THE GROWING WAGE GAP

Contact: Chuck Collins
April 17, 1996

THE GROWING WAGE GAP

Top Executives Get Another Raise
While Workers' Incomes Remain Flat

It's April and executive pay is in the news. Continuing a trend of several years, the gap between the earnings of corporate executives and their workers grew substantially during 1995. Measuring CEO pay is complicated and two highly regarded studies that were recently released yielded significantly different numbers. But, as we will see below, even the most conservative numbers indicate a strong and disturbing trend that has left many working Americans with a growing sense of unfairness about the way the economy is going.

MEASURING THE WAGE GAP

Two sets of numbers were released in the last few weeks: one by compensation expert Graef Crystal, reported in the New York Times (3/29/96) and the other by the William M. Mercer Company, under contract with the Wall Street Journal (4/11/96). Business Week will publish a third study this week. There was a pronounced discrepancy between the figures reported in the New York Times and those reported in the Wall Street Journal. Both sets of figures are provided here. The discrepancy between them and our reasons for preferring Graef Crystal's calculations are discussed separately below.

  • According to the Times average CEO salary and bonuses grew 14 percent and average Total Compensation grew 31 percent. Total compensation averaged approximately $5 million.
  • According to the Journal salary and bonuses grew 10.4 percent and Total Compensation grew 14.2 percent. Total Compensation averaged approximately $2 million.

In comparison, the average blue collar worker saw no inflation-adjusted raise in 1995 and the average white collar worker saw less than a 1 percent increase after inflation (U.S. Dept. of Labor, NYT 3/29/96). These one-year figures follow a trend which has seen a 9 percent decline in real wages for 80 percent of American workers from 1979 to 1994 (Economic Policy Institute). Median household income fell 6 percent from 1989 to 1994 (U.S. Census Bureau).

Despite the lower Wall Street Journal figures, Joann S. Lublin, who authored the lead article accompanying the study, opens by noting that, "The earnings gap between executives at the very top of corporate America and middle managers and workers has stretched into a vast chasm". This observation is supported by figures compiled by Graef Crystal for the last several years. In a study of 292 large corporations the ratio between the pay of the average CEO and the average worker was 145 to one in 1992; 170 to one in 1993; 187 to one in 1994 (Crystal Report 7/95). Though this study has not been completed for 1995, indication from the preliminary study reported in the Times suggest that the ratio will reach over 200 to one. In 1973, the ratio was 41 to one. Current ratios in Japan and Europe are between 30 and 40 to one.

IS THE WAGE GAP A PROBLEM?

Management specialist Peter Drucker argues that vast pay differentials within an organization, particularly at a time of economic uncertainty for workers, undermines commitment and productivity. For society as a whole, escalating CEO pay, at a time of stagnating wages and widespread economic insecurity, contributes to public anger and cynicism about our economic and political institutions. People see corporate and political elites working together to insure their own security while ignoring the needs of the middle class. This fuels the anti-government extremism of the militias and "freemen' and the scapegoating and demagoguery of Republican Presidential candidate Patrick Buchanan. The growing wage gap moves us further in the direction of a winner-take-all society. It undermines the incentive for ordinary people to work hard and play by the rules.

THE CAUSES OF ESCALATING CEO COMPENSATION

Some critics of excessive CEO compensation argue that it is primarily an organizational problem. Board members who decide CEO compensation are likely to be either: corporate insiders whom the CEO can fire, outsiders whom the CEO has picked or who are CEOs of other large corporations, or "professional" directors who sit on many boards. These CEOs and board members cooperate to protect each others interests. You scratch my back and I'll scratch yours.

The recent surge in CEO pay can also be explained in part by a laudable effort, spurred by shareholders, to tie compensation to performance: Rewarding CEOs who provide returns to shareholders by increasing stock prices and paying dividends. The portion of compensation that CEOs receive in the form of restricted stock and stock option plans has increased dramatically in recent years (see Table 1 on page 4). This has the unfortunate consequence of rewarding highly those executive who increase shareholder value at the expense of workers, either by keeping wages low or by "downsizing". Two widely cited cases involve 1. Robert Allen at AT&T who received a compensation package valued at more than $16 million during a year in which he initiated the layoff of 40,000 employees and 2. Albert Dunlap of Scott Paper who received compensation of more than $24 million in 1994 after laying off 11,000 employees.

REDUCING THE WAGE GAP

A recent Boston Globe editorial argued that, "it is too cumbersome for government to regulate pay ratios, but stockholders and the media should pay attention to make sure corporate executives are truly worth high salaries by presiding over corporations that value workers" (4/11/96). This recommendation ignores the fact that the divergent interests of workers and shareholders is a major cause of the problem. It is shareholders, particularly institutional shareholders, who are pressing companies to produce short term performance. Their interests frequently coincide with those of the CEO who stands to gain if he provides return to shareholders over the short term, even at the expense of workers and communities. Wall Street and Main Street do have different interests in this situation.

Government policy contributes to the pay gap because CEO compensation is treated as a tax deductible business expenses as long as it is tied to performance. In effect, ordinary taxpayers are subsidizing excessive compensation for CEOs. One remedy, backed by a coalition of community and labor organizations, is The Income-Equity Act (HR 620). Introduced by U.S. Representative Martin Sabo (D-MN) it raises the federal minimum wage two dollars, restoring it to its 1967 purchasing power of $6.50, and it limits the deductibility of compensation that is more than 25 times the lowest paid worker in a firm.

This measure attempts to redress the wage gap by introducing the notion that a rising tide should lift all boats. It attempts to restore balance to corporate compensation by sharing the benefits of economic growth with workers. It ends the practice of ordinary taxpayers subsidizing excessive executive compensation through the tax code.

VARYING MEASURES OF EXECUTIVE COMPENSATION

The Graef Crystal/ New York Times study provides a more accurate measure of executive compensation. There are two factors that produce the variance between the Times and the Journal studies: 1. Sample size and 2. the way that stock options are counted. Despite a larger sample size that should make their figures more reliable the Journalí•s method underestimates Total Compensation

1. Sample Size. Crystal's sample is smaller. Seventy-six of the largest corporations as compared with the 350 largest used in the Journal study. Since pay generally increases with the size of the corporation this lends an upward bias to Crystal's numbers. This explains, in part, why Crystals percentage increase in salaries and bonuses is almost 40 percent higher than the Journal's, 14 percent rather than 10.2 percent. Recalculation of the Journals numbers, using the method of accounting for stock options that Graef Crystal uses, produces a figure of $3.5 million for Total Compensation. This means that half the variance between the Journal figure of $2 million and the Times figure of $5 million can be explained by sample size.

But sample size does not explain why Crystalí•s percentage increase in Total Compensation is more than double the Journal's , 31 percent rather than 14.2 percent. Crystal has already performed a study that doubled his sample size and found that it only reduced the figure for percentage increase in Total Compensation from 31 percent to 29.6 percent, still more than double the Journal figure.

2. Accounting for stock option plans. The two studies count stock options granted to CEOs differently. Crystal counts the present value of option grants in the year they are granted. The Journal study provides this number but does not include it in Total Compensation. Instead the Journal study counts in Total Compensation only the gains on options exercised. Since the period between the granting of options and the right to exercise them is usually five to seven years, the gain being counted by the Journal study in 1995 most likely dates from options granted between 1988 and 1990. This is like a trailing economic indicator. It tells you about the past but does little to help you understand the future. Since the largest growth in compensation in recent years has been in the form of option grants the Journal study misses this development. Counting the present value of options in the year granted, as the Times study does, gives a much better indication of the value of current compensation packag.

Counting gains on options that are exercised, rather than values when granted, can even obscure the size of compensation packages. If a CEO does not exercise his options until after he retires, this compensation will never be counted. Once the executive leaves the company, he and the company are no longer required to report any compensation. The method the Journal study uses undervalues current compensation and can result in the failure to account for some compensation.

CONTACTS FOR THE ISSUE OF EXECUTIVE COMPENSATION

Chuck Collins, and Felice Yeskel - (617) 423-2148

United for a Fair Economy, 29 Winter Place, Second Floor, Boston, MA. 02108. United for a Fair Economy is a citizen organizing project concerned with the growing gap between the wealthy and everyone else.

Graef Crystal - (619) 759-8038

Graef Crystal is the editor of The Crystal Report, 5 Verbena Court, San Rafael, CA 94903. Graef Crystal is a widely recognized expert on executive compensation. He has limited time to talk to the press.

Charles Derber - (617) 552-4048

Sociology Department, Boston College, Chestnut Hill MA 02167. Prof. Derber is the author of The Wilding of America: How Greed and Violence are Eroding our National Culture. St. Martins Press, 1995

Lawrence Mishel and Jared Bernstein - (202) 775-8810

The Economic Policy Institute, 1660 L Street, NW, Suite 1200, Washington DC 20036. Lawrence Mishel and Jared Bernstein are the authors of The State of Working America Economic Policy Insitute, 1994.
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