The Washington Post, August 20, 2019
To great fanfare Monday, the chief executives who make up the Business Roundtable declared that companies should pursue a variety of social goals rather than focus solely on shareholders. The CEOs said they should invest in employees, foster diversity and protect the environment. As Jamie Dimon, the CEO of JPMorgan Chase and head of the Business Roundtable, put it, “If companies and CEOs do not get involved in public policy issues, making progress on all these problems may be more difficult.”
Since the Roundtable’s members include many of the country’s largest companies, such as Apple, Boeing, Walmart and Amazon (whose chief executive, Jeff Bezos, owns The Washington Post), its joint statement implied a real change — a big deal in a realm where the shareholder has long been king. But this presupposes that maximizing shareholder value is what corporations have been doing all along. They haven’t. Returns to shareholders have actually been unusually low in the past two decades. What has been maximized? Executive compensation.
Both the left and right generally accept the public rhetoric about shareholder primacy, but it does not reflect reality. The average real return to shareholders since December 1997 has been 4.8 percent a year. This compares with a longer-term average real return of more than 7 percent annually. (I use 1997 as a starting point, instead of taking the more natural 20-year average, to avoid distortions created by the 1990s stock bubble. The average real return over the past 20 years has been just 3.6 percent.)
These relatively low returns are especially striking because corporations have benefited from substantial tax cuts over this period. The first set was a series of relatively minor provisions put in place under President George W. Bush. The second set, under President Trump, included a reduction in the corporate tax rate, to 21 percent from 35 percent.
It is hard to reconcile more than two decades of low stock returns with a commitment to maximizing shareholder value. The data points to a more obvious goal of CEOs: maximizing their own paydays.
A recent analysis by Larry Mishel and Julia Wolfe at the Economic Policy Institute found that CEO compensation has risen 940 percent over the past four decades, after adjusting for inflation. The analysis put the average pay for CEOs at the country’s 350 largest companies at $14 million a year, or more than $17 million if we count the realized value of stock options.
It is easy to see how CEO compensation could have become divorced from returns to shareholders. As Steven Clifford points out in his book “The CEO Pay Machine,” the salary of top executives is most immediately determined by corporate boards. Board members typically owe their own high-paying positions to the CEO and other top management.
Clifford estimates that a board member works about 150 hours a year on average. With these directors of large corporations often receiving pay of several hundred thousand dollars, their pay rate can come to well over $1,000 an hour.
It is almost impossible for shareholders to dislodge members of corporate boards. Over 99 percent of directors nominated by the board win reelection. The only way board members really risk losing their positions is by antagonizing other members.
It seems unlikely, then, that questions like “Can we get a CEO who is just as good for half as much money?” come up too often in the corporate boardroom. While the pay of other workers is subject to market discipline, this does not seem to be the case with CEOs.
Excessive CEO pay matters not only because a relatively small number of people get exorbitant paychecks. If a CEO is paid $14 million a year, most likely the next layer of executives is getting close to $10 million. Even the third tier can earn well over $1 million a year. High pay in the corporate sector also affects salary scales elsewhere. It is now common for university presidents and CEOs of major nonprofit organizations to get well over $1 million a year. Government officials view it as a sacrifice to work for, say, the $211,000 annual salary received by members of the president’s Cabinet.
Simple arithmetic tells us that more money for those at the top means less money for everyone else — including shareholders.
To be fair, it is good to see corporate CEOs commit themselves to respecting their workers, their communities and the environment — and it will be interesting to see whether and how they follow through. Here’s one way to do it: In the 1960s and ’70s, the ratio of CEO pay to the pay of ordinary workers was 20 or 30 to 1. If CEOs committed to restoring this pay ratio — lowering their pay to $1.5 million or $2 million — they’d go a long way toward achieving the goals they boldly declared Monday.