock options masked the true cost of employee wages and therefore inflated net profits. According to Forbes, that’s why when Berkshire Hathaway bought a company during that time period, CEO Warren Buffet would replace stock option plans with a clear-cut salary plan so that the company’s “true compensation cost is thereby brought out of the closet and charged, as it should be, against earnings.”

Still, many workers didn’t much feel like complaining about their CEOs’ skyrocketing wages, especially when the market was doing well and people had jobs. But then, on March 10, 2000, the dot-com bubble burst and the market crashed.

Lavish CEO pay not going away

After the bubble burst, CEO pay substantially decreased—falling to $10.75 million on average by 2006. But then, mysteriously, it started to crawl back up.

“In the last few years, we finally caught up and surpassed where we were in 2001,” says Murphy.

Using the most recent data from the Economic Policy Institute, a CEO of one of America’s largest companies made an average $15.6 million, or 271 times the typical American worker, in 2016.

In trying to explain the persistence of such unequal pay schemes, Harvey theorizes it may come down to making a safe bet. “A lot of business is: You go with what you know. I think we’re in a risk-adverse environment right now, [and] if there are only a few people out there that are franchise CEOs, people with big names and proven track records, they’ll bring the big salaries,” he says.

Additionally, salaries that average Americans consider eye-popping are often standard among those who have the most say over executive pay—the company’s board, which Harvey calls “an inbred group of people with similar interests.”

Whatever the reason might be, CEO compensation growth is still massively outpacing that of the workers.. CEO salaries increased by between 807 and 937 percent, depending on how you measure, between 1978 and 2016. Comparatively, during that same period, the typical American worker’s salary grew by 11.2 percent.

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