Opinion

The Great Debate

Supersize salaries: How much is that CEO worth?

By Paul Hodgson
April 30, 2014

california combo

The disparity between what chief executive officers earn and what their employees earn continues to grow exponentially. CEO pay levels have increased dramatically for more than 20 years. Pay levels for workers, however, have stagnated. This is a much-cited statistic. But now a proposed bill in the California state Senate aims to do something about this.

Two state senators want to make sure that companies based in California pay a price for granting super-sized salaries to their CEOs. Businesses that reward their top officials with outlandish bonuses and salaries would be forced to pay a special tax.

ellison -- small unhappyOracle CEO Larry Ellison, for example, was paid $78.4 million in 2013. If the median pay for all Oracle employees, including contractors and non-U.S. workers, is less than $200,000 (roughly one four-hundredth of Ellison’s pay) — and my guess would be it is — under the new law the company could soon be paying a 13 percent state corporation tax rate, rather than its current 8.84 percent.

The ratio between the pay for a company’s CEO and the median pay of all other employees — known as the CEO/worker pay ratio — has been getting a lot of political attention lately. The most contentious component of the Dodd-Frank financial reform bill has been the CEO/worker pay ratio disclosure requirement — not Say on Pay (the right of shareholders to vote on executive pay), or financial oversight agencies, or creating the Consumer Financial Protection Bureau or even initiating the Volcker rule. More letters have been written by more corporations, shareholders, lawyers and consultants to the Securities and Exchange Commission than ever before,  both supporting the disclosure and fighting against it.

The corporate horror that greeted this part of the bill — which requires companies to disclose by how much the CEO’s pay exceeds that of the median workers’ pay — was extreme. Judging by the reaction, the figures are likely so startling that no one wants them made public.

According to a website called PayScale, for example,  Walt Disney’s CEO is paid an estimated 557 times more than the median pay of Disney employees; for McKesson’s CEO  it is more than 300 times, Apple’s CEO more than 190 times and Wells Fargo’s CEO more than 185 times. All these California-based companies could be hit by this extra corporation tax.

iger of disneyYet, many critics  had wondered exactly what purpose the disclosure was going to serve —  especially in relation to investors, the group that Dodd Frank was supposed to protect. After all, no punishment for excessive ratios was attached to the law.

Until now.

The legislation proposed by California state senators Mark DeSaulnier and Loni Hancock seeks to put teeth in the disclosure requirement. If the compensation of a company’s CEO exceeds 100 times the median wage of the workforce, the company’s state corporation tax rate goes up incrementally to a maximum of 13 percent if the ratio is greater than 400 times. If it’s lower than 100 times, the corporation’s tax rate goes down.

The bill passed California’s Senate Governance and Finance Committee last week. But it will need a two-thirds majority in the senate to be signed into law.

After the committee vote, Desaulnier announced: “History has taught us that the gross disparity between CEO and worker pay is a direct threat to American democracy. The difference between CEO and worker pay has sky-rocketed over the past few decades — it is unsustainable and a danger to our society.”

Hancock added: “This bill begins to address rising income inequality. Virtually all of the economic gains of the last several decades have gone to the very few at the top, while hard-working families struggle to hold their own. Our bill is a start toward creating incentives for ethical and responsible corporate behavior that respects the contributions of all its workers and employees.”

But if it gets passed into law, will it have any effect? Or, more important, will it have the intended effect of reducing CEO pay, increasing worker pay — or both?

This is not the first time that tax law, particularly corporation tax law, has been used to try to limit executive compensation. It has been tried before, with little success.

In a piece of serendipity, this California bill is backed by Robert Reich, President Bill Clinton’s labor secretary and part of the administration that gave us an early example of pay legislation. This bill disallowed the deduction of any fixed executive pay above $1 million for corporation tax purposes. Performance-related pay is deductible, including stock options, bonuses, performance stock — but not base salary, perks, restricted stock, and discretionary bonuses.

reichReich says he argued against this exception at the time, for it is widely recognized that it actually caused executive pay to increase exponentially. Almost 20 years later, more than 90 percent of executive pay now comes from performance-related pay — largely in stock options. This would be  acceptable if stock options were actually performance-related.

Since a company’s stock price can go up or down for any number of reasons — most of them related to large economic influences rather than the performance of an individual manager — the performance link for stock options is extremely vague. Indeed, there is now legislation before Congress that seeks to remove this exception.

In fact, this bill was the first in a series of pieces of pay legislation that had unintended consequences. The most recent, imposed after the 2008 financial crisis,  are Treasury limits on bank CEO’s pay. These limits forbid cash bonuses. Which meant the only form of incentive pay that banks could award was restricted stock worth 50 percent of an employee’s salary. The result? Banks increased CEO’s salaries by up to 500 percent.

Let’s leave aside the question of whether it is the proper job of government to limit executive pay. (Nothing else works, but this doesn’t have the best track record either.) The key question is: Does this California bill expose itself to unintended consequences?

Since it is based on a ratio rather than an absolute limit like the earlier effort, and a ratio based not internally on the CEO’s own pay, but externally on other workers’ pay, it would seem that any consequences will actually be intended. If companies want to avoid paying higher taxes, the ways to decrease the ratio are: decrease the CEO’s pay or increase median worker pay; Both reactions would be approved by the bill’s proponents.

Thus the bill would either raise revenue for California by reducing the pay of its highly-paid CEOs (think McKesson, Apple, Walt Disney and eBay), or increase the pay of employees based in California (which would also raise revenues) and around the globe. Critics of the bill say it will drive business away from the state, Apple will relocate; Hewlett-Packard, Wells Fargo and Occidental, will all leave. Silicon Valley will be a desert.

This doesn’t seem likely, however. California already has high rates of corporation taxes and it doesn’t seem to have discouraged many tech IPOs from locating there.

Thus, unlike every other piece of pay legislation I have come across, both here and in Europe, I would give this particular bill my tentative approbation and say: Let’s see how it works out. At least it gives a purpose to the CEO/worker pay ratio disclosure.

 

PHOTO (TOP): The logos of Oracle and Apple, Cinderella’s Castle in Disney World and the Wells Fargo logo are seen in a combination file photo.  REUTERS/File

PHOTO (INSERT 1): Oracle Corporation CEO Larry Ellison introduces the company’s latest SPARC servers in Redwood Shores, California, March 26, 2013. REUTERS/Stephen Lam

PHOTO (INSERT 2): Walt Disney Company Chairman and Chief Executive Officer Robert Iger announces Disney’s new standards for food advertising on their programming targeting kids and families at the Newseum in Washington, June 5, 2012. REUTERS/Gary Cameron

PHOTO (INSERT 3): Robert Reich, former labor secretary, testifies before the Senate in Washington, September 15, 2005.  REUTERS/Jonathan Ernst

 

n Apple store is pictured in Los Angeles, California September 18, 2012. Apple Inc booked orders for over two million iPhone 5 models in the first 24 hours, reflecting a higher-than-expected demand for the consumer device giant’s new smartphone and setting it up for a strong holiday quarter. Apple shares rose in extended after-market trading to touch $700 per share for the first time. They have gained nearly 22 percent in the past 3-1/2 months in the build-up to the launch of the iPhone 5. REUTERS/Mario Anzuoni

 

Robert Reich, former labor secretary, testifies at the confirmation hearings for Supreme Court chief justice nominee Judge John Roberts in Washington September 15, 2005.  REUTERS/Jonathan Ernst

Comments
4 comments so far | RSS Comments RSS

Paul: A great article, like usual, but with a fundamental flaw that negates a substantial part of the discussion. The bill does not only apply to “companies based in California,” as you suppose, but to companies doing business in California.

I don’t want to get too much into the weeds but firms with “operations” in multiple states have the right to apportion income among those states to ensure no state taxes more than its share of the firms income. So, the tax isn’t easily evaded… unless a company doesn’t want to do business in California.

To be fair, the Los Angeles Times and others don’t seem to understand this aspect of the bill either. Maybe that’s what comes of just about everyone folding up their press offices in California’s Capitol building, although the LA Times still has two reporters. We used to have two reporters from the Wall Street Journal as well. Now, I think 6 newspaper journalists in total.

So, the bill isn’t a job killer. In fact, it is a job creator if signed into law, since if it works at all at least some employees (not just in California but in the U.S.) will get a raise and will be able to spend more — driving up the economy.

Like our AB 32 on climate change, hopefully SB 1372 will set a new standard for the nation.

Posted by Corpgov.net | Report as abusive
 

I am glad someone is trying to tackle the ridiculous compensation packets that the business oligarchs award each other. It used to be that the top pay compensated for the risky nature of the top job, but the banks & auto manufacturers have taught us that nobody at the top is held responsible if there is failure. Given that we the people have to bail them out and they STILL award themselves pay raises and big bonuses, it is time that we change the rules to get back to reality.

Posted by euro-yank | Report as abusive
 

The CEO is worthless without the personel that make things happen. With that in mind, how much is a CEO worth..? Probably, as much as the janitor.

Posted by rikfre | Report as abusive
 

I worked for a while for a mediumish company that – as an item in their articles of incorporation – mandated no more than a 25-to-1 ratio between the highest paid and lowest paid employee. The boss was free to give himself a raise – but had to look to the lower end of the scale at the same time.

Remember “the rising tide raises all ships”?

Posted by TheWhiteLine | Report as abusive
 

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