Don’t Count on Shareholders

By Robert B. Reich

The American Prospect, April, 2007

An acquaintance of mine sits on the board of a major company that just agreed to pay its CEO close to $10 million this year, including deferred compensation and stock options. I asked him how he and his colleagues on the board could possibly justify this kind of money. "No choice," he said. "That’s what our competition is paying. It’s the going rate." As Congress struggles to raise the minimum wage to $7.25 an hour, the going rate of CEO pay is now $5,000 an hour.

Polls show most Americans think this is obscene. But how to rein in CEO pay? A growing consensus believes the best way is to give shareholders more voice. New SEC rules require companies to inform shareholders in greater detail what their companies are paying top executives. In recent months, shareholder activists have submitted proposals at sixty companies seeking input on CEO pay. House Democrats now are working on legislation that would give shareholders the right to have more say over pay.

But the growing consensus is wrong: Shareholders won’t constrain the growth of CEO pay, because most shareholders don’t care about it. The vast majority own their shares through mutual funds and pension funds, and don’t even know which companies they’re invested in at any given moment. Their only concern is maximizing the return on their total portfolios. They keep the pressure on fund managers to do this by moving their savings from funds that underperform to those that show better overall results.

Fund managers, for their parts, don’t care about CEO pay, either. They’re looking for companies whose share prices are rising, and they push firms to get their prices up by shifting capital out of those whose prices are lagging into those that show more promise.

Presumably, shareholders and fund managers would want to constrain CEO pay if it hampered company performance but it hasn’t. While CEO pay has soared over the last twenty-five years, share prices have soared, too. Between 1980 and 2003, the average value of America’s five hundred largest companies rose by a factor of six, adjusted for inflation. What happened to average CEO pay in those companies? It rose roughly sixfold. Shareholders have no reason to complain. They don’t – and they won’t.

Depending on shareholders to rein in CEO pay is like relying on gamblers to rein in the owners of Las Vegas casinos. Just look at Britain. Since 2003, changes in British securities law have given investors there Britain more say over what British CEOs are paid. Nonetheless, executive pay in Britain has continued to skyrocket, now just about matching the pay of American CEOs. Companies listed on the London stock market have done sufficiently well that British investors don’t care what CEOs are paid.

The real scandal of CEO pay has almost nothing to do with shareholders. It has to do with what’s happened to the pay of most workers as CEO pay has soared. Shareholder returns have kept up with CEO pay, but median wages have not. In 1980, the CEO of a major company took home about 40 times what the median worker earned; by 1990, CEO pay was about 100 times the median worker’s pay; in 2006 it was close to 300 times. (Last year, Wal-Mart’s Lee Scott Jr. earned 900 times the pay of the average Wal-Mart worker.)

CEO pay is part of a much larger problem: the growing portion of the nation’s income that’s going to a small number of people at the top. The pay packages of many denizens of Wall Street are even more outrageous than CEO pay – last year reaching $40 million for top traders and over a billion dollars for top hedge-fund managers. The new stars of Wall Street are private equity funds that are buying public companies back from shareholders and raking in 20 to 25 percent annual returns for their private investors – mostly wealthy individuals with yearly incomes in the stratosphere.

Not since the robber-baron era have income and wealth been so concentrated as they are today. This doesn’t threaten shareholders; after all, most shares are held by the wealthy. It threatens democracy, as the wealthy bankroll politicians who tilt public policies in the direction of the wealthy – by, say, reducing their taxes and cutting public services for everyone else. It also threatens our economy, as more and more investment decisions are made by fewer and fewer people, and as the middle class loses its capacity to pay for the goods and services the economy produces.

The answer is not to grant more rights to shareholders. It’s to enact a far more progressive income tax, including a sharply higher marginal rate on yearly incomes above, say, a measly million.