Disciplining Corporate Directors: The Real Culprits in CEO Pay

August 10, 2015

Dean Baker
Truthout, August 10, 2015

View article at original source.

More than five years after the passage of Dodd-Frank the Securities and Exchange Commission (SEC) finally issued rules on disclosure of CEO pay last week. The financial reform law required that corporations make public the ratio of CEO pay to the pay of a typical worker at the company. Corporate lobbyists have spent the last five years complaining that this disclosure would impose an enormous burden. After much delay, the SEC finally decided to carry through with the requirements of the law and issued specific rules for the disclosure.

This is likely to provide useful information for people interested in trends in inequality, but it does not directly address the issue. At most it will serve to provide some degree of embarrassment to the companies where this ratio is most out of line. It’s worth thinking more carefully about why CEO pay got so ridiculous and how it can be reined it.

The most obvious story is that there is no effective check on CEO pay. While most workers have bosses who don’t want to pay them a nickel more than they have to, CEOs don’t live in that world. The pay of CEOs is determined by corporate directors who decide their compensation package.

In principle the directors are supposed to represent the shareholders of the company. They should be looking at CEO pay in the same way that CEOs look at the pay of ordinary workers. They should be trying to push it as low as possible to maximize the amount of money left over for shareholders.

However, this is rarely how corporate boards operate. As a practical matter, many directors are likely to owe their job in part to the CEO, who typically plays a role in selecting directors. And being a director is typically a pretty good deal. Directors of major companies generally earn stipends of between $200,000 and $400,000 a year for attending six to ten meetings. Meetings are often held in plush resorts, with a large amount of money spent on food and accommodations.

In this context, directors may not feel much incentive to scrutinize CEO pay very closely. In fact, they may feel more allegiance to the CEO than the shareholders they are supposed to represent. From their perspective, it will generally be much easier to hand over another $2 million or $3 million worth of stock options than to provoke a big fight by asking whether they could get away with paying the CEO less money. After all, everyone at the table is having a good time, why risk getting people angry and possibly your own future as a director?

If we really hope to rein in CEO pay, it will be necessary to alter the incentive structure facing directors. The current disclosure rules may be a small step in this direction. Hopefully, the directors at companies with especially high ratios of CEO to median worker pay will at least feel some embarrassment.

In the same vein, another provision of Dodd-Frank required that CEO pay packages be put up for a vote of shareholders at regular intervals. These “say on pay” packages are approved more than 97 percent of the time, since it is very difficult to organize among shareholders to oppose them.

However, it is possible to use the say on pay votes to change the incentive structure for corporate directors. As it stands the votes are purely advisory. But suppose directors lost their stipends if a say on pay vote was turned down by shareholders. This risk would give directors a real incentive to ask whether they are overpaying their CEOs.

Needless to say, corporate directors would scream at the idea of putting their stipends at risk, but this really is a pretty low bar. After all, they have nothing to worry about unless they are in the bottom 3 percent of all directors.

This sort of measure may not be sufficient to reverse the extraordinary run-up in CEO pay over the last four decades, but at least it would give directors a serious incentive to exercise restraint. It’s hard to see a downside except for those who are partying on outlandish paychecks at the expense of the rest of us. 

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