Is CEO compensation strangling the economy?

By Mike Stankiewicz

CEO compensation has been a debate at the center of many economic policies. Many believe CEO’s earn too much in proportion to their employees. This has been causing a huge divide in the political world over whether executive pay should be reined in by the government or if the free market should continue to dictate salaries.

Average CEO Compensation, when adjusted, increased 937 percent from 1978 to 2013. This compares the 10.2 percent increase for the average worker over the same period. Doug Alman, an associate professor at Columbia University Department of Economics says that this dramatic difference in wage increase means that the system is broken.

By Mike Stankiewicz

“Looking at the history of business and economics in this country, the difference between what the top are earning and what the bottom is earning today hasn’t been this dramatic since the turn of the 20th century, when big business had its rein over the social and political systems due to their wealth,” Alman says. “It’s scary when you think about it.”

In light of the financial recession, in 2009 several proposals were made at Congress to cap CEO compensation at 20 times the average worker’s salary in a firm. However, how CEO’s are compensated and where the earnings come from is a very complex system.

Debate centers on whether CEO pay is earned or captured. When pay is earned, CEOs are incentivized to display good performance and high productivity, as demonstrated through observable measures of firm performance. On the other hand, when pay is captured, CEOs have fewer incentives to improve performance. Instead, they extract pay from a less powerful board, making the CEO’s wages dependent on the availability of rents and the CEO’s bargaining power over the board and shareholders. Less powerful boards can be attributed to social relations that the CEO may have with certain board members. A McCombs School of Business study found that CEOs who had social connections with board members, such as friendship or being on the board of a non-for profit, tended to have more leeway and less board oversight. Basically, social connections have an influence on board structure, which can in turn affect the way CEO performance is measured to determine CEO compensation.

Additionally, CEO pay is also influenced by complexity, growth opportunities, board structure, performance, stock market volatility, and especially firm size. CEOs receive a low base line salary, in 2013 cash made up 37 percent of average CEO total compensation. A low base salary gives incentive for CEO’s to increase profits and make more money in bonuses and stocks. Base salaries give the CEO money even if the company tanks and their performance is poor. Bonuses make up, on average, nine percent of total compensation.

There are two types of bonuses. The first is an annual bonus which is determined along with base salary, so just a larger base salary in disguise. The second type is given based on executive’s performance. Performance can be determined by: profits, return of equity, revenue growth. On average 40 percent of total CEO compensation is in stocks. Giving stocks when a company’s stock prices are low gives an incentive to increase the stock value and lead to higher stocks. This benefits both the executive and company but can cause negative effects if the executive focuses on next quarter earnings instead of long-term growth. Also, CEOs may prefer one form of CEO compensation to the other. This can be attributed to whether or not a CEO is a risk-averse individual. Risk-averse individuals would prefer to have a secure form of income, such as cash, versus a riskier income source, such as stocks. Therefore, the board of a firm may increase the base pay of a risk-averse CEO rather than offer a stock option to incentivize desired managerial skills.

The amount by which some CEOs make over their lowest paid workers angers workers’ rights advocates who say that there should be salary caps for the highest earners.

“It is ridiculous how these abuses are allowed to go on when people like me are struggling to support our families on these low salaries,” says Derek Pagan, a workers’ rights advocate at Jobs with Justice. “People should be allowed to make as much money as they want until it starts hurting other members of society, and that’s what we’re seeing.” Pagan says he wants to see a limit on how much a CEO can make over his or her lowest paid worker. For example; the CEO of a company can only make 30 times that of the lowest paid worker. So if the lowest salary in a company was $30,000, then the top earner could only make $900,000.

While this is a growing movement, very little action is being seen on Capitol Hill. No bills on measures concerning CEO pay have passed committee in past four years, which means that maybe it needs to start in local and state wide government, that have already started passing other wage-control measure like minimum wage increases.


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