Michael Wolraich's picture

    Rich CEO Demands to be Taxed

    Reed Hastings, CEO of Netflix, publicly asked the government to raise his taxes in a NYT op-ed today. His position was not that of Warren Buffett, who has argued that taxes are unfairly low for the super rich. Rather, Hastings argued that higher taxes offer a more effective way to limit CEO incomes than pay caps. And he's right. To see why, we need to first understand why CEO salaries have gotten as high as they have.

    In Econ 101, we learn that price is driven by supply and demand. When workers with a particular skill are scarce, they can charge higher wages. I often see this in the tech industry. For example, many companies still use antiquated mainframe systems that require regular maintenance, but few young programmers want to learn the outdated technology. As a result, there aren't enough mainframe developers to fill demand, which means that those few remaining in the industry earn a lot of money.

    CEO salaries, however, are not driven by classic supply and demand. There are very few Fortune 500 CEO positions (only 500, in fact) and many more people with the will and means to do the job. While some candidates are more capable than others, being a CEO is not like being a mainframe developer where you either have the skills or you don't. For every CEO, there are plenty of eager VP's with solid management experience.

    So if not supply and demand, then why? Some conjecture that top executive salaries are artificially inflated by corrupt board members in bed with their CEO's. But while there have certainly been examples of inept boards, there's no evidence that inappropriate executive-board relationships are widespread enough to create a significant market inefficiency. The fact is that the market value for good CEO's is just really, really high.

    So if the market value of top CEO's is not driven by low supply and is not caused by a market inefficiency, what's behind it? We can answer this question by looking at another class of overpaid professional who have seen their salaries balloon in recent years: actors. As any struggling actor will tell you, there is no shortage of talented actors. New York and L.A. are swarming with them. So no supply problem. Nor is there evidence of widespread corruption that inflates the incomes of A-list actors.

    So why are top actors paid so much? It's very simple. An A-list actor almost guarantees heavy box office turnout, so a movie with A-list stars is likely to gross much more than the same movie with B-list actors. For a producer, it's a no brainer. A B-list actor may be almost as skilled (or even more skilled) than an A-list actor and cost much less, but that A-list actor will bring in tens of millions more revenue, so it's well worth the extra millions to go A-list.

    We see the same phenomenon in other high-grossing businesses, e.g. pop music, popular fiction, and professional sports. There many great musicians, writers, and athletes, but it's the elite few in certain categories that bring in the big bucks, both in terms of what they're paid and what they generate for the people who pay them. And what about those investment bankers that everyone has been pillaring lately? Investment banking is not an easy job, but there are many lower paying jobs that require more talent, e.g. scientists, artists, liberal bloggers, etc. Bankers command higher salaries than other professionals primarily because they work with very large sums of money. The difference between an excellent i-banker and a competent one can mean millions of dollars in savings, so a million dollar bonus is not a high price to pay, relatively speaking.

    If the relative financial differences among actors and investment bankers is high, it's even higher among CEO's of Fortune 500 companies. A single CEO can turn a company into a juggernaut or a dead man walking (no offense to Deadman), meaning that billions of dollars are at stake. So what's a few extra million to help ensure that you've got the best that CEO that money can buy?

    My point is not to argue that CEO's deserve their fat bonuses. From a fairness point of view, I don't believe that anyone deserve millions for anything, including actors, athletes, and i-bankers. But the market isn't fair. Moreover, the market is notoriously difficult to control. Companies are highly incentivized to highly incentivize their top executives. Trying to stop them from doing so is like trying stop a fire hose with your thumb. There's too much pressure; the water is going to find a way out. Boards and executives are geniuses when it comes to creative compensation.

    That's why Hasting's proposal makes sense. Let the CEO's get their bonuses, but tax it up so that a higher percentage of their income goes into government programs or paying down the national debt. Furthermore, while massive CEO salaries may stand out because of the disparity between their pay and that of their employees, the top CEO's make up a very small share of the population. If we truly hope to address income inequality in this country, we need to go after all those actors, athletes, and i-bankers as well.

    Comments

    Would you extend that to the CEOs of firms operating on TARP or other government funds?  I really don't have a fundamental problem with the market valuing their pay, but I think it's legitimate to ask why you're paying a bonus to someone who's run a failed company.  If someone is highly compensated, but primarily compensated on the basis of a performance bonus, then I really don't see how that can be reconciled with the argument given for compensating them so highly in the first place.  It creates a world where this conversation is possible:

    "So, as we discussed, if you perform well you'll receive a hefty bonus."

    "And if I don't?"

    "You'll receive a hefty bonus."

    "I will?"

    "Yes, but it'll be covered by the taxpayer."

    "Ah, right."

    Also, RE: Income inequality, I don't think the problems of income inequality are about addressing the high highs so much as the low lows.  Nice post, BTW.  Your explanation and analogy were both very good.


    fascinating column, G. well-thought out, and i think i mostly agree with your reasonings and hastings' argument.

    honestly, tho, shareholders have so much more power than they realize and they've been way too silent so far about the egregious executive compensation packages that have been doled out. I think the cozy board-CEO setup you mention but mostly glossed over actually is a large part of the problem.

    the fact of the matter is, large compensation packages don't make sense in that they just do not help find the best of the best executives. Indeed, some of the elements common in many of today's compensation packages - most notably golden parachute or severance packages - may even encourage failure.

    But unlike with some of the other industries you also mentioned which give very high pay to a select few top performers, the market has done a terrible job figuring this out and tying compensation to performance in corporate America. If an actor all of a sudden stops bringing in big box office numbers, trust me, his salary will go down very quickly. Same goes with a ballplayer who has stopped performing. And if a team owner spends a lot of money on his players but the team stops bringing in a profit, that owner will quickly shift gears.

    But the way compensation works on Wall Street and in corporate America, that kind of direct tie-in to performance is missing. If the system worked as it should, CEOs would get paid most of their compensation based on how well they've increased company profits.

    The industry has tried to move in that direction, but there have been two main problems. One is determining how much an executive is responsible for a company's success or failure is difficult. Do you look at profits? Stock price? Do you look at the company on an island, or how it's done versus its competitors? What time frame do you consider - there may be changes that would be good for a company in the long-term but if you're only judging short-term performance, no executive in his right mind will make them.

    The other, far more important roadblock to performance-based executive compensation is that the system is still highly tilted to favor those already in charge. Shareholders only have a limited say in terms of how compensation plans are created.

    What would be so much more effective in terms of limiting these type of packages than any government fiat, regulation, or even higher tax, is to give company shareholders more power and make it easier for them to influence matters like compensation. It would certainly expedite that process if public outrage reached a boiling point in the matter.


    D&D, you both make good points about poor incentive structures. While I agree that bonuses should be tied to performance, it would very difficult for the government to regulate incentive packages.

    That said, I agree that I glossed over board abuses, and I think that the government can and should regulate board liability and shareholder power. Hopefully, that would help the market to correct the incentive structure.

    For the record, the analogy isn't really mine. Hastings mentions actors, athletes, and hedge fund managers, and the philosopher, Robert Nozick, has a famous argument against distributive justice in which he presents a thought experiment involving Wilt Chamberlain (dating himself in the process).


    The Netflix guy makes a great point about higher taxes. But aren't there all sorts of creative ways to avoid paying them (I mean non-Daschle, legal-like ways). Also, I think the fact that some people make so much is really gross, but ultimately, if a company wants to pay somebody that much to work for them, whatever. But when that company is going to fail without help from the government, they can either take the strings that come along with the money or they can try to stay afloat some other way.

    I don't really have a problem with government imposing salary restrictions on the companies it bails out. I just think it's cosmetic. It won't do much for income distribution problems.

    Take hikes should come with restrictions on tax loopholes.


    Winter should come with restrictions on snow. Just cuz it should doesn't mean it will.


    If you try to impose a snow quota, I wll mobilize the biggest, baddest, blusteriest filibuster the world has ever seen.


    Meanwhile, I'm working on turning the filibuster into an alternative energy source.


    You should have ample hot air.


    The Board sets the CEO compensation.  Stop the focus on the CEO and shift it to why Boards are not focused on pay for performance.

    There is such a thing as a Banker Rock Star.  Just look at Madoff.  Even the SEC was so starry eyed they couldn't think straight.

     


    I agree about Banker Rock Stars. It's obviously not a good way to do business, but that's human psychology for you. When it comes to hiring, it doesn't actually matter whether a candidate can make billions of dollars for your company. if you believe that they will, you'll agree to pay them handsomely. I don't think that the government can change psychology. It should stick to do what it does best--tax income and regulate abuse.


    Over on TPM I thought you asked about Board control of CEO pay and the breakdown between.  I did a little searching and found first this link

    http://www.truthout.org/article/containing-ceo-pay-a-case-government-efficiency

    quick and clear.

    I also got a little confused about what decade i was in.  Complaints about CEO overcompensation from the 90's mixed in with the 00's.  But I did find a book preview on that had this quote

    Core, Holthausen, and Larcker study provides evidence consistent with this prediction (... pay arrangements can be expected to be more favorable to the CEO when outside directors sit on multiple boards.) It indicates the CEO compensation increases, all else being equal, with the number of outside directors serving on 3 or more other boards ... CEO pay increases when a board contains interlocking directors.

    That's from Pay without Performance

    I guess you and Hastings are talking about Xtreme progressive taxation.  And it is a way to handle the excesses in pay and redistribute the wealth.  But aren't there always loopholes?  I'm still rather squeamish but governement regulating pay beyond the bailouts.


    Thanks Blue, it's a good link, and I'm all for regulating shareholder approval of salaries. There is certainly some board abuse, and the poor incentive structures that DF and Deadman have mentioned seem particularly dumb for companies to accept.

    But it's interesting to me that people get their knickers in a twist over rich CEOs but not rich rock stars or athletes. When a team buys an expensive contract for a player who doesn't deliver, people may criticize the owner and manager for stupidity, but they're unlikely to get really angry at them, and they're even less like to get angry at the player. I suspect that it's because CEOs are a lot more central in class conflicts, particularly when they battle with organized labor. But CEO performances at large corporations are likely to have larger financial consequences than top athlete performances.

    Top government employees, such as the President and Cabinent members, are frankly underpaid in the sense that their performance has extreme financial consequences. But the government can get away with paying them what it does b/c there's no competition. It's not as if Obama can threaten to become president of Japan if the U.S. doesn't pay him more.

    If we could somehow require all companies to pay their executives less, the system would still work, as it works in other countries and used to work here, because there would be no competition offering higher salaries. But my point is that it would be very difficult to enforce such a requirement b/c there are powerful market pressures boositng executive pay.

    That's why I say tax, don't cap. And yes, let's close some of the loopholes.


    I can only speak for why my own knickers are in a twist. Rock stars and athletes don't ask the government for my money to fund their yearly bonuses or spa retreats (or hookers--anybody watch 20/20 on Friday?). They only get my money when I choose to buy a ticket.

    Now, I know referring to the government bailout as "my money" is overly dramatic, but it doesn't make it less true. I willingly pay taxes so that our roads are paved, our schools are staffed, our country is protected from outside threats and for any number of other worthy reasons and programs. I do not, however, pay taxes willingly so that executives or anybody else working for a failing company gets a freaking bonus. Capitalism does not mean that when things are good you can get rich and when things go bad, you can stay rich because the government will support you. 

    I've heard lots of arguments for why they need such high pay and ridiculous bonuses, but they are about as convincing to me as Thune's picture of hundred dollar bills stacked into space.


    I can imagine that an argument that executives need such high pay and ridiculous bonuses might not be very convincing. But I've never read anyone stupid enough to argue that. Nor have I read anyone stupid enough to argue that executives should be getting big bonuses from taxpayers. What some argue, and what I've argued, is that there's a real market reason why executives have been able to negotiate such sweet deals for themselves, and any attempt to solve the issue that ignores the market pressure will certainly fail.

    So here's the question: Do you want to shout your self-righteous indignation into the blogosphere, or do you want to investigate the causes and possible solutions to the pernicious effects of income inequality? Because the sound and fury surrounding the bonuses of a few executives at a few banks is a red herring. You could have these executives tarred, feathered, and bombarded with the angry little shitballs, but it would do nothing to change the value of your 401K, the state of the economy, or the atrociously wide income gap that bedevils the country.


    Sorry for my own outburst. You're not the really the one who provoked my ire. I don't know why I bother posting anything provocative at TPM. I have a really strong aversion to screaming villagers with pitchforks. Perhaps because my ancestors were often at the receiving end of the pitchforks.


    My ancestors (German Mennonites) were quite oppressed as well, albeit not in an eradicate your race sort of way. 

    In this case, clarification accepted. And for the record, I would like to investigate pay inequity and I've been advocating for stronger labor unions for a while. I think that is the key to a healthy middle class and sanity in salaries at all levels. But in the meantime, while I cop to having moments of self-righteous indignation, I'm not sure this is one of them. If a company accepts taxpayer dollars, why shouldn't they have to accept government conditions on the money? We exact conditions from individuals who accept government assistance in the form of welfare. Expecting that corporations will know better than poor women how to responsibly spend the money they receive is a fairly odious assumption, I think. 


    I never argued against government bailout conditions. I just don't think it accomplishes much. The number of overpaid execs at bailed out companies is not very large. I'd far rather channel energy into longterm solutions to income inequality.


    First of all, i think it's obvious that a company that accepts government bailout money because it effed up MUST accept whatever conditions the government lays out.

    I also agree however that the idea of limiting executive compensation for the top 5 managers for a limited period of time will do absolutely nothing to address the major structural issue, which is that the current system - which favors those in charge and makes shareholder activism very difficult - does not lead to rational compensation packages.

    I think making this into an income inequality battle is unwise. That's a separate issue as far as I'm concerned. If investors truly came first, trust me, you just would not see these kind of obscene packages for underpeforming executives. Superstars would probably still get paid big bucks, and I'm not entirely sure they shouldn't if they truly are adding value (again, if you want to talk about the comparable value-add to society of a top executive compared to a top teacher, that's a valid and important discussion, but also a much different and much more ideological one).

    There's an article on realmoney.com that talks about this in good detail (it's a pay site so I can't link). But you need to tie compensation to performance. Make sure the performance being judged is long term (at least 12 months, maybe longer). Give shareholders a say in pay and limit the rather ridiculous limits that Delaware incorporation rules place on shareholder activism. Stock options or restricted stock may be one of the best compensation tools, but you need to outlaw or extremely limit repriced options (certainly for management if not for the rank and file). Take a good hard look at the soundness of golden parachutes and huge severance packages.

    The most obscene thing about the current mess is that billions of dollars were paid to people who were not creating value, but destroying it (and bringing down the country's economy at the same time).

    We have the ability now to use the current crisis to address some of the structural problems with how companies compensate their top executives. If enough hue and cry is raised, many of the most egregious examples of unjustified compensation would hopefully go the way of the dodo.

    You'd still get some bad decisions, just like in baseball, you still have your steinbrenners, but it wouldn't be as systemic a problem as it is now.


    Then I'm not sure what we're disagreeing on. The government doesn't (and shouldn't) have the right to tell private businesses how much to pay their employees and I agree that pay inequity is a problem. Government has a role to play in solving that problem, but through legislation like the Employee Free Choice Act and the Lilly Ledbetter Fair Pay Act, not through regulating salary levels.

    But when they're taking bailout money, they need to act with austerity. If they're too far gone to realize it, the government has every right to lay out the conditions.


    dang this cough medicine.  I'm still rather squeamish about government regulating pay beyond the bailouts.


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