Dean Baker

Corporate CEOs don't earn the millions they're paid

A new study shows that the top five executives of major corporations pocketed 15 to 19 cents of every dollar their companies gained from two recent tax cuts. The paper, by Eric Ohrn at Grinnell College, should be a really big deal.

The basic point is CEOs and other top executives rip off their companies. The officers are not worth the $20 million or more that many of them pocket each year.

Again, this is not a moral judgment about their value to society. It is a simple dollars-and-cents calculation about how much money they produce for shareholders. The piece suggests that it is nothing close to what they pocket.

This is a big deal because it is yet another piece of evidence that executives are able to pocket money that they did nothing to earn.

It is no more desirable to pay a CEO $20 million if someone just as effective can be hired for $2 million than to pay an extra $18 million for rent.

In the case of these tax cuts, company profits increased because of a change in government policy, not because their management had developed new products, increased market share or reduced production costs. Some of them presumably paid for lobbyists to push for the tax breaks, so their contribution to higher profits may not have been exactly nothing.

There is much other work along similar lines. An analysis of the pay of oil company CEOs found that they got large increases in compensation when oil prices rose. Since the CEOs were not responsible for the rise in world oil prices, this meant they were getting compensated for factors that had little to do with their work. A more recent study found the same result.

Another study found that CEO pay soared in the 1990s because it seemed that corporate boards did not understand the value of the options they were issuing.

A few years ago, Jessica Schieder and I wrote a paper showing that the loss of the tax deduction for CEO pay in the health insurance industry, which was part of the Affordable Care Act, had no impact on CEO pay.

The loss of this deduction effectively raised the cost of CEO pay to firms by more than 50%. If CEO pay were closely related to the value they added to the company's bottom line, we should have unambiguously expected to see some decline in CEO pay in the industry relative to other sectors. In a wide variety of specifications, we found no negative effect. Bebchuk and Fried's book, Pay Without Performance, presents a wide range of evidence on this issue.

Ripping Off Companies

As can be easily shown the bulk of the upward redistribution from the 1970s was not due to a shift from wages to profits, it was due to an upward redistribution among wage earners. Instead of money going to ordinary workers, it was going to those at the top end of the wage distribution, such as doctors and dentists, STEM [science, technology, engineering and math] workers, and especially to Wall Street trader types and top corporate management. If we want to reverse this upward redistribution then we have to take back the money from those who got it.

If top management actually earned their pay in the sense of increasing profits for the companies they led, then there would be at least some sort of trade-off. Reducing their pay would mean a corresponding loss in profit for these companies. It still might be desirable to see top executives pocket less money, but shareholders would be unhappy in this story since they will have fewer profits.

But if CEOs and other top management are not increasing profits in a way that is commensurate with their pay, their excess pay is a direct drain on the companies that employ them.

Money Thrown in Garbage

From the standpoint of the shareholders, it is no more desirable to pay a CEO $20 million if someone just as effective can be hired for $2 million than to pay an extra $18 million for rent, utilities or any other input. It is money thrown in the garbage.

As I have argued in the past, the excess pay for CEOs is not just an issue because of a relatively small number of very highly paid top executives. It matters because of its impact on pay structures throughout the economy. When the CEO gets paid more, it means more money for those next to the CEO in the corporate hierarchy and even the third-tier corporate executives. That leaves less money for everyone else.

The Ohrn study found that 15% to 19% of the benefits of the tax breaks he examined went to the top five executives. If half this amount went to the next 20 or 30 people in the corporate hierarchy, it would imply that between 22% and 37% of the money gained from a tax break went to 25 of the highest paid people in the corporate hierarchy.

If the CEO is getting $20 million, then the rest of the top five executives are likely making close to $10 million; the next echelon making $1 to $2 million.

If we envision pay structures comparable to what we had in the 1960s and 1970s, CEOs would be getting $2 to $3 million. The next four executives likely would earn $1 to $2 million. The third tier would be paid in the high six figures. With the pay structures from the corporate sector carrying over to other sectors, such as government, universities and non-profits, we would be looking at a very different economy.

Arranging Their Own Pay

If CEOs really don't earn their pay, the obvious question is how do they get away with it? The answer is they largely control the boards of directors that determine their pay.

Top management typically plays a large role in getting people appointed to the board. Once there, the best way to remain on the board is to avoid pissing off your colleagues. More than 99% of the directors nominated for re-election by the board win their elections.

Being a corporate director is great work if you can get it.

As Steven Clifford documents in his book, the CEO Pay Machine, which is largely based on his experience at several corporate boards, being a director can pay several hundred thousand dollars a year for 200 to 400 hours of work. Directors typically want to keep their jobs, and the best way to do this is by avoiding asking pesky questions like, "Can we get a CEO who is just as good for half the money?"

While many people seem to recognize that CEOs rip off their companies, they fail to see the obvious implication that shareholders have a direct interest in lowering CEO pay.

For example, a common complaint about share buybacks is that they allow top management to manipulate stock prices to increase the value of their options. (Editor's note: Before 1982, buybacks were illegal, deemed a form of manipulation.)

If this is true, then shareholders should want buybacks to be more tightly restricted, since they are allowing top management to steal from the company. If shareholders actually wanted CEOs to get more money from their options, they would simply give them more options, not allow them to manipulate share prices. Yet, somehow buybacks in their current form are still seen as serving shareholders.

Shareholders Losing Out

As a practical matter, it is easy to show that the last two decades have not been a period of especially high returns for shareholders. This is in spite of the large cut in corporate taxes under the Trump administration.

There seems to be confusion on this point because there has been a large run-up in stock prices over this period. Much of this story is that shareholders are increasingly getting their returns in the form of higher share prices rather than dividends.

Before 1980, dividends were typically 3% to 4% of the share price, providing close to half of the return to shareholders. In recent years, dividend yields have dropped to not much over 1%, with the rest of the return coming from a rise in share prices. If we only look at the share price, the story looks very good for shareholders, but if we look at the total return, the opposite is the case.

If CEOs really are ripping off the companies they lead, then shareholders should be allies in the effort to contain CEO pay. This would mean that giving shareholders more ability to control corporate boards would result in lower CEO pay.

As with much past work, Ohrn's study found that better corporate governance reduced the portion of the tax breaks the CEO and other top executives were able to pocket.

Reform Proposal

There are many ways to increase the ability of shareholders to contain CEO pay, but my favorite is to build on the "Say on Pay," provision of the Dodd-Frank financial reform law. This provision required companies to submit their CEO compensation package to an up or down vote of the shareholders every three years. The vote is nonbinding, but it allows for direct input from shareholders. As it is, most pay packages are approved with less than 3% being voted down.

I would take the Say on Pay provision a step further by imposing a serious penalty on corporate boards when a pay package gets voted down. My penalty would be that they lose their own pay if the shareholders vote down the CEO pay package.

While a small share of pay packages get voted down, my guess is that if just one or two corporate boards lost their pay through this route, it would radically transform the way boards view CEO pay. They suddenly would take very seriously the question of whether they could get away with paying their CEO less money.

I also like this approach because it is no more socialistic than the current system of corporate governance. It would be hard to make an argument that giving shareholders more control over CEO pay is a step toward communism.

The basic point here is a simple one: The rules of corporate governance are unavoidably set by the government. There is no single way to structure these rules. As we have now structured them, they make it easy for CEOs to rip off their companies. We can make rules that make it harder for CEOs to take advantage of their employers and easier for shareholders to contain pay.

Progressives should strongly favor mechanisms that contain CEO pay because of the impact that high CEO pay has on wage inequality more generally. And, shareholders should be allies in this effort. There is no reason for us to feel sorry for shareholders, who are the richest people in the country. They can help us contain CEO pay and we should welcome their assistance.

If you're concerned about rising Federal debt -- read this

How will our children know they face a crushing debt burden?

The question above may seem silly.

Of course, they will know because there are a number of well-funded policy shops that will be spewing out endless papers and columns telling them that they are facing a crushing debt burden.

Because these policy shops are well-funded and well-connected we can be sure that major media outlets, like The New York Times, The Washington Post and National Public Radio, will give their complaints plenty of space.

But let's imagine a world where our children weren't constantly being told that they face a crushing debt burden. How would they know?

Even with a higher tax burden due to the debt we are now building up, workers 10 years out should enjoy substantially higher living standards than they do today.

It might be hard if the latest budget projects are close to the mark. The Congressional Budget Office (CBO) just released new projections for the budget and the economy.

They show that in 2031, the last year in their budget horizon, the interest burden on our debt will be 2.4% of Gross Domestic Product. That's up from current interest costs of 1.4% of GDP. That implies an increase in the debt burden, measured by interest costs, of 1.0 percentage point of GDP.

Side note 1: The true debt burden is actually somewhat less. Last year the Federal Reserve Board refunded $88 billion, roughly 0.4% of GDP, to the Treasury. This was based on interest that it had collected on the bonds it held. That leaves the actual interest burden at around 1% of GDP.

Will an interest burden of 2.4% of GDP crush our children?

On the face of it, the deficit hawks have a hard case here. The interest burden was over 3.0% of GDP for most of the early and mid-1990s. And for those who were not around or have forgotten, the 1990s, or at least the second half, was a very prosperous decade. It's a bit hard to see how an interest burden of 2.4% of GDP can be crushing if burdens of more than 3.0% of GDP were not a big problem.

Imagining Even More Debt

But, the debt burden may be higher than the current projections show. After all, President Biden has proposed a $1.9 trillion pandemic rescue package. He also will have other spending initiatives. The CBO baseline includes tax increases in current law that may not actually go into effect.

CBO's latest projections put the debt (currently $22 trillion) at $35.3 trillion in 2031.

Let's assume that the rescue package and other issues raise the debt for that year by 10%, or $3.5 trillion. This brings the interest burden to 2.7% of GDP. That's still below the 1990s level.

Furthermore, insofar as the rescue package and other initiatives are successful in boosting growth, GDP, the denominator in this calculation, will be larger, which will at least partially offset the higher interest burden.

One point the deficit hawks add to this calculation is that interest rates are extraordinarily low at present.

CBO does project that interest rates will rise, But in 2031 they still project an interest rate on 10-year Treasury bonds of just 3%. This is up from 1.1% at present, but still well below the rates we saw over the 40 years before the Great Recession. It certainly is not impossible that interest rates will rise to 4% or even 5%.

Higher Interest Rates

Higher rates will mean that the debt poses a greater interest burden. But there are a couple of important qualifications that need to be made. First, much of our debt is long-term. The 30-year bond issued in 2021 at a 2% interest rate doesn't have to be refinanced until 2051. That means that even if interest rates do rise substantially they will only gradually lead to a substantially higher interest burden.

The other point is that we have to ask about the reason interest rates are rising.

It is possible that interest rates will be rising even as the inflation rate remains more or less in line with CBO's latest projection of around 2%. In that case, higher interest rates mean a greater burden over time.

However, interest rates may also rise because we see higher than projected inflation. Suppose the inflation rate rises to 3%, roughly a percentage point higher than projected. If interest rates also rise by a percentage point, so that the interest rate on a 10-year Treasury bond in 2031 is 4%, instead of 3%, we would still be looking at the same real interest rate. In that case, the value of the bond would be eroded by an extra 1 percentage point annually, due to the impact of higher inflation.

In the case where higher inflation is the reason for higher interest rates, the actual burden of the debt does not change.

With nominal GDP growing more rapidly due to the higher inflation, the ratio of debt to GDP would be lower than in the case with lower inflation. This means that we only need to worry about a higher interest burden if interest rates rise without a corresponding increase in the rate of inflation.

Side Note 2: If the economy grows at a 2% real rate over the next decade, and the inflation rate averages 2%, then nominal GDP will be 48% larger in 2031 than it is today. If it grows at a 2% real rate and the inflation rate averages 3%, nominal GDP will be 63% larger in 2031 than it is today. With nominal GDP 10% larger in 2031 in the case with higher inflation than the case with lower inflation, the same amount of interest would imply a 10% lower burden, relative to GDP. Alternatively, to have the same burden relative to GDP, interest payments would have to be 10% higher.

What would adding a 1 percentage point interest burden look like?

Paying The Bill

Suppose that the CBO projections prove to be exactly right.

At first glance, this higher interest burden implies that, if the economy is operating near its capacity, we would have to get by having the government spend roughly 1 percentage point less of GDP on various programs. This could mean, for example, cuts to spending on education and infrastructure, or the military. Alternatively, it would need to raise taxes by roughly 1 percentage point of GDP, or some combination in order to offset the additional interest payments on the debt.

In fact, the first glance story is likely to substantially overstate the impact of this debt burden. The reason we would need to cut spending and/or raise taxes is to keep the economy from overheating.

The interest burden increases this risk by increasing the income of bondholders, who then spend more money because of their higher income.

But the bondholders don't spend all of the interest income they receive, in fact, they might spend a relatively small share.

Bondholders Are Big Savers

Remember, the people who hold government bonds are disproportionately higher-income households. That's why it is possible to say there is a burden from interest payments. If the interest was paid out to all of us equally, then we would just be paying ourselves. As was the case with the pandemic checks, and there would be no burden.

With a large share of interest payments going to the wealthiest households, perhaps 70 cents on a dollar ends up being spent. This is what we have to offset with spending cuts or higher taxes. That means we need to come up with a combination of spending cuts and tax increases that will reduce demand in the economy by 0.7% of GDP.

If we did this on the spending side, we would need to cut an amount of spending roughly equal to this amount. In the current economy, 0.7% of GDP would come to around $150 billion in spending cuts, roughly a fifth of the military budget or twice the annual budget for Food Stamps.

On the tax side, we might be tempted to take it from the wealthy, but we then come back to the same issue, that the wealthy save much of their income. If we want to reduce the consumption of the wealthy by an amount equal to 0.7%, we may have to raise taxes on them by something close to twice this amount, or 1.4% of GDP.

Suppose this proves politically impossible, so we end up having to share the higher tax burden more or less evenly across households. This means a tax increase equal to roughly 0.7% of people's incomes. Is this a big deal?

Wages and Productivity Get Divorced

The figure above shows the impact of CBO's projected increase in productivity over the next decade on wages, assuming productivity growth is fully passed on in higher wages.

It also shows the 0.7 % hit from debt burden taxes. As can be seen, the projected wage gains from higher productivity growth are roughly twenty times the "crushing" burden of the debt calculated above.

This means that even with a higher tax burden due to the debt we are now building up, workers ten years out should enjoy substantially higher living standards than they do today.

There is the obvious issue that productivity growth does not automatically translate into higher wage growth.

While wage growth for the typical worker did track productivity growth from 1947 to 1973, that has not been the case since 1979. Average wage growth did not track productivity growth reasonably well in the last four decades. Most of the gains went to high-end workers, such as top-level corporate executives and Wall Street types. Typical workers saw little benefit.

This pattern of upward redistribution of before-tax income could continue for the next decade, which would mean that most workers cannot offset an increased tax burden with higher pay. That would be a very serious problem, but the problem would be the upward redistribution blocking wage growth, not the relatively minor tax increase they might see due to the debt.

Anyone generally concerned about the well-being of workers ten years out, or further in the future, should be focused on what is happening to before-tax income, not the relatively modest burden that taxes may pose due to the debt.

Monopolies Impose 'A Private Tax'

This brings up a final issue about burdens. As I have often pointed out, direct spending is only one way the government pays for services. It also grants patent and copyright monopolies to provide incentives for innovation and creative work.

By my calculations, these monopolies add more than $1 trillion a year (4.8% of GDP) to the cost of a wide range of items, such as prescription drugs, medical equipment, and computer software. The higher prices charged by the companies that own these monopolies are effectively a private tax that the government allows them to impose in exchange for their work. No honest discussion of the burden of government debt can exclude the implicit debt that the government creates with these monopolies.

At the end of the day, we hand down a whole economy and society to future generations. Anyone seriously asking about the well-being of future generations must look at the education and training we have given our children, the physical and social infrastructure, and, of course, the state of the natural environment. The government debt is such a trivial part of this story that is hard to believe that would even be raised in the context of generational equity, if not for the big money folks who want to keep it front and center.

Featured image: Visual Capitalist

Here's why you don't want to live in a Republican-run state

As infection rates surge, Democrats still are outpacing Republicans in thwarting coronavirus spread according to my interpretation of data.

A few weeks back I noted in a post that states governed by Republicans had the highest positive COVID-19 test rates, while the states with the lowest positive rates mostly were governed by Democrats.

I argued that positive test rates are a good measure of how serious, or not, governors are in trying to bring the pandemic under control.

While leaders can take measures to limit the actual spread, such as longer and stronger lockdowns and mask requirements, many factors determining the spread are outside their control.

By contrast, they do have control over the amount of testing, although legislatures can play a role since they can appropriate or restrict funding.

Testing also has become a political issue since Donald Trump explicitly said that he wanted to see testing slowed to reduce the number of cases identified.

I thought it was worth an update to see what the story looks like as the country is experiencing a huge surge in infections.

Here's the more recent picture showing the 10 states with the highest infection rates and the 10 states with the lowest rates, based on the John Hopkins Coronavirus Resource Center, seven-day moving averages. (Data are for Oct. 26, 2020.)

Source: John Hopkins Coronavirus Resource Center


Eight of the 10 states with the highest rates have Republican governors. Kansas and Nevada, which come in eighth and ninth, both have Democratic governors.[1] While Democrats also control the legislature in Nevada, the legislature in Kansas is overwhelmingly Republican.

The story is more mixed among the states with the lowest positive rates, with five having Democratic governors and five having Republican governors. However, it is worth noting that all five of the states with Republican governors have legislatures that are controlled by Democrats.

In short, by this measure of efforts at getting the pandemic under control, Democrats seem far more serious than Republicans.

[1] The 100 percent positive rate shown for Mississippi is the result of the way John Hopkins reports the data. It shows the number of positives as a percentage of the tests given in the period, not as a percentage of the results reported that day.

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