Should Executive pay be capped?

iBankedUp's picture
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I know this sounds anti-capitalism. But think about it. Executives received a pay ratio of 30x in 1978. Today, that ratio was 286x in 2015.

No economist can defend these numbers. And when you look at quality of life, nothing changes when you lose, say $20MM on $66MM. But that amount distributed to the lowest scale employee could make a big difference not just in their lives, but also in the economy.

The issue I see is executive pay increases because the data is available now and it's probably difficult to convince execs to take less. So, cap it like in the NBA or NFL to make the market more competitive.

Comments (35)

May 1, 2019

Interesting in theory, but anytime you cap something like that there are going to be unintended consequences. Should the government really be in the business of regulating executive pay? It would be an incredibly complex piece of legislation as compensation packages for execs differ from industry to industry/firm to firm.

You also have guys like Jeff Bezos who pay themselves $81,840, despite being one of the wealthiest businessmen on earth. No matter what piece of legislation you throw out there guys will game the system and get their cut.

An easier solution would be to just raise the minimum wage or create tax incentives for companies to increase employee wages. Considering the feds can barely do their job "as-is", I'd rather we not let the camels nose under the tent on this one.

May 1, 2019

I'm on board with the tax incentives to increase wages. While I don't see the difference between $20M vs $60M, I wouldn't want there to be a cap. Most of those wages are incentives and not base salaries that have been agreed upon by the board. They can lower those wages if they want to, but I don't see how that's the public's business.

May 1, 2019
trustmeimanengineer:

I'm on board with the tax incentives to increase wages. While I don't see the difference between $20M vs $60M, I wouldn't want there to be a cap. Most of those wages are incentives and not base salaries that have been agreed upon by the board. They can lower those wages if they want to, but I don't see how that's the public's business.

I would argue for capping incentives in a detailed stepping process. If an exec leads a company through a complicated M&A transaction (and maybe not even tied to a transaction, maybe growth, organic or not organic), maybe the cap is higher than say, good profitability, but the cap for profitability stops increasing after something like 20%. This transparency should literally help even boards out by giving them the leverage to know exactly what to offer to execs.

Of course, I would hope payout reflects compensation, but after the cap is hit, a bonus is issued to those with the smallest, non-equity compensation levels.

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May 1, 2019

I think that private companies should get to do as they please, as far as their leadership goes. It's for the board to decide.

But with that said, I don't think just dumping more and more cash on CxO will improve leadership. The current practice seems to be deeply rooted in the old "We need to pay more to attract the best talent" mentality that spawned during the 80's, and at this point I'm sure many are doing to because that's how it's "always" been, and because it's such a relationship driven area (the boards of directors, that is).

May 1, 2019

What would the criteria for capping it be? CEOs can only make 20x what the lowest paid employee makes? What if the lowest paid is minimum wage? What if it's a software engineer making 130k? I don't think you could come up with a universal criteria for capping pay that would work across the board without making it three times more complicated than the tax code.

The easiest way to redistribute the wealth is by increasing tax rates on high earning people. The problem is that congress thinks of high earning people as anyone over 100k and wants to increase tax rates for that group. If you're going to increase tax rates it needs to be on people making a milly or more. But then we get into government waste and efficiency problems and the discussion continues...

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May 2, 2019

Short answer: No

Long answer: The overall narrative is built on false assumptions. For starters, the exec/worker pay ratio you cite is for a subset of the worlds largest and most successful companies. That alone is misleading, as the number decreases massively when you include ALL companies. It also doesn't include benefits, or consider hours worked, etc.

Second, the underlying assumption of this line of thinking (and you even state it explicitly) is that if executives made less, other workers at the same company could make more. Let's see if that's true:

S&P 500 CEOs made a collective $6.77 Billion in 2017. Let's take their pay to ZERO and divide it by the 103,457,000 workers employed by those firms. The result? An extra $66 dollars per year before tax.

Again, that figure assumes ZERO compensation (not realistic), and of course doesn't even account for the various incentives that capping pay would create.

Finally, it's a bit silly to worry about the top end of pay if you understand that the overall pie size is what matters most, and that the income earned by these execs is not "taken" from anybody. Capping their pay alters incentives that results in lower overall wealth creation. This of course doesn't even touch on the vast good that sums of wealth can do for society (endowments, charities, research, or even investments),

You can argue about the best way to spread the results of the system, but I'd be weary about altering the system which provides the most wealth.

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May 1, 2019

Thanks for the thoughtful response. A few callouts taking away from your analysis:

DayMan247:

Short answer: No

Long answer: The overall narrative is built on false assumptions. For starters, the exec/worker pay ratio you cite is for a subset of the worlds largest and most successful companies. That alone is misleading, as the number decreases massively when you include ALL companies. It also doesn't include benefits, or consider hours worked, etc.

I don't know what companies are included, but I assume it's across the spectrum. For example, Disney CEO Iger had a ratio ~7x higher than the average. It's an average that must include some small companies, so I think you're pretty wrong on it is only a "subset of the world's largest and most successful companies".

And also, hours worked does not make sense here as total compensation including bonuses does not completely depend on hours worked. Benefits may be worth including, but do you really think top execs don't have their own impressive packages of healthcare or savings you can throw in the numerator?

DayMan247:

Second, the underlying assumption of this line of thinking (and you even state it explicitly) is that if executives made less, other workers at the same company could make more. Let's see if that's true:

S&P 500 CEOs made a collective $6.77 Billion in 2017. Let's take their pay to ZERO and divide it by the 103,457,000 workers employed by those firms. The result? An extra $66 dollars per year before tax.

Again, that figure assumes ZERO compensation (not realistic), and of course doesn't even account for the various incentives that capping pay would create.

  1. A weighted average would be more appropriate than a flat average across all employees
  2. You can't assume that all employees would be getting the bonus, as in top companies there tend to be highly paid non-exec level employees and equity compensated employees aside from the lower earning employees
  3. If you take Disney as an example the numbers workout much more in favor of employees than what you painted: if you brought Iger's ratio down to 1,000x which is still very excessive, the $20MM would go to 38,000 employees represented by an Union for minimum wage earning pepole at Disney parks, and comes out to a bonus of ~$526, which is not nothing for a minimum wage earner.
DayMan247:

Finally, it's a bit silly to worry about the top end of pay if you understand that the overall pie size is what matters most, and that the income earned by these execs is not "taken" from anybody. Capping their pay alters incentives that results in lower overall wealth creation. This of course doesn't even touch on the vast good that sums of wealth can do for society (endowments, charities, research, or even investments),

You can argue about the best way to spread the results of the system, but I'd be weary about altering the system which provides the most wealth.

I wouldn't necessarily think it makes sense to look at it as taking pay away that they didn't earn. It's more about creating additional opportunity that goes to the bottom. The whole company, even those low wage earners people don't place a ton of value on, can benefit when a company does well. If the exec hits a certain threshold like 900x the current low earner pay (or something like that), why shouldn't that mean the amount over gets to benefit lower earners?

My main contention is that, there are too many "smart" people running things. Just because you can tell people you earned the pay for whatever precedents that have been set, doesn't make it justified. It's just another modern form of the coal mines where people had to do undignified work for shit pay and just suck it. I think in the long-term, we will come to realize that the reason this stuff looks so bizarre and that it doesn't make sense, is because it doesn't, no matter how good of a spin you put on it.

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May 2, 2019

I appreciate the discussion.

iBankedUp:

I don't know what companies are included, but I assume it's across the spectrum. For example, Disney CEO Iger had a ratio ~7x higher than the average. It's an average that must include some small companies, so I think you're pretty wrong on it is only a "subset of the world's largest and most successful companies".

With all due respect, I'm telling you--not speculating--that it's for a subset of large companies...because I am familiar with the data you're referencing. Two of the big studies use the top 350 companies or the S&P 500 companies. If you look at the mean annual compensation for all company CEOs via the BLS, it's just 196k. That brings the overall ratio to < 4 to 1. Like I said, the extreme figures that make headlines are only for a tiny subset of massive and successful corporations. Big difference.

You highlighted an anecdotal example of Disney, and even still, 500 bucks a year (pre-tax) is likely less than most people would expect. This doesn't even consider that the compensation to distribute may not exist without the incentives or actions of the CEO, or the fact that you're redistributing a significant portion of his/her earnings.

Rather than pick one company, my redistribution figure takes the entirety of the group you reference, and shows that the redistribution bump is, on average, meager at best, and largely eliminates the narrative.

iBankedUp:

My main contention is that, there are too many "smart" people running things. Just because you can tell people you earned the pay for whatever precedents that have been set, doesn't make it justified. It's just another modern form of the coal mines where people had to do undignified work for shit pay and just suck it. I think in the long-term, we will come to realize that the reason this stuff looks so bizarre and that it doesn't make sense, is because it doesn't, no matter how good of a spin you put on it.

You're making an appeal based strictly on your personal worldview about what feels "justified" or "makes sense" or appears "bizarre" to you. That's fine, but it's a departure from your arguments about redistribution.

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May 3, 2019
DayMan247:

Finally, it's a bit silly to worry about the top end of pay if you understand that the overall pie size is what matters most, and that the income earned by these execs is not "taken" from anybody. Capping their pay alters incentives that results in lower overall wealth creation. This of course doesn't even touch on the vast good that sums of wealth can do for society (endowments, charities, research, or even investments),

Well, there is certainly an argument to be made the smoothing out the gap in pay between executives and labor may cause lower level employees to feel more buy in and loyalty to the company, which would be one way to increase the overall pie, in your parlance. Happier employees are generally more productive employees. If my boss makes $25mm a year and I'm taking home $50,000, I am rightfully going to question how much more valuable he/she is providing. And if I think that he's basically skimming my productivity into his salary (which is exactly what is happening), then why do I have any incentive to work harder or be more efficient/productive?

I agree government shouldn't be involved, but the entire concept that a Board of Directors sets pay for a CEO or C-suite executive is almost always absurd. The cronyism and inbred nature of those relationships aren't healthy for a functioning company.

And for what it's worth, lesser pay for CEOs won't hurt productivity or overall wealth creation. No one is doing a worse job because they're paid $20mm instead of 50. It's debatable how effective most CEOs are in general.

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May 1, 2019
Ozymandia:
DayMan247:

Finally, it's a bit silly to worry about the top end of pay if you understand that the overall pie size is what matters most, and that the income earned by these execs is not "taken" from anybody. Capping their pay alters incentives that results in lower overall wealth creation. This of course doesn't even touch on the vast good that sums of wealth can do for society (endowments, charities, research, or even investments),

Well, there is certainly an argument to be made the smoothing out the gap in pay between executives and labor may cause lower level employees to feel more buy in and loyalty to the company, which would be one way to increase the overall pie, in your parlance. Happier employees are generally more productive employees. If my boss makes $25mm a year and I'm taking home $50,000, I am rightfully going to question how much more valuable he/she is providing. And if I think that he's basically skimming my productivity into his salary (which is exactly what is happening), then why do I have any incentive to work harder or be more efficient/productive?

I agree government shouldn't be involved, but the entire concept that a Board of Directors sets pay for a CEO or C-suite executive is almost always absurd. The cronyism and inbred nature of those relationships aren't healthy for a functioning company.

And for what it's worth, lesser pay for CEOs won't hurt productivity or overall wealth creation. No one is doing a worse job because they're paid $20mm instead of 50. It's debatable how effective most CEOs are in general.

I just want to clear up that I do think it should be boards and no government involved. It's a matter of it should be the boards, but I think it's impossible too for boards to say, "our rival is paying 1,500x in potential earnings, but we're paying only 500x". If one company is paying astronomical amounts, then that's what CEOs should earn. I have trouble believing you can make things fair without transparency created through regulation.

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May 10, 2019

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May 3, 2019

It shouldn't be capped but it's ridiculous that poor performing CEOs get the axe and walk away with millions. If we want to talk about fairness, most people would agree that if you make a revolutionary turn around of a bad company, then you deserve your vaste compensation. If you suck however, then why on earth should you walk away as a winner? It's a perverse incentive.

May 3, 2019

I agree, a crappy CEO leading the titantic into the iceberg should get very little. Great performance needs to be rewarded.

Overall, this is a board issue. Boards tend to be weak on things like this and are entering into lopsided contracts with CEOs.

Stronger boards will fix the overall problem. It is the Board of Directors, not the government, whose job it is to fix any of these issues. If the boards are too strong they won't be able to attract talent, the board composition will change, etc.

May 3, 2019

Agree with this, it's the makeup of the board that causes issues. More often than not, it's other execs/ friends/ former colleagues on the BOD, so you're not exactly getting unbiased judgement here.

May 3, 2019
David_Puddy:

I agree, a crappy CEO leading the titantic into the iceberg should get very little. Great performance needs to be rewarded.

Overall, this is a board issue. Boards tend to be weak on things like this and are entering into lopsided contracts with CEOs.

Stronger boards will fix the overall problem. It is the Board of Directors, not the government, whose job it is to fix any of these issues. If the boards are too strong they won't be able to attract talent, the board composition will change, etc.

I agree with both you and Neink. However, how do you get stronger boards? Boards make decisions that are in the best interests of the shareholders but management usually has a disproportionate number of the shares. In effect, the board is making decisions that to a significant benefits management. While I am certainly no expert on this, I would think that the board members have conflicts that sometimes prevent them from making better decisions.

May 3, 2019

It's not perverse when you consider who is setting their pay. It's other C-suite executives on the Board. So even if they had any incentive to do their job and do right by the shareholder, they also want to make sure that their peers get golden parachutes, because when the time comes to negotiate their next job, they want that same massive payout, even if they fail.

It's simply not possible for a board of corporate executives to set a fair "wage" for a CEO.

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May 3, 2019

Good point

May 3, 2019

Can't help but think that capping salaries on public company head honchos would likely only enhance the various "golden handcuffs/golden parachutes" that already exist - corporate jet access, stock options/award certificates/dividends, bonuses, tax reimbursements, charitable donation matching, club dues, vacation time/sabbaticals, high-end housing, body guards/security and more.

Equilar does a range of C-suite-level surveys and studies - they compile stats on all the above and more, and these figures are only growing and getting larger.

https://www.equilar.com/reports/31-executive-benef...

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May 1, 2019
InfoDominatrix:

Can't help but think that capping salaries on public company head honchos would likely only enhance the various "golden handcuffs/golden parachutes" that already exist - corporate jet access, stock options/award certificates/dividends, bonuses, tax reimbursements, charitable donation matching, club dues, vacation time/sabbaticals, high-end housing, body guards/security and more.

Equilar does a range of C-suite-level surveys and studies - they compile stats on all the above and more, and these figures are only growing and getting larger.

https://www.equilar.com/reports/31-executive-benef...

So, you're basically suggesting, all of it just comes down to corporate waste, excessive compensation and the other ilk ?

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May 3, 2019

I'm not suggesting anything beyond that if caps were ever to be implemented on public companies' executive pay, there would be a myriad of ways to dance around whatever limits are in place.

Just like in sports, where you have a spending cap and yet you can go over it by way of the luxury tax.

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May 1, 2019

To reiterate the point, people want to say, philosophically, managers should be rewarded, economically, managers should be incentivized, but then that same philosophy/economic principle is not applied to other employees. I think it's bullshit. If you believe in this it should apply to all employees, especially above a level that cannot make a real marginal difference.

May 9, 2019

I don't have the time to give this issue the full attention it deserves, but I wanted to offer a few thoughts, in my normal, unorganized stream of consciousness style of writing (stick with me). first, are many CEOs overpaid? absolutely! should they be punished? absolutely! are they always? nope! how do we fix that? beats me!

ok seriously. yes, overpaying for underperformance is a problem, and I would argue under normal circumstances, if a CEO is in power for 5-10 years, the stock price should track their leadership. if they are growing earnings, the stock price will follow and they should be rewarded. so then you think: well, let's just give him/her enough cash to live on and then do the rest in stock appreciation rights, PSUs, and non qualified options, right? here's the issue: being a CEO is an incredibly difficult job, and the circumstances are not normal.

say you got tapped to be CEO of Wells Fargo, what a blessing, right? wrong. this CEO is doing damage control, not growth of an empire like Bob Iger who you mentioned earlier, so an arrangement that incentivizes stock price growth at the expense of cash comp (probably making the ratios a little more even), you'd get fucked over.

on the other hand, say you're tapped to lead Tesla after Elon has gotten pushed out by the SEC and your first 3 years are having to deal with refinancing bonds and competition from Volvo. should you be paid less because the stock is going to suffer? probably not, and if the comp offered is less than ideal, you won't attract talent.

on the other hand, why are the numbers ballooning so much? should the CEO of a major bank get $30mm a year? is $10mm enough to attract the talent? why not $15mm? I think the issue you'll run into is it's incredibly difficult to quantify what the CEO's value is versus other executives. I think whoever mentioned the board's impact on all this is spot on. the vast, vast majority of boards are "yes" men/women, and the largest shareholders of most public companies do virtually no due diligence (Vanguard, Fidelity, Blackrock, TRowe, CapGroup I'm looking at you) and it's boards plus top shareholders that have the ability to effect change.

so what would I do? well, first of all to think that the government regulators would be good at setting comp when they can't even liability match for one of the easiest math problems since 2+2 (social security), that's just asinine. the last thing we need is government sticking their nose more into the private sector. where I do think there is wiggle room is in different share classes. you want the benefit of public capital markets? you don't get to keep all of the founders shares with 10x the vote of the class you offer to the public. you shouldn't have it both ways: liquidity and power, you have to give to get. what else needs to happen? boards and large asset managers (particularly index funds which are absent from boardrooms) need to get some stones, call out the ineffective CEOs, and not sign off on every proxy that comes through. the only way to get change is to change the power dynamics, and I don't think government caps to ratios of pay is the best way to do it

on your last point about spreading the love, I'm a big fan of this and as someone whose practice focuses on equity based compensation, I think you should absolutely have more broad based equity awards. I've seen it time and time again, when employees benefit from their company's success, they feel more tied to the company, they work harder, and they appreciate the benefits the company bestows on them. unless of course, the company is run shittily, but if you want people to start paying attention to proxies, make every employee a voter and see how things change. too many companies exclude the bottom and fatten the top with equity comp and it's a shame. given the chance, I'd happily take 10% less cash for 20% more equity comp assuming I'm at a good company

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May 9, 2019

What is rarely taken into account when people make these comparisons in executive pay is the growth in responsibility. In 1978, aside from being a highly cherry picked year due to a being near the tail end of a rapid increase in minimum wage over series of years, the companies that are used as comparison points for multiples were just starting a major M&A cycle that has continued through the current year. Major companies such as banks are easily 7 - 10x bigger than they were back in the mid to late 70s. Executive pay has likely even fallen on a per dollar of revenue basis. Modern companies are not only bigger in terms of human capital and revenue but they are also wildly more complex in operational management and regulatory management than they were back in the late 70s. Simple minded people who say "rah rah CEO's make 200x the average employee rah rah" don't have a fucking clue what they are talking about.

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May 9, 2019

I am not in favor of capping CEO pay, but while CEO comp as a % of revenue might be about the same or less, they are not working much harder than CEOs did back 40 years ago. Yes, they may have more responsibility for bigger orgs, but they aren't working way more hours. Plus the downside now is much more favorable - getting fired almost always pays well. Both downside and upside are much higher.

May 9, 2019
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May 14, 2019
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