The Golden Parachute: Why Current CEO Compensation in America is Unjustified

Now that the presidential election has passed and the future Commander in Chief of the United States is known, attention has shifted from the promises of change in the future to fixing the country’s deteriorating economy. One of the biggest issues that have elicited cries of outrage is the topic of CEO compensation in public companies, especially the ones that have been failing during this financial crisis. For example, Richard Fuld, former chief executive of Lehman Brothers Holdings Inc. received $484 million in compensation from 2000 until it filed for bankruptcy in September. Similar payouts have been recorded at other failed institutions like AIG and Countrywide. Considering that those individuals led their companies to failure, the question must be raised as to whether or not these CEOs are deserving of the outrageous pay packages they are given. Is it necessary to pay the top men in Corporate America tens or hundreds of millions of dollars in salary, stock, and other benefits? Additionally, is it fair that their bonus packages are often not directly linked to the performance of their company’s stock? When I started my research for this post, I was of the belief that CEO compensation in America is mostly justified, except for the extreme cases like Lehman Brothers and Countrywide. However, the more I looked into the topic, the more I came to believe the opposite. Except for certain cases where a CEO significantly increases the value of a company’s stock, the current level of pay for CEOs in America is not justified, for the amount of value they add to it is exceeded by their cost of services.

For most employees in the world, the amount of money and other benefits they are given for their work is directly correlated to their performance and the value they add to their employers. Recently in America, it seems that CEOs of large public companies have become exempt from that policy. One of the responsibilities of a CEO is to maximize value for shareholders. The problem has been that, looking at some of the highest earning CEOs in 2007, their pay is an unjustifiably large percentage of the company's earnings (see below, left). For those institutions that do link executive income to performance, they have developed too narrow of a focus on earnings. As Leo Hindery, Jr. observes in BusinessWeek, “from the end of World War II until the mid 1990s, prominent public and private company CEOs almost universally viewed their responsibilities as being equally split among shareholders, employees, customers, and the nation.” However, as time passed and companies became less regulated and their owners more greedy, shareholders became the most important. Hindery also points out that “at that point, because of the prevalence of stock option and restricted stock grants, shareholders included many if not most senior managers at a large number of publicly traded companies.” The problem that arises when the focus of a company turns towards making a profit and not towards accountability and responsibility is that encourages short-term profiteering and long-term irresponsibility, the American Federation of Labor and Congress of Industrial Organizations argues in an article entitled “Why the Mortgage Crisis Matters”. This attitude lead to the use of the complex financial instruments that produced large short-term gains, but in the end, is at the root of the credit crisis our country is suffering from right now.

In addition to being unjustified, bad for the company, and unhealthy for the economy, giving CEOs these huge salaries and stock options with even larger severance packages only grows the gap between the rich and the poor. On average, during 2007, average CEO pay was 344 times that of an average worker in the United States. Hindery points out that in other industrialized nations like Britain, Canada, and Japan, that multiple drops to 22, 20, and 11, respectively. What is it about the average CEO that makes him or her hundreds of times more important to a company than its average employee? Would the average CEO be more useful to a company than an additional 344 employees? Freek Vermeulen discusses how the boards of directors in these companies (the people who determine how much a CEO makes) use a comparison to a company’s “peer group” to justify the number they choose. Unfortunately, the problem with this logic is that the overcompensation of executives is system wide. It is a rare instance when the head of a company is not making at least upper seven digits. In reality, there are only a handful of individuals who are actually worth the kind of money CEOs are being given today. They are the Warren Buffet’s and the Jack Welch’s of the world. They are the people who, if the company were to lose them, they would potentially lose billions of dollars of value. The average CEO is not that person. He or she is skilled or intelligent, but there are many skilled and intelligent people in the world. The only difference between the two groups is that one is being paid millions and millions of dollars, while the other may be making little over what the average worker makes. I see that as a cruel injustice which polarizes our society and harms our economy. It must be changed.

Luckily, executive compensation has become a top issue in our government today. Considering the fact that the United States government is making hundreds of billions of dollars available to these companies, it absolutely should be an issue. Taxpayers should not be the ones supporting the lavish lifestyles of the people who caused the economic downturn in the first place (see right). Unfortunately, the current bailout package has loopholes in it that would allow this spending to continue unchecked, a fact which some legislators have not overlooked. They are calling for caps on CEOs salaries if they receive money from the bailout. While the bailout is a special situation, I think that there should be broader changes across the market. Stockholders, not a board of directors, should be the ones who determine how much a company’s executive makes. They are the ones who stand to make or lose money depending on how the company performs, and so they are more likely to reward smart, sustainable decisions. There may be better ways to remedy this issue, but the fact of the matter is that the amount CEOs of American companies make is excessive, and as such, is a problem. It is a detriment to the growth of a company and disease that, if allowed to continue, will keep our economy from truly regaining its health.

Wall Street vs. Main Street: Why the Treasury Bailout Plan Failed

Last week I wrote about the rise of socialist economics in American policy-making, citing the bailouts of Fannie Mae, Freddie Mac, and AIG as examples of this rising socialism. I also addressed the question of whether or not this marked the decline of capitalism in the United States. Since that time, there has been increasing turmoil in the financial markets as well as increased involvement by the government in the economy, most especially the proposed $700 billion bailout plan by the United States Treasury. When this plan was shot down in the House of Representatives on September 29th, it acted as a catalyst for the single largest dollar decline of the Dow Jones Industrial Average (over 777 points) as well as the Standard & Poor’s 500 Index (over 106 points) (see below, right). This reduction in stock values translated into an approximately $1.2 trillion decline in market value of the entire U.S. stock market. Considering the implications of the House of Representatives’ decision, I decided to explore various blogs to answer two questions of mine: why was the bailout plan deemed inadequate, and did the House of Representatives make the right choice in voting against it? After noting how close the vote was in the House of Representatives (228-205), I was surprised to see that most blogs agreed that the bill did not deserve to be passed. Admittedly, this is my own opinion as well, but I imagined there would be more of a counter-argument than there actually was. The question that more blogs disagreed on was why the House of Representatives decided to vote against the proposed bailout. I found two blogs that gave the most interesting insight into this decision and left my feedback on them. In the first blog, Amateur Economists, Evelyn Black addresses the issue in an entry entitled “Why Did Paulson’s Bailout Plan Fail in the Congress?” Black claims that the issues raised were the lack of regulation of CEO pay for companies that choose to receive money from the bailout plan as well as the fact that there is no guarantee the bailout would work. In the second blog, Church of the Customer, Ben McConnell briefly addresses the issue in an entry titled “Why the Bailout Package Failed.” He claims there are three main issues: the concentration of too much authority in the hands of Treasury Secretary Henry Paulson (see below, left), the lack of transparency about the administration, and, like Black, the lack of regulation of Wall Street CEO pay. For your convenience, in addition to posting my comments on their respective blogs, I have copied them below.

“Why Did Paulson’s Bailout Plan Fail in Congress?”
Comment:
Thank you for your useful insight into why Paulson’s bailout plan was voted down in the House of Representatives. It really helped to shed some light on the faults of this $700 billion piece of legislation With the market’s record-setting drop after this news was released, I think many people are wondering why exactly Congress voted against this plan and, had it been passed, whether the economy would have taken the downturn it had on Monday. Your analogy of the lobbying for this plan to an old western film is depressingly fitting, as Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke seem to be convinced that the only way to turn our economy around is by taking money out of the hands of the public and into the hands of the people who started this crisis in the first place.

I liked how you used the comments on New York Times editorials as evidence of a confrontation between Main Street and Wall Street. It adds a tangible aspect to a claim that is otherwise hard to quantify. I also liked your analysis of the analogy between this bailout plan and the Resolution Trust Corporation of 1989. I have seen the link made between the two before, especially in the context of the bailout not costing taxpayers as much as initially thought, but did not know enough about the Resolution Trust Corporation to be able to make the comparison. I agree that the comparison is not valid, for the RTC bought and sold actual assets, while this proposed bailout plan would be buying faulty financial instruments, the mortgage-backed securities.

Though I thought your blog was well researched and informative, I have some questions and comments about it. First, do you think the only reasons for the public outrage were CEO salaries? I don’t see any other reasons in the article other than the lack of a guarantee that the plan would work. Also, while you say that Congress negotiated some governmental oversight and provisions for helping homeowners keep their homes, I think this article would have benefitted by explaining those changes in more detail. The current description is relatively vague.

Thanks again for the helpful insight and I am looking forward to continuing reading your blog as the financial crisis progresses.

“Why the Bailout Package Failed”
Comment:
Thank you for your succinct article on why the bailout package failed to clear Congress. Like most people, I have been following the credit crisis closely over the past year and was especially following the progress of this bailout package. The way you opened the article with five especially gloomy headlines from a single day’s Wall Street Journal (and not even on the front page!) really painted a picture of just how dismal our economy is right now and put the entire bailout package into context perfectly.

In the body of your article, I liked how you very clearly laid out the three reasons why you believe Congress voted against the bailout. It was clear, concise, and eye-opening. I agree that the biggest issue with this bailout package was the lack of transparency in the system, especially given how much power Paulson would have been given. It is as if the government is trying to test the phrase “power corrupts, absolute power corrupts absolutely.” It was heartening to hear how the public became involved in this legislation, and I found your statistic that calls were averaging 100-1 against the bailout especially interesting. It solidified your statement that “vast numbers of citizens” were calling their representatives to reject the bailout and added credence to your argument that this financial crisis might bring about transparency in business and government.

Though I loved the article and I liked the way you started your article, I think you would have benefitted by saying what the front page headlines actually were. I understood your intentions behind what you did, but I believe it is more confusing that it has to be. Also, do you think that some of the outrage came from the fact that the government was giving money to the companies that caused this crisis rather than the people who have been hurt by it? The way you talk about rich fat-cats makes me think that you are one of the people who would rather see the money go into a stimulus package than bailing out Wall Street.