Paying People Too Much – A US Problem

Introduction

The New York Times just published its annual report on executive pay. It is a regular reminder of just how out of line US income policies are relative to those in other developed nations. A summary of their results are presented in Table 1.

Table 1. – Compensation of Highest Paid US Chief Executives

Source: New York Times, May 27, 2018

And while chief executives are among the highest-paid people in the country, they are not alone in enjoying lavish pay. For example, consider entertainers. In Table 2 some of the musical performers charging the most for appearances are listed.

Table 2. – Leading Performer Appearance Fees

Source: priceonomics.com

Table 3 lists US professional athletes who make the most.

Table 3. – Leading Professional Athletes’ Pay

Source: Various

The following chart lists the average salaries of professional athletes globally. Cricket players in India make a lot. Note also the distinction between “Gridiron Football” and “Football” (Soccer).

Overall, US Chief Executives get an average annual compensation of $183,000. For those in the Equilar study, the average was $15.7 million.

But some get paid a lot more than any of those covered above. I quote from the New York Times piece referenced earlier:

“David T. Hamamoto, a former C.E.O. who until January was the executive vice chairman of Colony Northstar, a real estate company, was awarded $53 million last year. Larry Ellison, the founder, chairman and chief technology officer of Oracle, was awarded $41.3 million, adding to his net worth of some $57 billion.

Financiers at hedge funds, which are generally private and not included in the Equilar study, can earn billions of dollars a year. Michael Platt, the founder of BlueCrest Capital Management, earned $2 billion last year, according to Forbes. James Simons, a founder of Renaissance Technologies, earned $1.8 billion.

 And two technology entrepreneurs who last year took their companies public were awarded generous pay packages, but were not included on the list because they did not file proxy statements, which is part of Equilar’s methodology.

 Evan Spiegel, a co-founder and the chief executive of Snap, received a stock award worth $636.6 million in connection with the company’s initial public offering. And the Dropbox co-founder and chief executive Drew Houston was awarded a performance-based grant worth about $110 million.”

To gain some perspective on the highly paid individuals mentioned above, Table 4 lists median salaries for a number of occupations that are needed for the economy to function effectively. Do the pay differentials between these and the highly paid individuals listed above reflect their relative values to society?

Table 4. – Median Salaries, Selected Occupations, 2017

Source: Employment Projections program, U.S. Bureau of Labor Statistics

The next section looks more closely the market for the highly paid CEOs.

The Market for CEOs Is Broken

Most CEOs are not idea people. They are bureaucrats generated by a rigged system controlled by head hunters so only those with CEO experience, good or bad, get chosen.

Mark Farmer has reviewed the literature on executive compensation and finds a very weak positive relationship between executive pay and company performance. It is clear that by the market test, a large number of senior executives are overpaid. Consider further the CEOs of the 161 companies with Equilar data on both 2016-17 change in compensation and the stock market performance of their companies. There is a negative correlation between these two variables. (Correlation Coefficient -0.148) meaning that on average for the entire group, better stock market performance will result in lower compensation. This does not make sense.

The takeaway is there is no link between performance and compensation. Table 5 lists CEOs whose pay has increased when stock market performance has been negative.

Table 5. – CEOs Whose Pay Increased Market Performance Declined (2016-17)

Source: Equilar

I quote further from Dean Baker, writing in the LA Times:

“Last year, we asked whether pay packages given to U.S. chief executive officers reflected long-term shareholder returns and found they did not.1 The bottom fifth of companies by equity incentive award outperformed the top fifth by nearly 39% on average on a 10-year cumulative basis.”

Why has the market broken down?  There two primary reasons. First, there are certain “assets” one must have to be considered for the senior executive “club” by large corporations and the “headhunter” firms that work for them. They like people who have already been CEOs. And the “compensation tables” developed by these firms are very difficult to challenge.

Second, collusion between the senior executive and the firm’s board of directors occurs.  Board members remain loyal to the CEO because they make good money by being a Board member. Back in 1990, Business Week reported that in a survey by Korn/Ferry International of 352 companies, the average director of these companies collected retainer and meeting fees of $32,352.  In 2006, the New York Times reported on a survey indicating that directors got paid between $52, 000 and $165,000. And in 2017, Tower Watson estimated that a typical Fortune 500 director now earns $250,000. In theory, these directors represent the interests of shareholders. In fact, these directors are normally selected by the Chief Executive and are likely to support his or her recommendations on most matters. It is reasonable to think that Board members serving with the approval of CEOs getting paid $250,000 annually will make quite generous offers on CEO pay and other issues the CEO favors.

The next section investigates what highly paid people do with their income.

What Do People Do With Their Money When They Earn So Much?

Bill Gates was very fortunate when IBM allowed him to use the PC-DOS system he developed for them to change the name to MS-DOS and allow Microsoft to develop it further. And there can be no question that the Gates Foundation has done much good in the world.

But there is a real question on how much income an individual can “effectively” spend. Mostly, high income people buy a lot of real estate. It took Bill Gates seven years and $63 million to build his Medina, Washington estate, named Xanadu 2.0 after the fictional home of Citizen Kane’s Charles Foster Kane. His house is huge, totaling 66,000 square feet.

Larry Ellison of tech giant Oracle is worth around $50 billion. He made $78.4 million last year. He doesn’t just build large houses, he buys islands. He now owns nearly all of Lanai Island in Hawaii. Starting with his famous $500 million deal in 2012, has acquired nine or so more homes near the Four Seasons Resorts Lanai at Manele Bay for more than $41 million, according to The Honolulu Advertiser. The Wall Street Journal reported that when Ellison has played basketball on the courts on his yachts, he has positioned “someone in a powerboat following the yacht to retrieve balls that go overboard.”

The Ultimate Solution

Let us get beyond these excessive incomes to a broader question: should there be an upper limit on what any individual should earn in any one year? And I ask this believing in capitalism and concerned about destroying work incentives. Back in 1991, I suggested we consider an annual compensation limit of $7.5 million adjusted annually for increases in living costs. Correcting for cost of living adjustments since then, this would be $13.8 million today.

Can one claim that this does not provide adequate incentives for executives to work and performers to perform?  And even if, as an athlete or other type of performer, professional life is extremely short, I suggest that you can live extremely well on the annual interest and dividends provided by one year’s work at $13.8 million (4% X 13,800,000 = $551,762.

Implementation

To implement my suggestion would involve imposing a 100% marginal rate on the annual earnings of anyone making than society’s upper limit.  Introducing this rate would mean:

  • Either the individual would pay all of his/her income to the government or
  • To avoid the taxes, the individual would take charitable deductions for income by creating or putting it into one or more government-registered non-profit organizations.

Investments

In light of the questionable “rewards” information presented in Table 5, I would think carefully before investing in the companies listed: Apache (APA), TripAdvisor (TRIP), United Natural Foods (UNFI), Allergan (AGN), CenturyLink (CTL), Discovery Communications (DISCA), Schlumberger (SLB), Patterson-UTI Energy (PTEN), Cleveland-Cliffs (CLF), Archer Daniels Midland (ADM), Tempur Sealy International (TPX), Incyte (INCY), Time Warner (TWX), and AT&T (T).

Of course, “special circumstances” can explain some of the reward information. But not all of it.

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of archive.org):
This entry was posted in Other. Bookmark the permalink.