Everybody, except perhaps the CEOs themselves and their compensation committees, know that CEO pay in the U.S. is out of control. At large firms the CEO-to-worker compensation ratio, 20 to 1 in 1965 and 26 to 1 in 1978, is now more than 300 to 1, perhaps as high as 700 to 1. (In Japan the ratio is 16 to 1, in Denmark 48 to 1, and in the UK 84 to 1.) How did CEO pay in the U.S. become so untethered to the wages of average workers and what can be done to bring it back in line, if indeed doing so would be in the best interests of the companies themselves and the economy as a whole?
The CEO Pay Machine: How It Trashes America and How to Stop It by Steven Clifford
Steven Clifford, formerly CEO of King Broadcasting Company and National Mobile Television and a director of 13 companies, tackles these questions with wit and compelling logic in The CEO Pay Machine: How It Trashes America and How to Stop It (Blue Rider Press/Penguin Random House, 2017). He sets out to show “how the sausage is made—how the Pay Machine actually works, how its parts interact, and how every step in the process pushes CEO pay to higher and higher levels.”
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He starts with a fairy tale about a loan officer at the Midwest Bank who asks his fairy godmother to help him get a promotion because his $75,000 salary isn’t enough. Ah, she replies, she can do better than that. She can get him more money for the same job. Applying CEO compensation practices to the loan officer’s pay package, the fairy godmother steers him, wide-eyed step by wide-eyed step, from his modest $75,000 salary to a whopping $5,845,000. In the process, the author sketches out the inner workings of the CEO Pay Machine.
Excessive CEO pay, the author argues, harms companies, shareholders, and the economy and undermines democracy. Not just because it is excessive but also because of the way in which it is typically structured. For instance, it usually misaligns CEO incentives with effective corporate practices and goals.
Clifford lays the blame for the emergence of the Pay Machine at the feet of “three totally unrelated actors: Michael Jensen, Milton Rock, and Bill Clinton. … They were not attempting to overpay CEOs and might be stunned and insulted to be grouped together as causal agents.” Jensen’s basically sound recommendations (that CEOs own a significant amount of company stock and be paid in part for performance) were largely misapplied.
Rock and his fellow compensation consultants introduced the idea of using peer groups to calibrate executive pay and benchmarking (usually above-average) to the salaries of the peer group CEOs. It’s easy to see that “the above-average benchmarking of pay within peer groups creates a relentless upward spiral in pay—a game of CEO leapfrog. Every time a CEO leaps, he establishes a higher compensation base for the next CEO in the group to leap over.” By the way, at this year’s annual Berkshire Hathaway meeting, Charlie Munger said:”I have avoided all my life compensation consultants. I hardly can find the words to express my contempt.” He did, however, find the words at the 2012 meeting when he said: for “compensation consultants, prostitution would be a step up.” Warren Buffett added at this year’s meeting, “If the board hires a compensation consultant after I go, I will come back mad.”
The last culprit, Bill Clinton, executing on his campaign promise to clamp down on excessive executive compensation, set out to eliminate tax deductions for executive pay–at first above a certain level and then, in a compromise move, above a certain level that wasn’t performance based. Business was still unhappy, so he agreed to exempt stock options from this cap. “Boards could now pay unlimited amounts as long as they could pass it off as ‘performance based’ and could grant unlimited stock options with no performance requirements.”
Clifford examines the pay packages and performance of the highest-paid executives of 2011 thru 2014—the CEOs of UnitedHealth Group, McKesson, Cheniere Energy, and Discovery Communications. The disconnect should come as no surprise.
By way of a solution, Clifford proposes a simple, blunt instrument: “For every dollar above $6 million that the companies pay their CEO or any other executive [and this includes all forms of compensation], they would pay a dollar in luxury tax. It would not be tax deductible.” Punkt. No loopholes. And, he realizes, no way it would ever get through this Congress. But maybe someday…
Article by Brenda Jubin, Reading The Markets