More For The Few, Less For The Many: How Little Known Laws Allow CEO Pay To Skyrocket
CEO pay, stock buybacks, and income inequality
This week Senator Cory Booker (D-NJ) introduced a bill to force corporations to do with the Trump tax cuts what Trump promised they would: share the bounty with the common worker. Instead, executives of the corporations have done what they have always done in recent years and benefited shareholders.
Senator Booker correctly points out that the increased stock buybacks mainly benefit the wealthy class. As of 2013, the top 1 percent of households by wealth owned nearly 38 percent of all stock shares, according to research by New York University economist Edward Wolf. There is an additional, and more insidious, motive for the buybacks: legal or ignored insider trading by the top executives—especially the CEOs. We need to take a closer look at the buyback practice and the laws that permit its unrestrained abuse in the context of today’s sky-high CEO pay.
For years newspaper headlines have blared about the obscene level of CEO pay that continued to rise despite voter outrage and politicians’ attempts to rein it in. According to a 2013 study by the Economic Policy Institute, “from 1978 to 2012, CEO compensation measured with options realized increased about 875 percent, a rise more than double stock market growth and substantially greater than the painfully slow 5.4 percent growth in a typical worker’s compensation over the same period.”
A little good may have come from that effort to make lavish pay an issue. One of the regulations of Dodd-Frank requiring corporations to disclose their ratio of CEO pay to median worker salaries has kicked in. It took 8 years, mind you.
Honeywell was the first to file, disclosing that its CEO, hired only nine months ago, makes 333 times more than the median worker wage of $50,295.
The question now is will such disclosures have any effect on causing corporations to moderate CEO greed, so a little more is shared with employees.
The Worldly Wisdom Of John Pierpont Morgan (1837–1913)
No one doubts J.P. Morgan’s business insight. He commented that CEO pay should never exceed more than 20 times the average workers’ pay. If it did, it meant the CEO was more interested in his own pocket than the corporation’s well-being.
What must old Pierpont be the thinking wherever he is now. In 2017, his present successor, Jamie Dimon at JP Morgan Chase, got a 37% increase from $20 to $27 million even though the bank’s profits fell 2% that year and it laid off 6,671 employees.
We will never know its median employee salary because banks do not have to disclose under the new regulation. They got a pass. But if you’ve been reading my articles, you would’ve already concluded that. Just another example of banker power at work.
It is public knowledge that starting wages at J.P. Morgan are $10.50 an hour where permitted. Where the state minimum is $15 an hour, the salary is $31,200 per year. Dimon makes that in the first three hours of his first day of work in the new year.
The New Invisible Hands
President Bill Clinton tried to stop the escalation of CEO pay with a tax trick that backfired. He shepherded a tax regulation that made any CEOs salary over $1 million not deductible for tax purposes — with a loophole. Stock option rewards based on performance were exempted from this restriction.
As a result, total CEO compensation exploded into stratospheres even higher than before this attempt at restraint — and hasn’t stopped since.
Stock options incentivize the CEO to the short-term goal of increasing stock prices over the long-term health of the company. The CEO can then exercise their options for a huge profit — with the added assistance of the buyback.
Surplus corporate funds are used to buy the shares issued to the CEO on exercise of the option. CEOs are permitted to have their corporation do the buybacks secretly (see my article for more details on how this is done here). And yes, this is potential stock manipulation by the ultimate insider; but how many voters understand this?
We have former Labor Secretary Robert Reich to thank for exposing how this subverting provision was inserted. Reich tells us in his documentary Saving Capitalism that then-Treasury Secretary Robert Rubin insisted on the exemption. Rubin was an ex-CEO of Goldman Sachs and well understood the potential for helping corporate America.
By the time of the Clinton years, Wall Street had realized that the real power in government over the financial industry lay in the civil service, especially the Treasury Department. Led by Goldman Sachs, bankers populated all levels of the Treasury Department with their alumni to the extent that, today, many journalists call it ‘Government Sachs.’
How The Bankers Got Their Big Bonuses Protected
The short answer is the fruit of their good planning.
For a short time nothing incensed the public more than the fact that the bankers, who had led their businesses to the brink of bankruptcy in 2008, continued to get their multimillion dollar bonuses —and now from the taxpayer bailout money. Even the outraged Obama was powerless to stop it. But he was only the President of the United States. As such, he was powerless against banker planning. Here’s why.
Recall that the 2008 crisis happened at the end of the George W. Bush era (2001–2009). The debate of the moment centered on what was to be done to save the global economy from immediate total collapse. Goldman Sachs’s forethought paid off. A Rubin successor as CEO at Goldman was his successor at Treasury, Hank Paulson. Goldman had a man in place at the right time.
There was no real question about the amount and the urgent timing. It would take hundreds of billions, and it must happen in a few days. Fed Chair Ben Bernanke told a committee of legislators: “If we don’t do this, we may not have an economy on Monday.”
During the Great Depression of the 1930s the US government had formed the Home Owners Loan Corporation (HOLC) to buy the mortgages in default (some were two years in arrears), lower the interest rate by a percentage or two and lower the monthly installments by extending the amortization period to give the homeowners a longer time in which to pay off the debt. Note that there was no significant increase in income inequality from that time until the Reagan years beginning in 1981.
And note well, as writers used to say, that the Treasury Secretary who implemented this project, Henry Morgenthau Jr., was not a Wall Street banker nor an economist. He was an architect and agriculturalist by training.
Recall that, as Michael Lewis demonstrated in The Big Short, the homeowners in default could afford the installment payments at the teaser rate (about 3%). The defaults started when the teaser rates ended and the higher rates (about 7%) kicked in. With a HOLC like program, the homeowners could’ve kept their homes, the housing market would have been subject to a correction not a collapse, and the toxic CDO’s would have been detoxed — but a Wall Streeter cannot think like that.
The Bait And Switch On Congress
The initiative to save the economy was called TARP (the Troubled Asset Relief Program). Congress appointed a Special Investigator General, Neil Borofsky, to oversee that the funds were used properly. We owe Barofsky for the explanation of how Wall Street’s man at the Treasury manipulated Congress to help bankers maintain their bonuses.
Significantly, although Borofsky’s credentials and first-hand information cannot be challenged, the only place you’ll find this complete explanation presented clearly is in an edition of Rolling Stone magazine. Political wonks who have the stomach for mind-numbing details can find an academic style history of these events here—but the underlying pattern identified by Borofsky is hidden by the complexity of the machinations.
As Borofsky tells the story, Paulson originally told leaders of Congress that he needed the $700 billion in a way that he could use in his sole discretion to save the economy. Congress protested. So Paulson presented a plan (drafted by Neel Kashkari, also ex-Goldman), somewhat similar to the HOLC rescue by which the majority of the funds would go to help homeowners. The New York Times published a draft of the Bill.
After the usual fighting and grandstanding, legislation was passed allocating $700 billion to Treasury to be used primarily to help the homeowners. Paulson then went to George W. Bush and got him to use his executive power to override the restrictions on use.
Paulson assumed (questionable) that the banks were solvent in that they could pay their debts, but frozen in that they had to use their capital reserves to do so, and then could not make loans to businesses. They would be zombie banks; the economy would stagnate for years; executives would still be able to extract their sky-high pay and bonuses.
The only reason that the banks needed bailout money, in Paulson’s opinion, was to increase their capital reserves allowing them to make loans. If Paulson restricted bailout funds so that they could not be used for bonuses, bankers might refuse the bailouts. Why would they give up the opportunity to continue the same level of salary and bonuses just to benefit the American economy and their less worthy citizens. In this, Paulson was undoubtedly correct. After all, what would Gordon Gecko do?
Of course there were politicians who asked that, at least, restrictions placeon the funds so they could not flow into the banker bonuses. Paulson refused.
In a C-Span clip (at the four-minute mark) Nancy Pelosi tells of the meeting with Paulson and leaders of Congress in which Paulson gave his reason for not restricting the use of the bailout funds. Pelosi and Democrats tried to block the advancement of funds after the switch, but they were powerless to do so.
Paulson gave no thought to the idea that the government could first buy the problematic mortgages and then offer the banks any top up needed for capital reserve requirements. How could an ex-Wall Streeter think like that?
Paulson now had the money and the power to use it as he saw fit.
This all happened under Bush. When Obama took office a year later, he fell into the Clinton trap. He attempted to stop the use of any remaining funds for bonuses by saying the funds could only be used for pay based on performance. That did nothing — only more stock options and buybacks.
BTW: Treasury Secretary, Steve Mnuchin (ex Goldman Sachs), profited from the fallout of the Paulson plan. The banks then sold the bad mortgages at a severe discount to Munchin and others. They foreclosed, got the properties at bargain basement values, kicked out the owners and are now renting the homes. Thus do massive transfers of wealth upward to the wealth class happen so quietly.
Why the Corporate ‘Say on Pay’ Movement Failed
Over 30 years ago, some small shareholder groups began a “say on pay” movement that slammed into an impenetrable stone wall.
In theory, the corporate form is a democracy, but in practice, it is a monarchy — the emperor CEOs set their own salaries.
They do this through the “proxy” system. A proxy allows a nominee to vote on behalf of a shareholder.
Before the Annual General Meeting, management sends out a proxy circular containing a proxy form with a suggested nominee. Many shareholders routinely sign the form and send it back.
The CEO has the power to hire and fire the person who drafts the circular. So, as self-preservation dictates, that employee obeys and writes in the CEO’s choice. The CEO’s choice votes for the directors whom the CEO wishes. In short, the CEO hires and fires the people who decide his salary.
Many shareholders are mom-and-pop investors. They buy their shares because they hope to make money either by dividends or capital gains. They have listened to advisors and have a diverse portfolio of shares in corporations in widespread industries ranging from manufacturing, banking to medical research. They know nothing about running any of them– and have no interest in the elections. They often sign the proxy form to be nice or ignore it.
Why Shareholder Activists Are No Help
That is a short, easy answer. They don’t care. They only want a CEO who will do their bidding: distribute amounts that should be retained for future development immediately by way of dividends, or sell off profitable subsidiary businesses and distribute the bounty by dividends. If the CEO does that, the big guys — the institutional investors, hedge and equity funds — will vote to approve anything that CEO wants.
The small shareholder groups couldn’t even get CEO pay on the agenda of the Annual General Meeting. Thus, another of the Dodd-Frank (S951) reforms required corporations to put this item on the agenda — but only for a voluntary vote. That has been happening since 2011. It’s hard to evaluate the results. Certainly, there have been a couple of instances where CEO compensation proposals have been rejected. The board at Stanley Black Decker lowered its CEO pay by 63% after a shareholder vote.
However, In 2012, one study says only 2.6% of companies which held say on pay voting failed to pass the proposed salaries. How do we know to trust the result of a study on shareholder approval of CEO pay? It could be the result of the CEO directing an employee to vote proxies or the acts of hedge fund managers rewarding CEO complicity.
Lessons Unlearned
Most politicians, including presidents like Clinton and Obama, who were dedicated to reducing income inequality, were totally ineffective because they depend on Wall Street friendly advisors — the Treasury Department—and economists. Charles Ferguson, in his documentary Inside Job, exposed how Wall Street has also captured most academic economists of any influence. I elaborated on that corruption here.
No matter who occupies it, the White House is in the grip of the fallacy that the best people to regulate Wall Street are people from the street itself. To the contrary, the worst people to have any position that could in any way influence any policy regarding Wall Street are people from that street.
It will be nearly impossible to drain that swamp in the Treasury Department of banker alumni snakes; they are likely in positions to do all the hiring now. But, the president can ensure that no banker, or economist with ties to banks, ever holds the position of Treasury Secretary while America exists. All that takes is widespread middle-class voter recognition of the serious harm that Wall Street executives in that position have done to the middle classes and democracy.
In the 1980s when CEO pay began its escalation, Peter F Drucker, who is on record for supporting proper compensation for performance, warned against the “Greed Effect.” He echoed J.P. Morgan’s 20 to 1 pay ratio as the solution. Drucker also forewarned against a build-up of worker resentment.
There are too many forces in the market, interested in their own wealth without regard to the long-term effect on the economy, to expect any lessening of the upward spiral of CEO pay from our free market system. It would be impossible to legislate such a restriction. However, it would be possible to put that restriction on any corporation that received any type of subsidiary or tax exemption from the government. How could a corporation need assistance, or special tax treatment, if it could afford to pay its executives hundreds of times it’s median workers’ salaries.
While corporate and bank top executives and managers will continue to earn even more outrageous salaries, bonuses, and stock options, the industry’s working class will continue to barely be able make ends meet. Worker resentment is building and they are lashing out. What is going to happen if Trump fails them?
Follow me on Twitter: @JanWeirLaw
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