In recent news, CEOs are back to earning almost 300 times more money than the average worker:
Now if you look at the above graph, you’ll notice some things:
- There was shift in the status quo somewhere around 1978.
- Things took an upswing just as the US entered the 1990s.
- And from about 1993/1994, the salary differential sky-rocketed.
So no one really knows the real reason for the increase. But there are theories out there, and there is one that I’m a particular fan of.
Before I get there, let me digress for a moment to talk about corporate governance.
The Trouble With Transparency
Corporate Governance has many buzzwords; but by far its favourite is “transparency”. Such as: “what we need is greater transparency”. As though opacity and/or discretion allow for underhanded nefariousness.
And that’s probably because we tend to see transparency in line with a game of poker. If all the cards were dealt face up, then it would be clear what’s happening, and no one would place any unnecessary bets on the table.
But greater transparency is not always a good thing. For example, let’s say that you were planning on selling your house. Do you tell every potential buyer what every other potential buyer is bidding and/or whether you have any potential buyers at all? If you did that, you would end up short-changed, because you’d have handed all the bargaining power over to your buyers.
Executive Remuneration Disclosure in the US
This brings me back to that chart up top, and that theoretical explanation for its movement.
In the interests of greater transparency, the SEC expanded its disclosure requirements for executive remuneration in 1978. These new disclosures gave some information, but they were open to significant interpretation (so companies disclosed as little as they could get away with). Then, in 1983, the SEC changed the rules to make the disclosures more airtight. But these disclosures were in narrative form, so the detail could be hidden in long-winded over-detailed explanations of what CEOs and the rest were getting paid.
“After analysing the effectiveness of limited tabular disclosure, the Commission adopted amendments to the executive compensation rules in 1992. These amendments abandoned the primarily narrative disclosure approach for a highly formatted tabular one to facilitate the comparison of annual compensation between companies.” (Donahue, 2008)
Effectively, the SEC said to companies: disclosure your executive remuneration in a way that allows executives to easily and transparently compare their packages.
Presumably, the idea was to shame people into taking lower packages?
Only, remuneration is a status game – it’s only shameful when you’re earning less than everyone else. And now those executives knew exactly what their peers were taking home. So actually, what those disclosure rules did was hand the bargaining power straight to the executives, who could now argue for more “market-related” salaries.
- Assume that there are only two executives: Executive A earning $2 million per year, and Executive B earning $10 million per year.
- The market-related “rate” for executive remuneration would be the average between them ($6 million per year).
- Executive A immediately turns to his company and says “I want you to pay me the market-related rate – otherwise, I’m going to take myself elsewhere.”
- And because executives don’t get to their positions by accident (executives have, by the nature of their positions, mastered the political game), Executive A’s salary goes up to $6 million.
- Meanwhile, Executive B will continue to earn $10 million because his salary package is part of his contract, and he’s not about to exit it now that he knows how great a deal it is.
- At this point, the market-related “rate” is the new average, which is now up to $8 million.
- So Executive A goes back to his board, and asks for an increase to $8 million on the basis of the movement in the market-related rate.
- Which moves the market-related rate up to $9 million.
- And so on…
- Only, at this point, Executive B starts to say “I’m better than Executive A”. Which is probably true – after all, he managed to negotiate a $10 million package for himself while Executive A was only earning $2 million, which is the sign of a skilled operator.
- So Executive B now argues for a higher package relative to Executive A’s package.
- Which moves up the market-related rate…
The point is, greater disclosure does not result in lower packages: it results in higher ones. To quote Dan Ariely in 2009:
“Once salaries became public information, the media regularly ran special stories ranking CEOs by pay. Rather than suppressing the executive perks, the publicity had CEOs in America comparing their pay with that of everyone else. In response, executives’ salaries skyrocketed. The trend was further ‘helped’ by compensation consulting firms (scathingly dubbed ‘Ratchet, Ratchet and Bingo’ by the investor Warren Buffett) that advised their CEO clients to demand outrageous raises.”
For me, the trouble is this: increased transparency smells a lot like trite moralism. It’s an easy sell, an easy solution, and it’s altogether too easy.
So it backfired.
And here’s the entertaining part: there are still academics that argue what we really need to combat this scourge of income discrepancy is more disclosure…