Turning to the experts for the 'why' of big corporate paychecks

Posted: August 14, 2011

Data about the high-flying pay of U.S. executives are pouring in, and the evidence is stacking up against those who argue that the munificent sums are for magnificent performance at the top.

If anything, the findings of two detailed studies over the last 18 months raise questions and intensify a growing sense that the justifications for exorbitant CEO pay are downright nonsensical.

Generous executive compensation packages have taken hold since the 1970s in ways unseen in prior generations. It is outrageous to many Americans, given that the abundance has rained down on corporate leaders during a period of slower economic growth for the overall U.S. economy and wage stagnation for middle-class Americans.

The 100 top-paid CEOs of the public companies that have headquarters or big operations in the Philadelphia region are evidence that the trend continues, even in recent years.

Research firm Equilar Inc. found that median total pay rose 11.96 percent in 2010, compared with 2009.

How is this still happening, especially given how terrible things are for workers, consumers, even our federal government, which recently barely avoided a global debt default?

For answers, we have to roll back the clock by decades.

A study was published in November, which examined tax return data from 1979 to 2005. Its findings about Americans with annual incomes above $1.7 million, including capital gains, are interesting.

In 2004, the largest cast of characters in that top 0.1 percent of the nation's income distribution were not bankers, financiers, sports figures or celebrities.

In fact, within that teenie tiny percentage of the most lavishly compensated American workers, roughly 41 percent - four out of 10 - were people who identified themselves on tax returns as executives, managers or supervisors of non-financial companies.

And 18.4 percent more were people in the famously enriching financial professions.

Taken together, the elite coalition accounted for six out of 10 of the highest-income Americans both that year and in 2005, according to the research by Jon Bakija at Williams College, Adam Cole of the Treasury Department and Bradley T. Heim of Indiana University.

Those non-financial corporate top guns also saw their cut of the national pie grow during that stretch of time. In 1979, they represented 1.37 percent of national income (excluding capital gains); by 2005, that had grown to 3.42 percent.

Why did the researchers methodically probe this data? They were hoping to pinpoint, or at least start to understand, the causes of growing income inequality in the United States by figuring out whose incomes were growing fastest. Then, they could begin to ask why.

Many theories are bandied about as to why compensation has skyrocketed for elite corporate types over the last 30 years. But researchers in this particular study concluded that two seemed most plausible.

"Part of the rising inequality," they wrote, "may simply reflect that people in these professions have compensation that is strongly tied to the stock market, and got lucky when the stock market went up."

Since some high-level corporate pay is often disbursed in the form of company shares or stock options, CEO paychecks fluctuate according to how markets are behaving. And between 1979 and 2005, the stock market did exceptionally well, on average.

But the researchers highlighted another probable theory for the big spike in corporate pay: social mores.

It has become socially acceptable in recent years, that theory goes, for leaders of privately held and publicly traded companies to be highly compensated in the cash and stock of the very enterprises they are hired to nourish.

"The reason why social norms must matter," Bakija explained in an interview, "is that stock prices went way up in France, but you didn't see the share of income at the top go way up.

"Executive compensation is much smaller in France, and hasn't grown as much," he added, citing research by others that suggests French society still frowns on the practice.

A slightly older study, published in February 2010, also harnessed a tremendous batch of historical data. In doing so, it put the lie to a popular but unproven argument that today's executives get paid more than the prior generation's because of high growth rates of modern-day companies.

Carola Frydman of the Massachusetts Institute of Technology Sloan School of Management and Raven S. Molloy of the Federal Reserve Board of Governors compiled and analyzed managerial compensation data from large firms from 1936 to 2005. Their data came from proxy statements and 10-K filings with the Securities and Exchange Commission.

What the researchers found, in their own words, was "surprising."

"Executive compensation was remarkably flat from the end of World War II to the mid-1970s, even though firms grew considerably during that time," they wrote.

Those postwar years were high-growth decades, both for U.S. companies and the domestic economy. And yet, executive pay grew at a lower rate than the pace of corporate expansion at leading companies, they found.

A generation later, however, from 1980 to 2005: "Executive pay and firms expanded at almost the same rate," the researchers found.

To those who argue that shareholders are simply rewarding today's executives for exceptional talent, the findings pose a challenge.

"We weren't doing that to the same level in the '50s and '60s, so what changed in the '70s and '80s?" Frydman posited in a recent interview.

It is true that many of today's companies are more complex and diverse in what they produce and where they operate than the companies of the postwar era. It's not enough to know how a turbine is made at a given company; you also have to know how to run divisions that may have nothing to do with manufacturing, for example.

Also, Frydman said, today's executives must tend to institutional shareholders - large blocks of investors such as pension funds or hedge funds whose fractional ownership over corporations has grown over the past three decades. They hold more sway over management than in the '50s and '60s, she said, when company control was often held by family members or was more broadly distributed among large swaths of investors.

In the end, though, no research has shown conclusively why today's executives seem to be pocketing so much more.

The volatile markets that as recently as this past week damaged many people's stock portfolios can be expected to shrink the paydays of executives somewhat. But even that pain should be short-lived.

"Based on historical patterns," Bakija said, "it won't nearly wipe out the gains since the late '70s, and it can also be expected to go back up, if the same long-term mechanisms are at play."

Contact Maria Panaritis at 215-854-2431 or mpanaritis@phillynews.com or on Twitter: @panaritism.


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