Beginning with Accounting 101, companies must publish financial statements, which identify the sources of funds used in connection with the provision of their products and services. The Company’s financial statements and related disclosures must identify the sources of the funds used in the production of the documents, including the existence and size of current and expected future cash and debt resources.
Reputational issues tend to lead to significant changes in the use of funds and changes in company strategy, because investors do not have to rely on the reports for information about a firm’s condition in order to make judgments about its value. As a result, the policies and practices that lead to changes in the use of funds and changes in strategy are often reflected in changes in the structure of the firm, such as changes in the ownership structure or a decrease in the size of the firm.
Some of the considerations that govern changes in the structure of a firm are the relationships between the owners of the firm, as well as those of the other owners of the firm. The effect that the presence of current or potential creditors will have on the activities of an individual owner is often discussed in a more generic way, in the context of company transactions and bankruptcy. The approach taken in this paper in examining the relationship between employees and the ownership of the firm is in the context of employee retention.
Individual employee retention is a very important strategic issue for publicly held firms and is of substantial importance in economic policy, particularly the relation between the U.S. and the Japanese economies. In recent decades, employee retention has been the subject of numerous studies, at the national and international level, and in academia, as well as in the public and private sectors.
PPP Was a Different Form of Employee Retention Credit
The principal economic rationale for extending the purpose of the U.S. wage and hour laws to explicitly cover executive pay is the fact that the line between income paid by a firm to a worker and income paid to a corporation is blurring in the modern information-intensive business environment. Individual labor units or employment is increasingly contingent on the performance of the firms’ resources and/or the organization’s customer base.
With the growth of the global marketplace, the business environment is becoming increasingly volatile, and firms cannot survive without the flexibility to hire, fire, and downsize employees in a given location. Recent decades have also seen a large shift in the relative location of executives and workers, in the United States and in other countries, with business executives being required to travel a great deal to meet with their counterparties and with their customers.
Along with these major changes in the role of workers in the U.S. economy, the passage of the Trade Adjustment Assistance Act, or TAA, in March 2000 is expected to have a direct and immediate effect on executive compensation. The combination of an unstable business environment, the growing reliance on executive compensation as a measure of managerial effectiveness, and the new requirement that U.S. firms must spend a certain percentage of income on workplace training programs is expected to have a powerful effect on the amount of executive compensation that U.S. firms pay, and to have a significant impact on the composition of the compensation packages of executives and on their level of compensation.
The large-scale transformation of the nature of the U.S. economy and the shifting of control of resources from the labor force to executives are leading to a series of important changes in the way that firms are managed, in the way they produce, distribute, and allocate goods and services, and in the way that labor markets are formed, operated, and managed.
In such a dynamic environment, firms and the economies that depend upon them are increasingly dependent on a single management team and a group of executives as an integral and critical part of their organizational design. In general, the entity that controls the enterprise, the individual who is viewed as the “CEO,” determines the orientation of the enterprise and, by extension, the economic and political environment of the nation and the world.
While it may be appropriate, in an optimal situation, to require such a person to devote the maximum amount of time and attention to the operations of the enterprise, the size of the pay package of a chief executive has grown from a few million dollars during the early twentieth century to more than $20 million annually in the United States today.
This increased compensation provides managers with a powerful lever to exert their influence over other employees, as well as to persuade them to carry out their work for a given firm for the ultimate benefit of shareholders, customers, and other key stakeholders. This greatly increased influence increases the vulnerability of U.S. enterprises to natural or manmade disasters, acts of war, or political unrest, and it has helped to spawn a series of speculative bubbles and economic crashes over the past three decades.
Since the U.S. economy has become increasingly dependent on the performance of a small group of executives and managers for its success, these executives have become much more responsible for the successful operation of the economy and its companies. These executives have taken on a far more active role in setting the pay packages of managers in their companies, and they are expected to direct the economic performance of the country, as well as of the enterprises that they control.
The 1990 Report of the CEO-Adjusted Pay Council
In 1989, the National Commission on Executive Compensation and Corporate Governance, or Cokecom, made the first formal recommendation for an adjustment of the ratio of CEO compensation to that of the median employee.1 In a chapter titled “Executive Compensation and Corporate Governance,” Cokecom stated, “The compensation ratio should be defined at a level that is equal to or greater than the median employee pay.
The equilibrium ratio between the ratio and the median employee pay could then be established by the simplest possible calculation of the ratio between the ratio and the actual pay of a random sample of CEOs in the S&P 500. The adjustment should have no effect on the economic health of the company or its competitive position. At the same time, compensation adjustments should not impinge upon the owner’s ability to ensure appropriate incentives for the executives under their control.”
Cokecom’s report also recognized that the current pay ratio is too high and that this impairs the ability of the typical employee to purchase company stock that is purchased by the company. As such, the report recommended that any form of compensation ratio should be driven by “the current market valuation of the firm and not by a predetermined rule of thumb or other method.” Cokecom’s committee that proposed the two most recent adjustments was composed of ten leading executives, including three of the three that initiated the CEO-pay reform initiative and three members of the current board of directors of the Federal Reserve Bank of New York, which has oversight over most of the largest American corporations.
The 1999 White Paper on Executive Compensation
The White Paper on Executive Compensation, the second major report of its kind, was published in 1999. Although the 1999 report differed from the 1989 report in proposing an adjustment for inflation, the result was the same in terms of a consideration of the role of executive compensation in ensuring the success of companies and their shareholders. As with Cokecom, the White Paper stated, “The factors that determine executive pay are the fundamentals of the business.” 3 As in the 1989 report, the 1999 report also called for an adjustment of the ratio to equal or exceed the median pay of a random sample of CEOs in the largest 50 companies in the S&P 500.
The 1999 report also recommended that the overall pay of executives be “free from arbitrary inflation-adjusted adjustments.” As a result, the report recommended that the overall pay of executives be frozen or eliminated. Of course, the employee retention credit would not have to be eliminated as a result of this adjustment. Rather, in order to continue to provide executive retention pay in accordance with the law, companies would have to pay the employees not receiving the credit out of their own pockets, where the cost would not be viewed as a “reduction in the pay of executives.”
Based on these recommendations, a majority of the CEC’s three major reports to Congress over the past 25 years recommended an adjustment of the CEO-to-worker pay ratio to the median or standard pay of employees of the same level in the labor market. In addition, the White Paper stated that the federal government should “convene a Commission on Total Executive Compensation.” The 1999 White Paper was a companion to a 1998 Senate report on executive pay. Although the White Paper did not make any specific recommendations for this report, it did cite the report’s recommendation that any adjustment to the pay ratio should not create a “discriminatory exclusion” for payments to anyone other than executives.
In the Commission’s 2001 report
Executive Compensation in America: A Corporate Collective Responsibility Report – there was no mention of, or suggestion that, the executive pay ratio should be adjusted for inflation.
Compensation Commission’s Executive Pay Report (2000)
The Commission’s report, the 2000 Executive Compensation in America: A Corporate Collective Responsibility Report, which was prepared by an advisory committee composed of 10 former heads of major U.S. corporations, such as ExxonMobil, Merrill Lynch, and AIG, did not specifically recommend an adjustment for inflation.
In the Commission’s 2001 report Executive Compensation in America: What Work Could Look Like, the commission stated, “Since the current ratio reflects current pay practices and payment practices change over time, the Commission is unwilling to put the current level of the CEO-to-worker pay ratio, currently at 450:1, in the prohibited zone.” During the 10-year period in which these reports were issued, the CEC received and was given $450,000 in funds from the U.S. Treasury and $40,000 from SIFMA.
Following are excerpts from the 2001 report.
The problem is that far too many of our highest compensated CEOs are receiving the type of compensation packages that were once reserved for media moguls and entertainment celebrities. The pay packages for these CEOs continue to rise exponentially – as if their businesses were on perpetual hot streaks. And that is the reason for this disparity. While the government is required to analyze the pay of CEO at companies in order to make sure their compensation packages are within acceptable bounds, that’s not the same thing as setting a floor, and telling CEOs:
This pay is fine, but if you want to receive this kind of compensation, you’ll have to pay it out in stock options. The result is that CEOs who have been overly compensated will be forced to forfeit their excess compensation, and the same CEOs who benefit from the explosion of CEO pay will be guaranteed to receive an even larger paycheck, by virtue of having taken the risk of cashing out of their stock options.
“The CEC’s position that the CEO pay ratio should be set at 3:1 or even 5:1, does not address the issue of compensation for all the other corporate leadership that takes place at those companies, or that is comparable to their chief executives. This problem is a profound one. As described above, far too many corporate leadership positions do not pay a salary at all, or pay only a nominal amount, while CEOs receive large bonuses based on the company’s performance.
And those salaries often come with onerous responsibilities, such as taking on the risks associated with employment, and are subject to termination, when performance is not satisfactory. A 3:1 ratio would not allow these other compensation levels to be included in any equation.” It should be noted that the “CEO-to-worker pay ratio” of the CEC does not address pay for the other 99 percent of workers.
Compensation Commission’s Executive Compensation in America: What Work Could Look Like
Report begins with a statement that the commission acknowledges is true:
“Some might argue that such comparisons do not make sense. The pay of CEOs is calculated using metrics that take into account the salaries of all the rank-and-file employees. Since these compensation measures do not recognize the vast disparities in other executive compensation practices, one would not expect the CEO-to-worker pay ratio to be skewed to such an extent.
We all accept that the CEO pay and compensation packages are based on such a complex and differing set of factors as the ratio of the CEO’s pay to that of the rank-and-file employee’s pay. However, there is little question that the CEO-to-worker compensation ratio is skewed by the enormous gap in the compensation of chief executive officers versus their non-executive employees.”
The commission attempts to address this problem by encouraging the SEC to change its definitions of compensation. “A more reasonable way to compare pay between a CEO and a typical employee would be to assess total compensation based on total shareholder return (or similar metrics). Under this approach, the CEO’s pay would be fully converted to a share of a company’s stock performance. For example, an executive who received a salary of $50,000 would be paid $250,000 in stock under this scenario. The same employee whose total compensation is based on a share of stock appreciation would be paid $100,000, based on a total share value of $5,000.”
But the commission notes that it is unlikely the SEC will change its definitions of compensation. “The SEC is considering changes to its definition of total compensation, but the proposed changes would allow CEO’s to deduct non-cash perks (such as housing allowances), a practice that results in lower pay than it would be if fully taking into account the associated costs of such benefits.”
The CEC reports that although it shares the goals of requiring the ratio between CEOs and the average worker to be reduced, that the commission does not have the ability to make that happen, as the Securities and Exchange Commission only regulates publicly traded companies. “This report acknowledges our shared goals with the SEC. We both agree that the pay of chief executive officers should be limited. But as no law requires the SEC to act on this, the CEC has no authority to compel the commission to impose restrictions on CEO pay.”
Why ERC does not address executive compensation by comparing workers to CEOs
Because of the fact that executive compensation is far higher than it should be, the equal pay for equal work (or ERC) movement attempts to draw attention to the inequities between CEOs and the workers that they are paid to lead.
“Over the last thirty years, CEO pay has increased at more than twice the rate of wages for the typical American worker, while the pay of the typical worker has barely changed. Eighty percent of the increase in CEO pay has occurred since the late 1990s. In recent years, average pay for the 100 highest paid CEOs increased by 394 percent, whereas the typical worker’s wage increased by 21 percent.
In addition, the average CEO of a large public company today receives over 800 times the pay of the average worker. These are eye-popping numbers. The extraordinary growth in executive compensation has had broad effects on the broader economy. In 2008, corporate profits contributed $2.0 trillion to the economy, or 20.7 percent of total GDP. Companies that pay their CEOs more than median CEO pay contributed to the largest portion of the increase in profits.”
CEOs argue that this is not the case, but data published by Equilar, an executive pay research company, backs the CEC’s claims. “This $13.7 billion pay gap between what chief executive officers and the typical American worker is a powerful indicator of the growing income gap in our nation. Yet, even in the face of this gap, business leaders continue to push for even greater compensation. During the 2014-2015 CEO compensation season, 160 firms in the Standard and Poor’s 500 index approved raises of $25 million or more to the chief executive officers, compared to 50 firms approving the same raises last year.”
PPP blames the low percentage of women in the CEO office for the lack of equality in pay.
“Wealth concentrations like these benefit CEOs and large shareholders but hurt working people. As CEOs are paid more, they get to use their own money to hire lawyers, advisers, and advisors to look out for their interests. These people argue that the vast majority of Americans are hardworking and honest. When they are wrong, this often makes them feel compelled to take out their anger by inflicting financial harm on average workers. This is what makes the relatively high levels of CEO pay so troubling.”
Averting disaster: Pay and benefits in the public sector
Workers in the private sector are in the same predicament as workers in the public sector, and workers in the private sector as well are in a situation where the value of their wages are being capped by the vagaries of the market, whether due to the rise of the minimum wage or the elimination of certain government programs.
As Gavyn Davies recently observed, “most executives of public companies are running their organizations on the basis of a particularly treacherous doctrine: that it is both right and profitable to do nothing to serve the public interest.” The CEC analysis takes the position that if the pay for workers in the public sector is reasonable, that this can be an inspiration for public sector executives to move away from the status quo in terms of pay and benefits.
“We need to talk about how to remove the financial roadblocks that workers face in comparison to their public sector counterparts. Our policy is to see to it that public sector employees have a fair share of the gains and their wages rise in parallel with those of the private sector.”
In addition, the CEC argues that the connection between pay and benefits in the public sector and the growth of inequality is as deep as it is in the private sector. “As the public sector has grown, we have seen a parallel growth in inequality. The gap between CEO pay and the typical worker’s pay has grown from 7.9 times in 1993 to 22.7 times today. At the same time, the gap between CEO compensation and the average worker’s pay has increased from 18.7 times to 34.9 times.”
In an environment in which average workers are also facing pressures on the quality and quantity of their wages and benefits, it is time to look to public sector workers to do more than just pay lip service to addressing the issue.