Excessive chief executive officer pay has always been seen as unfair. But now it's becoming clear that those bloated CEO pay packages actually cost the rest of us some serious money.
The explosion in CEO pay during the 1990s was fueled by stock options. In 1990, the average American CEO made $2 million a year. But after rolling in stock options for 10 years, the average corporate chief was raking in $13 million a year.
Those stock options were supposed to align the interests of CEOs and shareholders. But by granting CEOs huge blocks of options, firms gave CEOs an incentive to pump up their stock prices by whatever means necessary. Layoffs were a popular stock-goosing device in the 1990s. As the stock market faltered, some companies turned to cooking the books.
A new report has now found a correlation between high CEO pay and aggressive accounting. According to the report, top executives at Enron, WorldCom, Tyco, and 20 other companies currently under federal investigation for their accounting practices earned an average of $62.2 million over the last three years. That's 70 percent more than the average of $36.5 million for all leading executives.
All told, the CEOs at the 23 firms under investigation pocketed $1.4 billion over the last three years. Meanwhile, their shareholders are dealing with massive losses. Between January 1, 2001, and July 31, 2002, the value of shares at these 23 firms plunged by $530 billion. Workers at these companies have taken it on the chin as well. Since January 2001, those 23 companies have laid off 162,000 workers.
But the costs of high CEO pay are not only felt by shareholders and laid-off workers. Taxpayers also bear a burden. Incredible as it may seem, corporations keep two different sets of books, one they show to ahareholders and one they show to the government for tax purposes. A recent United States Internal Revenue Service study found that the income corporations report to shareholders was 24 percent higher than the income reported to the government.
How can this be? Once again, the trusty stock option is at the center of the action. Companies are not required to show a stock option expense in the earnings statements they release to shareholders. But what's good for the goose is apparently not good for the gander. When an employee cashes in his stock options, the gain does show up as an expense on the company's tax return, reducing the total tax due. These stock option deductions cost taxpayers an estimated $56 billion in 2000. That's $194 for every single person in the country.
This stock option tax dodge isn't a new discovery. Sen. Carl Levin of Michigan has been trying to get corporations to expense stock options since the early 1990s. He recently introduced a bill with Sen. John McCain of Arizona that would require that companies show the same set of books to shareholders and the government.
In 1994, Levin almost got a similar bill passed. But he was defeated at the last moment by an overwhelming barrage of corporate lobbyists. Had it passed, the bill might have discouraged the use of stock options, removing a powerful incentive for executives to cook the books. Who knows? Maybe the stock market bubble, and the crash, might have been averted.
Notions of fairness get short shrift when it comes to economics. Market fundamentalists scoff at those who argue that, regardless of how well a company or the stock market appears to be doing, it is simply "unfair" that CEOs are making 400 times as much as workers.
But it turns out that the CEO-worker wage gap was like a warning light on the U.S. economy's dashboard, flashing "unfair - unfair - unfair." If investors had heeded that warning light, they might have pulled over and checked the engine.
Perhaps they would have probed into the accounting treatment of stock options, and how those options set up incentives that put their own investments at risk. Maybe they would have questioned the sky-high value of the stock market itself.
If we're smart, next time we'll pay more attention to that unfair warning light and get the economy repaired before we're stuck with another trillion-dollar repair bill.