Wealth of Nations April 2006

Shameless Gougers

Year in, year out, the median pay of top executives rises much faster than wages and salaries overall. It's time for shareholders to demand an end to the gouging.

Nothing disgraces American capitalism so much as the enormous, and growing, disparity between the pay and performance of many top executives. With remorseless efficiency—and for the greater good of the country, as I usually try to argue—American free enterprise grinds away at almost every kind of cost, and notably the cost of labor. This process, brutal as it may seem, drives growth in productivity, in national income, and ultimately in living standards. It is the foundation, and the price, of America's economic success. That is what many a chief executive will tell you, as well, with all due gravity. But in so many cases, this zeal for control of costs is jarringly absent when it comes to those bosses' own pay. Many CEOs are gouging the owners of the companies they work for, and they are doing it shamelessly. Shareholders, unfortunately, keep letting them get away with it.

Every proxy season brings new evidence of amazing rapacity. In the past few days, The Wall Street Journal, The New York Times, USA Today, and other papers have run long and admirably detailed reports on the subject, drawing on the latest company filings. The theme of the coverage is not new by any means, nor are the particular instances in qualitative terms. In fact, people are getting inured to the issue, and that is only going to make things worse. Steadfast critics of capitalism express the usual outrage over these cases, of course, but that carries no weight: They are routinely outraged about so many things. It is the embarrassed silence of the defenders of capitalism that is so disappointing, and that really matters. Those people should be ashamed, and seen to be ashamed, of the injustice—of the brazen ethical failure—that lies behind each new crop of figures.

The New York Times, with good reason, paid particular attention to the case of Verizon. The firm's CEO, Ivan G. Seidenberg, received $19.4 million last year, in a mixture of salary, bonus, restricted stock, and other payments, a rise of nearly 50 percent over the previous year. That was justified, according to the company's compensation committee, because Seidenberg met some "challenging" performance benchmarks. So the company did well in 2005? Not exactly. Earnings fell by 5.5 percent, the company's shares dropped 26 percent, and its bonds were downgraded. The Times also reported that 50,000 of the firm's managers had their pensions frozen. (The company had a difficult year, you see: The pension freeze was doubtless a painful but necessary sacrifice.)

Verizon is on a list of 11 big companies accused of "paying for failure" by The Corporate Library, a corporate-governance research outfit. In a just-published study, TCL found that over the past five years board compensation committees "authorized a total of $865 million in pay to CEOs who presided over an aggregate loss of $640 billion in shareholder value." The 11 companies are AT&T, BellSouth, Hewlett-Packard, Home Depot, Lucent Technologies, Merck, Pfizer, Safeway, Time Warner, Verizon, and Wal-Mart. Each of these "paid their CEOs more than $15 million in the last two available fiscal years; had a negative return to stockholders over the last five years; and underperformed their peers over the same period."

But the problem goes much wider than this. Year in, year out, the median pay of top executives rises much faster than do overall wages and salaries. There is no reason why this should be so—not if the market for CEOs is working as rigorously as the market for other kinds of labor. But, of course, it is not. There is no economic rationale, no "incentivizing" justification, for enormous severance payments to departing (failed) CEOs, or for full-salary pensions worth eight figures or more, granted to bosses about to retire. The idea is a joke. The cases that TCL has drawn attention to, and the wider trend of rising CEO pay regardless of performance, show that the market for CEOs is broken.

That is a bad thing in itself—and, fairness aside, the scale of the resulting misallocation of resources is not small. An academic study published last year by Lucian Bebchuk and Yaniv Grinstein in the Oxford Review of Economic Policy estimated that from 2001 to 2003, the total pay of the five highest-earning CEOs of public companies was equivalent to nearly 10 percent of the companies' earnings, roughly double the share of earnings paid out that way from 1993 to 1995. Pay on that scale, if it elicits no improvement in company performance, is perceptibly depressing return on investment. That, as I say, is serious enough, but a far larger cost comes in damage to the system's reputation.

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