Alpha Dominance

There is a lot of talk presently about excessive executive compensation.  Many are deeply angry about the looting of our companies and country by a handful of nepotic plutocrats who serve on each other’s boards and award excessive compensation packages to one another, and rightly so.  Executive compensation here in the States is vastly more generous than in any other country on earth.  Essentially corporations today have got their priorities backwards and an impartial observer might think they exist merely to channel corporate profits to executives.  To go back to econ 101, companies exist to serve several interests 1) customers 2) employees and 3) shareholders.  Ability should be rewarded, yes, and compensation should be linked to performance, but what we have today is a heads I win tails I break even scenario for execs.  Despite often mammoth blunders, these often blithering morons are laughing all the way to bank leaving shareholders, employees, and now taxpayers holding the bag.  This is entirely unacceptable.  Heads must roll.

Despite my ire, I am not in favor of salary caps (except for companies bailed out by the taxpayers).  Private enterprise should be free to select the compensation packages necessary to retain (actual) talent (which many execs arguably are not given recent events).  Somebody outside of the insular world of CEOs and executive boardrooms however should be making that decision.  These somebodies are the shareholders.  It is astounding to me that we are only now having the debate of whether shareholders should be given a non-binding vote on exec pay.  Here’s a thought, how about a binding vote?  Shareholders own the company and should be able to determine among themselves what acceptable remuneration is.  Execs and boards should not have any end-run around the owners of the enterprise.  If one has a private company one expects to have the final say about employee compensation.  The same holds here.

Timothy Geithner is proposing some changes in an ostensible attempt to rein in executive compensation (or at least grandstanding to give that impression) and I laud the attempt to open the dialog, but his ideas don’t go nearly far enough in my opinion.  Here are the basics of his proposal:

First, compensation plans should properly measure and reward performance.

Second, compensation should be structured to account for the time horizon of risks.

Third, compensation practices should be aligned with sound risk management.

Fourth, we should reexamine whether golden parachutes and supplemental retirement packages align the interests of executives and shareholders.

Finally, we should promote transparency and accountability in the process of setting compensation.

There is nothing here that I would contest, but the devil is in the details.  Geithner, being a product of Wall Street, is suspect in his allegiances (as are seemingly half of the DC cronies, so many of them Goldman Alums) in my opinion.  Be that as it may, this is a start.

Many voices, including some very influential investors feel similarly.  In the words of Carl Icahn:

Executive pay is out of control in this country.

CEOs of Fortune 500 companies now make about 520 times the average worker. Yale School of Management argues they make about three times more than their counterparts in Japan and more than twice as much as those in Western Europe.

This disturbing trend has gotten worse over the last few decades – a period when this country has increasingly lost its economic lead. The trend suggests that CEOs have become increasingly focused on their pay packages and not the welfare of shareholders, employees, stakeholders and our national economic well being.

A major reason executive pay packages are ballooning is because of the incestuous relationships between boards and CEOs who conspire to give lucrative pay-and-perk packages to each other. But it is also due to the egregious use of “compensation consultants” that soak up multi-million dollar fees to provide strategic counsel to boards and in addition advise ever higher pay packages to top managers they presume to oversee – whether they perform well or not.

The use of these compensation consultants, which are paid handsomely with shareholder money, gives both boards and CEOs the appearance of legitimacy for their decisions to award massive pay packages to lackluster CEOs, making it appear that these decisions are objective and scientific, which they absolutely are not.

According to a recent study by researchers at the University of Southern California, Executive Pay and “Independent” Compensation Consultants (2008), executive and director pay is higher at companies where consultants are hired. The study found that median CEO compensation is $1.5 million in companies not using consultants, $3.0 million in companies that purchase surveys but do not directly retain consultants, and $4.2 million in companies that retain consultants.

Warren Buffett too, blames compensation consultants, execs and boards:

Buffett and Vice Chairman Charlie Munger have criticized excessive executive compensation in the past.

Buffett has served on 19 corporate boards, excluding those of Berkshire (BRK .A 104,800, +4,490.00, +4.48%) (BRK .B 3,450, +152.50, +4.62%) and its subsidiaries, but calls himself the “Typhoid Mary” of compensation committees.

Buffett has only been on one compensation committee and was outvoted quickly on the most important issues.

At Berkshire, Buffett sets salaries and incentives for the CEOs of roughly 40 significant operating businesses. In his 2006 shareholder letter, the Berkshire chairman said the process takes virtually no time, while noting that no CEOs ever left for other jobs in 42 years.

He partly blamed consultants for perpetuating a system that gives CEOs “astronomical compensation” for “mediocre” results.

“Compensation reform will only occur if the largest institutional shareholders — it would only take a few — demand a fresh look at the whole system,” Buffett wrote in the 2006 letter.

Note that Buffett, being a voice of reason, is typically excluded from compensation committees.  Here is one of the sanest minds in finance today, and they exclude him, precisely for that reason.  They want to populate these committee’s with bootlicking lackeys willing to give away the farm in order to curry favor.  For shame!  Objectivity is clearly lost on these folks.  Note also the incestuous relationships with the often ethically conflicted “compensation consultants” who merely serve to rubber stamp egregious compensation packages.  The companies retaining them seemingly have pay packages twice as generous as their unaudited rivals.  This sounds like so much shining of shit to me.  What an unmitigated disaster.

Let’s take a look at how out of hand executive compensation has become.  This article, which dates from 2005, illustrates that even by this time the average executive’s compensation as a multiple of the pay of an average worker had more than quadrupled since 1990.

In 2004, the ratio of average CEO pay to the average pay of a production (i.e., non-management) worker was 431-to-1, up from 301-to-1 in 2003, according to “Executive Excess,” an annual report released Tuesday by the liberal research groups United for a Fair Economy and the Institute for Policy Studies.

That’s not the highest ever. In 2001, the ratio of CEO-to-worker pay hit a peak of 525-to-1.

Still, it’s quite a leap year over year, and it ranks on the high end historically. In 1990, for instance, CEOs made about 107 times more than the average worker, while in 1982, the average CEO made only 42 times more.

Now, many would defend these stratospheric pay levels as “pay for performance” yet if this were true, we ought to see pay levels for execs in other developed nations coming in at similar rates, yet nowhere on earth are they even close, for instance in Japan, the multiple is 11 times and in Britain, 22 times.  American CEO pay has become simply criminal.  It is clear that pay has little relation to performance, and the massive bonuses paid to bailed out Wall Street firms illustrates this.  Shareholders are beginning to take note, yet their protests are toothless since they don’t determine exec comp.

Another reason CEO pay packets are coming under scrutiny is the feeling that big pay for executives doesn’t always mean good returns for the shareholders. According to a August 2003 report by THE ECONOMIST, median total pay for senior executives among America’s top 350 companies rose by 10 percent in 2002, after the economy began to recover from the stockmarket bubble, even as median total shareholder returns in those companies fell by more than 5 percent.

Figures such as this have led some shareholders and institutional investors to campaign for change in the way corporate pay is structured. Some reformers are casting an eye on who determines the pay package — asking that someone outside the corporate board make the deal or shareholders themselves have a say. According to THE ECONOMIST, “Top bosses’s pay is decided by compensation committees composed of non-executive directors. These may favour bosses over investors rather than display the detachment that might ensure a direct link between performance and pay. Muddying the waters are compensation consultants, who are often appointed by the very chief executives whom they advise upon.”

From the same article, the point is driven home: America is the most unequal of society of all developed nations in terms of pay and of course the lions share goes to the execs.  They are looting America.

According to the Institute for Policy Studies, the pay of the average worker remained almost flat at $27,000 from 1990 to 2004, adjusted for inflation, while average chief executive pay has risen from $2.82 million to $11.8 million. Some economists see this a part of a national, or even global trend — the wealthiest among us — are getting richer and richer. The Organisation for Economic Cooperation and Development (OCED) has found the United States to be the most unequal society of all industrialized nations. The U.S. ranks last among OECD nations in terms of income equality, yet in 1993 the poorest 10% of the U.S. population was still wealthier than two-thirds of the rest of the world.

In its recent report “The State of Working America 2002-03,” the Economic Policy Institute estimated that the bottom 80 percent of American households control only about 17 percent of the nation’s wealth. Meanwhile, wages, benefits, and working conditions for workers at the bottom continue to decrease. Worldwide, the story is the same. A 2002 study by the World Bank found inequality growing not only between nations, but within nations.

This is causing many problems because concentrating all of the wealth in the top 10% has eroded the standard of living of the middle and lower classes.  Only by transitioning to dual income families have we made any headway whatsoever since the early eighties, when the pay multiple for CEO comp was “only” 42 times.  Each dollar paid to low income earners is going to be spent, stimulating the economy and increasing the velocity of money, whereas the bulk of them paid to high income earners will be saved or invested and will not have this effect.

Moreover the tax treatment of high incomes differs from that of the rest of us.  This article in the Wall Street Journal (subscription required, full text here also) surmises that the shortfall in our Social Security fund would be entirely eliminated if the threshold of roughly $108k for payroll taxes were eliminated.  In essence we all pay about 12% of our gross incomes in Social Security taxes, part of which funds Social Security, half from our salaries and half contributed by the employer.  This only applies to the first $108k however, earnings above this are not subject to it, nor are stock options or restricted stock grants, which are subject only to the 20% capital gains tax.

The nation’s wealth gap is widening amid an uproar about lofty pay packages in the financial world.

Executives and other highly compensated employees now receive more than one-third of all pay in the U.S., according to a Wall Street Journal analysis of Social Security Administration data — without counting billions of dollars more in pay that remains off federal radar screens that measure wages and salaries.

Highly paid employees received nearly $2.1 trillion of the $6.4 trillion in total U.S. pay in 2007, the latest figures available. The compensation numbers don’t include incentive stock options, unexercised stock options, unvested restricted stock units and certain benefits.

The pay of employees who receive more than the Social Security wage base — now $106,800 — increased by 78%, or nearly $1 trillion, over the past decade, exceeding the 61% increase for other workers, according to the analysis. In the five years ending in 2007, earnings for American workers rose 24%, half the 48% gain for the top-paid. The result: The top-paid represent 33% of the total, up from 28% in 2002.

The growing portion of pay that exceeds the maximum amount subject to payroll taxes has contributed to the weakening of the Social Security trust fund. In May, the government said the Social Security fund would be exhausted in 2037, four years earlier than was predicted in 2008.

The data suggest that the payroll tax ceiling hasn’t kept up with the growth in executive pay. As executive pay has increased, the percentage of wages subject to payroll taxes has shrunk, to 83% from 90% in 1982. Compensation that isn’t subject to the portion of payroll tax that funds old-age benefits now represents foregone revenue of $115 billion a year.

The magnitude of executive pay has been difficult to measure, even as policy makers grapple with ways to rein in compensation at companies receiving taxpayer bailouts. Companies aggregate the salaries of all employees in their filings to the Internal Revenue Service and to the Securities and Exchange Commission, and disclose details only for top officers.

But payroll taxes provide an indirect way to calculate amounts executives receive. Only earnings up to a certain ceiling are subject to a U.S. payroll tax of 12.4%, split between employer and employee, which finances Social Security retirement benefits.

Did you get that?  One third of all income is now going to executives and the highest wage earners.  Unbelievable but true, and the fund’s insolvency may arrive sooner than we are told.  There is no talent or ability to justify what is wanton theft of our productivity.  It is merely a return to plutocracy and class warfare, and most of us have lost out on an opportunity at having the American Dream.  We’ve been systematically pumped and dumped by an unconscionably greedy and poorly regulated banking system.  We’ve been lied to about whom the system as it is presently incarnated benefits.  It’s time to make the bastards pay.  We must end the incestuous relationship between Wall Street and DC.  We must demand transparency from our companies and our government.  We must demand accountability.  What is astonishing to me is the lack of ire I witness among my fellow Americans.  These schmucks are a cancer and they are feeding on you and then asking you to pay the tab for their ill-fated machinations.  It is time to tear down the edifices of privilege and demand reasonable pay for our labor and limits to the corruption and greed so endemic today in our nation.  Being a sucker is beta, and we’re being collectively sodomized by these stooges.  It must end now.  Claw back what they’ve stolen and throw the dogs in jail.