How CEOs became so obscenely high-paid (and how one retired tech founder wants to fix that)

By David Holmes , written on May 14, 2014

From The News Desk

America in 2014: Where corporations make record profits, pay some of the lowest effective tax rates in decades, and pass fewer and fewer of those spoils onto employees.

That's right, US corporations make more after-tax profits today than they have in the entire 85 years the Commerce Department has been keeping track. Meanwhile, employer-paid compensation, which includes wages and employer contributions to health care and social security, are at their lowest level since 1948. Making matters worse, the compensation CEOs receive has skyrocketed to 273 times what an average worker makes. By comparison, in the 1960s, the CEO-to-employee pay ratio was only 20:1. And people wonder why we have an income inequality problem in America.

Robert Reich, former US Secretary of Labor under President Clinton, does a good job explaining why these out-of-whack ratios matter on his blog:

This growing divergence between CEO pay and that of the typical American worker isn’t just wildly unfair. It’s also bad for the economy. It means most workers these days lack the purchasing power to buy what the economy is capable of producing — contributing to the slowest recovery on record.
So if we believe egregious CEO pay is a problem (and, to be fair, not everybody does), what should be done about it? A new proposal introduced in the California State Senate may provide a solution for this growing disparity. And if it passes, it might be good news not only for workers, but for all stakeholders of a corporation.

Well, except CEOs.

California Senate Bill 1372 seeks to tie the corporate income tax rate of publicly-traded companies to each firm's CEO-to-worker pay ratio. For example, if a CEO at a firm doing business in California makes 100 times more than an average worker at the company, then the tax rate will go down from the current 8.8 percent to 8 percent. If the CEO-to-worker pay ratio is only 25, the rate will go down to 7 percent. In turn, a company with a CEO like Tim Cook, who in 2011 made 6,258 times as much as an average Apple employee, would pay a tax rate as high as 13 percent. The objective is simple: To create a financial disincentive for Boards of Directors who approve obscenely high CEO compensation packages.

Granted, the proposal doesn't guarantee that CEO pay cuts will go toward raising worker wages. But proponents of the bill also argue that, even if workers don't directly benefit (which most believe they will), reducing CEO-to-worker pay ratios may also improve how corporations perform.

"When [CEOs] were paid one-tenth of what they were paid now, their performance was better," says Steve Silberstein, an advisory board member at UC-Berkeley's Goldman School of Public Policy and co-founder of Innovative Interfaces, an early pioneer in library software. Silberstein has been pushing for a tax like this for years and has been an active donor to the California Democratic Party and other progressive issues and candidates, giving $1,335,000 from 2001 to 2011, according to California Watch. Finally, after suggesting the proposal to State Senators Mark DeSaulnier and Loni Hancock, the two lawmakers heeded the call, introducing the bill to the California Legislature. Last month, the bill completed the first of many legislative obstacles before it, advancing out of a state Senate committee by a vote of 5-2.

So if CEO performance is inversely related to pay, (and business school professors overwhelmingly agree that it is), how did CEO wages become so high? Why would a Board of Directors approve such exorbitant CEO pay which not only eats into profits, but may also make CEOs less effective?

It's all about keeping up with the Joneses, Silberstein says. "Nobody wants to have a CEO that's [paid] below average. So as one person's pay goes up, everybody's pay goes up. It's kind of a club." This practice is made worse by the fact that many corporate compensation committees are stocked with fellow CEOs. The Washington Post's Harold Meyerson likens them to "CEO 'Unions.'"

One might imagine that if there's one place where CEO-to-worker pay ratios are more reasonable, it's tech. After all, the fight against outrageous CEO compensation is very much in the spirit of Silicon Valley's roots. Fairchild Semiconductor, the company that laid so much of the groundwork for how companies were built and structured in the Valley, resisted hierarchy and treated employees and executives alike as equals. Over the years a number of tech CEOs from Elon Musk to Steve Jobs have paid themselves in the single digits for the good of the company.

But just as we saw with Google's and Apple's wage collusion schemes, many of the Valley's biggest companies are beginning to act more and more like the incumbents they sought to replace. Tim Cook's astonishing CEO-to-worker ratio is only one example. In 2012, eBay's John Donahoe made 656 times more than his employees. That same year, Oracle's Larry Ellison, despite having a salary on paper of only one dollar, took home $96.2 million in stock options and other awards, giving him a compensation ratio of 1,287. In Ellison's defense, these option bonuses mean his take-home pay is indeed tied to the performance of the company. But many experts doubt the efficacy of these pay-for-performance incentives.

Silberstein explained to me this shift in Silicon Valley corporate culture:

Tech companies usually start out as relatively egalitarian operations, this kind of culture of everybody working together with less hierarchy. When the venture capital comes in, you don't have a situation where the venture capitalists say to the CEO, 'I'm going to pay you $10 million a year and see what you do with the company.' They usually pay them not much more than the other people in the company.

As startups begin to take in massive profits, however (and in the case of Apple, when a founder departs and takes some of his company's culture with him), Silberstein says the door is opened for the same greedy, chummy "CEO Club" one-upmanship.

The guy who ended up becoming CEO, Tim Cook, went to the board and said I need $400 million to stick around here so the board paid him $400 million dollars. My guess is if he went to Steve Jobs and asked for that he'd be fired in eight seconds.

Opponents to the bill, like the California Chamber of Commerce, label it with the favored term of the anti-tax set: "job-killer." The Chamber fears that the proposal will “have the boomerang effect of reducing investment in California and reducing the very jobs this bill seeks to promote.” The idea is that, in the face of additional tax burdens, companies will move their business out of the state, just like Toyota did last month.

But Silberstein shrugs off these concerns, emphasizing that a CEO pay tax would affect all income generated in the state of California by a public company, regardless of where the firm is headquartered. And it's unlikely that large companies will simply stop doing business in the most populous state in the country. In fact, at 8.8 percent, California already has one of the higher corporate income taxes in the country, and yet "you don't see everybody say, 'I'm not doing any business in California,'" Silberstein says. He reiterates, that despite opponents' efforts to paint this as a tax hike, the bill also offers tax reductions for "well-behaved" firms as Silberstein calls them, giving them more reason than ever to sell their wares in California.

So what are the bill's chances of passing?

In California, to change the tax code like this it takes a two-thirds vote," Silberstein says. "That's difficult to achieve. It's not impossible but it's difficult. The Democrats do not have two-thirds of the vote right now in the county Senate. There would have to be some Republican support for this. Will it pass in the next 30 days? Well it's very rare that any bill passes right out the gate. Usually it's a several year effort.
That said, as income inequality widens, worker wages remain stagnant, and CEO pay continues to balloon, the appetite from the public for a bill like this will only increase, Silberstein says.
Corporations are rolling in cash, and in the last few years people have realized that's the reason the economy's not doing well. We've had the slowest recovery in history. What kind of policies can you implement to somehow get the wages to rise? One policy people are talking about is to raise the minimum wage. Another policy is to provide more EITC (Earned Income Tax Credit). So here's another policy idea to incent and reward corporations that spread the wage bill around a little more equally. And I think we're going to have more conversations of this kind.
[Illustration by Brad Jonas for Pando]