From yesterday's WSJ:
Switzerland will vote next week on a proposal limiting executive pay to 12 times that of a company's lowest paid worker, the second time this year the country will use the ballot box in an attempt to rein in corporate compensation.
On Nov. 24, voters will be asked to approve or reject the 1:12 Initiative for Fair Pay, which organizers say would address a growing wealth gap in Switzerland. The initiative is premised on the idea that no one in a company should earn more in a month than others earn in a year.
One of the many problems with this proposal is that capping executive pay is a lousy way of dealing with income inequality, for reasons I explain in my book Corporate Governance After the Financial Crisis:
Complaints during times of economic distress about supposedly excessive executive compensation are hardly new. In the 1930s, during the Great Depression, for example, a lawsuit challenging executive bonuses as corporate waste gave rise to the aphorism “no man can be worth $1,000,000 per year.”[1] This complaint rested, at least in part, not on a belief that executives were being paid too much relative to their company’s performance but on the belief that the amounts they were being paid were simply too high.
Similar populist themes abound in the rhetoric surrounding the crises of the last decade. A 2008 House of Representatives committee report, for example, noted that “in 1991, the average large-company CEO received approximately 140 times the pay of an average worker; in 2003, the ratio was about 500 to 1.”[2] Delaware Vice Chancellor Leo Strine observed in a 2007 law review article that both workers and investors “feel that CEOs are selfish and taking outrageous pay at a time when other Americans are economically insecure.”[3] William McDonough, the then-Chairman of the Public Company Accounting Oversight Board (PCAOB), complained that:
We saw … an explosion in compensation that made those superstar CEOs actually believe that they were worth more than 400 times the pay of their average workers. Twenty years before, they had been paid an average of forty times the average worker, so the multiple went from forty to 400—an increase of ten times in twenty years. That was thoroughly unjustified by all economic reasoning, and in addition, in my view, it is grotesquely immoral.[4]
The rhetoric of class warfare makes a poor foundation for economic policy. As a justification for regulating executive compensation, however, it is particularly inapt. First, why single out public corporation executives? Many occupations today carry even larger rewards. The highest paid investment banker on Wall Street in 2006 was Lloyd Blankfein of Goldman Sachs, for example, who “earned $54.3 million in salary, cash, restricted stock and stock options,”[5] or about 4 times the median CEO salary from the year before. The pay of some private hedge fund managers dwarfed even that sum. Hedge fund manager James Simons earned $1.7 billion in 2006, for example, and two other hedge fund managers also cracked the billion-dollar level that year.[6] Not to mention, of course, the considerable sums earned by top athletes and entertainers.
Second, regulating executive compensation may scratch the public’s populist itch, but it does little to address inequalities of income and wealth. To be sure, as Brett McDonnell observes, fat cat “CEOs have become poster boys for” the dramatic increase in “inequality in income and wealth in this country.”[7] Even if one assumes that redressing such inequalities is appropriate social policy, however, capping or cutting CEO pay is not an effective means of doing so.
Steven Kaplan and Joshua Rauh determined that executives of nonfinancial corporations comprise just over 5 percent of the individuals in the top 0.01 percent of adjust gross income. Hedge fund managers, investment bankers, lawyers, executives of privately-held companies, highly paid doctors, independently wealthy individuals, and celebrities make up the bulk of the income bracket. They further found that the representation of corporate executives in the top bracket has remained constant over time and that realized CEO pay is highly correlated to stock performance. Accordingly, they conclude that “poor corporate governance or managerial power over shareholders cannot be more than a small part of the picture of increasing income inequality, even at the very upper end of the distribution.”[8]
McDonnell is critical of the Rauh and Kaplan paper on several grounds, but even he concedes that “it does seem quite plausible that investment bankers, the managers of hedge funds and private equity funds, and corporate lawyers are at least as large a part of the problem of rising inequality as are the top officers of public corporations.”[9] If so, regulation that singles out public company executives is unfairly under-inclusive. Such regulation, moreover, will have important distortive effects. If public corporation CEO salaries lag relative to those paid in other fields, the best and brightest will shift career tracks to the higher-paying jobs.
In sum, we need not decide here whether wealth and income inequality in society deserves legislative attention. In either case, regulating executive compensation is an inapt and unfair approach to that broader social issue. The disparities between CEO and worker pay packets thus cannot justify what Sarbanes-Oxley and Dodd-Frank did to executive compensation.
[1] Harwell Wells, “No Man Can Be Worth $1,000,000 a Year”: The Fight Over Executive Compensation in 1930s America, 44 U. Rich. L. Rev. 689, 726 (2010).
[2] House Report 110-088, at 3.
[3] Leo E. Strine, Jr., Toward Common Sense and Common Ground? Reflections on the Shared Interests of Managers and Labor in a More Rational System of Corporate Governance, 33 J. Corp. L. 1, 10-11 (2007).
[4] William J. McDonough, The Fourth Annual A.A. Sommer, Jr. Lecture on Corporate, Securities & Financial Law, 9 Fordham J. Corp. & Fin. L. 583, 590 (2004).
[5] Jenny Anderson & Julie Creswell, Top Hedge Fund Managers Earn Over $240 Million, N.Y. Times, Apr. 24, 2007.
[6] Id.
[7] Brett H. McDonnell, Two Goals for Executive Compensation Reform, 52 N.Y.L. Sch. L. Rev. 586, 587 (2008).
[8] Steven N. Kaplan & Joshua Rauh, Wall Street and Main Street: What Contributes to the Rise in Highest Incomes, NBER Working Paper No. 13,270 (July 2007).
[9] McDonnell, supra note 289, at 594.
