Is the executive pay bubble popping?
Signs are it won’t just be the salaries of bankers coming under fire.
An unusual array of forces are combining to make it very likely that top tier pay may be structurally falling, rather than simply taking a cyclical dip during a downturn.
Take it for granted that pay in the financial sector will fall. A combination of increased government ownership and a shrinking businesses taking fewer risks with other people’s money will see to that.
But even if you cast arguments about a new mood of sobriety aside as humbug, government intervention and shareholder activism may combine to force down the share that top executives get of profits in businesses across the economy, even among companies not getting government handouts.
U.S. Treasury Secretary-designate Tim Geithner told Congress last week he would consider extending a $500,000 cap on the tax deductibility of executive pay to companies beyond those taking government bailout money.
“If confirmed, I would consider extending at least some of the TARP provisions and features of the $500,000 cap to U.S. companies generally as well as potentially imposing other rules beyond those potentially in effect,” he wrote in reply to questions from Senator Carl Levin.
Measures to limit pay will have a trailing wind so long as the economy sinks and will be heard in the boardroom, even if they’re not particularly effective or not enacted at all.
Shareholders too are becoming more militant, and not just at institutions that have obviously underperformed or taken huge risks.
More than 100 “say-on-pay” shareholder resolutions, which give shareholders a vote on compensation, have been proposed at U.S. corporations this annual meeting season. Computer maker Hewlett-Packard adopted such a measure this month, although it won’t come into effect until 2011. Swiss companies UBS, Credit Suisse and Nestle have all agreed to introduce such an annual vote after pressure from a governance advocacy group backed by Swiss pension funds.
But why is this happening now, and will movements to limit compensation be just one more cause that is forgotten when good times return?
There has been something approaching correlation between the growth of debt in the U.S. economy and growth in pay for top executives. Both began to take off in the 1980s but the real acceleration came during the past 15 years.
It is impossible to say how linked the two were, but you can argue that the growing levels of debt artificially inflated economic growth, company profits and stock market returns.
Those great returns were a sedative for shareholders, encouraging them to stay quiet: let the big boys get on with making money and bank the dividends.
In other words, we were all getting rich, so why rock the boat because pay at the top was taking a bigger share? That is all over, and profits and return on capital will be under pressure from all sides for an extended period. It may well be that shareholders fail in attempts to wrest more of the profits from company insiders. But they will certainly have more of an incentive to try, as well as probably having more tools courtesy of regulation with which to beat company boards and executives about the head and shoulders.
In gross terms, CEO compensation fell in 2007 by 15.8 percent, according to a survey by consultants Mercer, though that was primarily driven by the falling value of stock-based compensation. Expect that trend to continue when the 2008 data is released.
For American companies with a market capitalization of more than $50 million the top five executives alone took home an average of almost 10 percent of aggregate earnings in 2001-2003, double the level of a decade before, according to research by Lucian Bebchuk of Harvard Law School and Yaniv Grinstein of Cornell University. Given that many of these companies will have had not tens, not hundreds but thousands of employees, the fact that the top five got 10 percent of earnings is astounding. They further found that even taking into account performance and growth at companies, CEO compensation nearly doubled between 1993 and 2003.
Bebchuk has argued that some of this is because relations between executives and the boards that approve their compensation aren’t truly arms-length. There are social factors and execs can reward or punish boards, though the fear of provoking “outrage” is one of the limiting factors. We certainly have reached a point where outrage is widespread.
But like ever rising house prices and debt levels, maybe the best way to view ballooning executive compensation is as a social rather than economic phenomenon. It started in the U.S. and spread, and the further it spread the easier it was to justify and the more normal it seemed — until something happened.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click here. —