Who Is Really Benefitting from Freer Trade?

Updated September 2018

With the NAFTA talks dragging on endlessly, a look at why freer trade seems to be so important to the corporate world is key to understanding who gains and who loses in a more open environment.  Obviously, a regular part of Donald Trump's "raging against the machine" is his views on international trade, particularly how the United States comes out as the losing party in many of the trade deals that form part of the move toward globalization.  In actuality, as recent research has shown, there is one clear winner and it might not be particularly surprising when you find out who is the clear winner.

A 2017 paper by Wolfgang Keller and Willian Olney looks at a comprehensive data set that explains this trend:

As most of us are aware, compensation for the top one percent of earners in the United States has risen at far greater rates than compensation for all other earners, a trend that has led to increasing income inequality.  In fact, the vast majority of the growth in income inequality has been driven by income gains among the top 1 percent of earners.  The authors look at the role of one key factor that may have caused this earnings growth; the growth in exports, particularly the growth in exports that is unrelated to decisions made by company executives and management, that is, globalization.

There is no doubt that globalization increases access to foreign markets; this results in an increase in  sales as well as a reallocation of market share from less productive companies to more productive companies.  That said, over the past two and a half decades, there have been other factors at work that have increased exports, particularly improvements in computing power,  investments in capital goods including automation, improvements in communication and improvements in transportation, all factors that have relatively little to do with who resides in the upper floor corner offices in Corporate America. 

Since there are actually many other factors that could influence both executive compensation and exports, it is important to understand whether one trend creates the other (i.e. are more highly compensated executives more successful at promoting exports?).   As such, the authors looked at data for the years between 1992 and 2015, looking for a causal relationship between export growth and executive compensation.  For the purposes of the study, the authors used a dataset which included total compensation information (i.e. salary, bonuses, non-equity incentives, value from exercised stock options, deferred compensation etcetera) for 44,000 top executives at 3,500 publicly traded U.S. companies.  The data for the top five executives in each company is included in the study and all companies must have data for all of the years in the sample (1992 to 2015).  The trade data, both export and import, is taken from the United States Census Bureau with nominal trade flows converted to real U.S. dollars using the Consumer Price Index.  The two data sets are then merged to create a complete analysis of each firm.  As well, the authors were able to use the data to ascertain insider board relationships, a variable that may indicate whether an executive at a given firm serves on a committee that makes executive compensation decisions at their own firm or at another firm which has an executive serving on the board of their company.  When these data are combined, the dataset included 3,821 executives from 191 firms over 21 years for a total of 19,788 observations.

Now, let's look at the results.  The authors found that four factors had a positive impact on executive compensation:

1.) insider board relationships

2.) firm size

3.) technology

4.) trade 

The authors found that exports are just as important in driving executive compensation as technology, firm size and insider relationships.  Even after controlling for firm characteristics like assets and sales, exports still have a significant positive impact on executive compensation.  In fact, the authors found that a ten percent increase in exports leads to a two to three percent pay increase for executives that work in that industry.

In closing, let's look at a graphic which shows how average executive compensation for the top five executives and exports levels have risen in lockstep over the past 25 years:

Here is a quote from the author's conclusion:

"The results of this paper suggest that globalization is playing a more central role in rising top incomes than previously thought. The importance of globalization in explaining the growth of top incomes is often dismissed using basic comparisons across countries and occupations. Instead we use a comprehensive data set and rigorous empirical analysis to show that globalization has played an important role in the growth of executive compensation.

Identifying why top incomes are increasing so quickly is an important step forward. However, we remain cautious about interpreting these findings as a rational to restrict international trade. Globalization has generated enormous benefits that likely dwarf the distributional consequences highlighted here. In addition, the rapid increase in executive compensation, while startling, seems to be at least partly driven by the increasing difficulty of the job in a global economy. Instead policy makers concerned about these distributional implications, should think more carefully about how to ensure that the gains from trade are more equitably distributed."

At least now you know who is really benefitting from all of those freer trade deals that governments around the world, particularly the United States, are so anxious to make.

CEO Compensation - Staying Ahead of the Sweaty Masses

As most of us are aware, wages for most American workers have barely kept pace with inflation.  In fact, as shown on this graph from FRED, real wages have grown by a miserly 12 percent since the first quarter of 2000:

Using this formula for compounded annual growth rate, over the past 15 years, real wages have grown by a compounded annual rate of only 0.76 percent.  That can only be termed pathetic.

A recent Economic Snapshot by Lawrence Mishel and Alyssa Davis at the Economic Policy Institute compares the rate of CEO pay growth to that of a typical worker back to 1979.  Here is a graph comparing the percentage change in CEO pay (in blue) and typical workers (in green), comparing both to the percentage change in the S&P 500 (in red):

By comparison, you can hardly see any growth in the inflation corrected pay of typical American workers over the past 36 years.  In fact, the average inflation-adjusted pay for an average private sector production and non-supervisory workers (who make up 82 percent of total payroll employment) rose from $48,000 in 1978 to $53,200 in 2014, an increase of only 10.9 percent.  On the other hand, inflation-adjusted CEO compensation rose from $1.5 million in 1978 to $16.3 million in 2014, an increase of 997 percent or nearly 100 times the rate of increase seen by typical workers.  As well, CEO pay nearly doubled the growth level of the stock market which rose 503.4 percent over the 36 year period.

This unequal growth in wages means that an average top CEO (in the nation's 350 largest firms) now makes $303 for every dollar that average workers make.  This is down from a peak of $376.10 in 2000 but up from $195.80 in 2009 and way up from a CEO-to-worker compensation ratio of only 20 to 1 in 1965.  Since the Great Recession ended, CEOs have seen their compensation rise by 54.3 percent whereas this is what has happened to real compensation in the work-a-day world:

If not for the increases in the fourth quarter of 2014 and first quarter of 2015, working Americans would have experienced zero net increase in their wages after inflation for the first five years after the Great Recession officially ended.

In case you cared, here is a bar graph that shows how real CEO compensation grew between 2013 and 2014 by pay fifth (quintile):

CEO pay grew the most in the bottom and second from the bottom quintile. 

Even if we compare CEO compensation to other highly paid workers who are earning more than 99.9 percent of all other wage earners, CEOs come off looking pretty good (from their perspective at least).  CEO compensation in 2013 was 5.84 times greater than the top 0.1 percent of wage earners, 2.66 percentage points higher than the 3.18 average ratio that prevailed between 1947 and 1979.  This suggests that CEO compensation growth does not simply reflect the increased value of highly paid executives (i.e. that CEO pay does not reflect the greater productivity of CEOs), rather, it suggests that CEOs (and Boards of Directors) have significant power to extract compensation concessions.  This is more apparent to shareholders now since corporations have been forced to inform shareholders of the logic behind their CEO compensation decisions in their annual reports because of the Dodd-Frank Act of 2010.  In these reports, we generally find that Company A is comparing the compensation packages of its Named Executive Officers to those of Companies B, C, D, E etcetera.  With one company basing its NEO compensation on other like-minded companies, we can easily see how executive compensation levels have risen at what can only be termed extravagant levels.

The fact that, in 2010, an average S&P 500 CEO received annual compensation that was roughly 200 times the median household income in the United States in that year may have something to do with our perception that, even though there are jobs, we aren't being compensated fairly.  Increases in compensation have not broadened throughout the economy, rather, significant increases in compensation are restricted to a very elite group of men (mainly) and women that reside in upper floor corner offices, a change that has left the vast majority of Americans falling further and further behind the real cost of living.

How Equity-based Compensation Misaligns the Interests of Shareholders and Management

Updated December 2016

In today's corporate world, most of us are aware that executive compensation has grown astronomically over the past two decades with most of the growth coming in the form of either stock options or bonus schemes that involve equities.  While the alleged reason that companies took this route was to "better align management interests with those of their shareholders", in fact, what it has done is significantly enrich a very select group of people.  Not only has the increased use of stock-based compensation become pervasive, the issuance of stock has been manipulated to increase the netback to executives.

Unlike most studies which look at how companies time the granting of options, a recent study by the European Corporate Governance Institute looks at how corporations/CEOs strategically time the release of discretionary corporate news to coincide with the months in which the equity portion of their overall compensation package vests.  The study looks at how prevalent this practice has become in two ways:

1.) a CEO who intends to sell stock in a given month that delays certain news releases until the month of vesting is reached.

2.) a CEO who intends to sell stock in a given month that accelerates certain news releases until the month of vesting is reached.

Obviously, corporations need to release information to the investing public to assist investors in making decisions about both buying and selling a stock, decisions that can have a significant positive or negative impact on a share price.  News releases can also be used to attract investor attention which can result in temporary share price appreciation.  By releasing news, ideally, the playing field for all investors is "levelled".

For those of you that aren't aware, stock-based compensation is generally not immediately available to recipients.  For example, in the case of stock options, a certain number of options will be granted and on each one-year anniversary date, a percentage of those options will vest, allowing the option holder to buy the stock at the option price and then sell the shares (presumably at a profit), pocketing the difference between the option strike price and the current trading price of the share.  In some cases, options vest over a three-year or five-year period, meaning that on the first, second, third, fourth or fifth anniversary date, one-third or one-fifth of the total volume of shares granted will vest.    Critical to the analysis, the authors found that CEOs are 23 percent more likely to sell an equity shortly after it vests.  This means that the schedule of vesting leads to equity sales which are closely linked to short-term price concerns.   

The authors used a database that ranged through the years from 2006 to 2011.  They used a database that allowed them to divide news releases taken from over 20,000 public news sources into two types:

1.) discretionary news:  this news is released at the discretion of the CEO and includes things like client and product announcements, special dividends, impairments and write-offs, IPOs, share buybacks etcetera.  Changing the timing of discretionary news is legal

2.) non-discretionary news:  this news is released on a fixed schedule and includes things like quarterly and annual earnings, board meetings, annual general meetings etcetera.

News items are included only if they are sourced from within the corporation and are ignored if they are sourced by the media covering stock market activity.  In months where corporations release news, a typical company has an average of 4 news releases, three of which are discretionary.  Over an entire year, when months with no news releases are included, a typical company releases 1.8 news items per month, 1.5 of which are discretionary.  A median discretionary media article contains 23 percent positive words, 32 percent negative words and 16 percent neutral words.  In vesting months, discretionary news releases have significantly more positive words and fewer neutral words.  Firms also release less discretionary news one month before and one month after the vesting month which suggests that CEOs are either delaying or accelerating the release of discretionary news.

The authors also examined the content of the news releases, looking to see whether the tone of discretionary news changes during vesting months.

Now, let's get to the author's findings.

The analysis shows:

1.)  that an average CEO equity sale represents 6.2 percent of the average daily trading volume and represents 0.165 percent of shares outstanding.  

2.) that the disclosure of one discretionary news item in a vesting month generates a 16-day abnormal return of 28 basis points (0.28 percent).

3.) that on the first day after a discretionary news release, abnormal trading rises by 0.32 percent of outstanding shares.

4.) that the median interval between a discretionary disclosure in a vesting month and the first equity sale by a CEO is five days and the median interval until the CEO sells the entire vesting amount is 7 days.  More than 50 percent of CEOs sell stock in the vesting month and in 17 percent of cases, the CEO sells all of the equity in the vesting month.  CEOs are 23 percent more likely to see shares in a month in which stock vests than in a month in which no stock vests.  All of this suggests that CEOs are concerned about short-term stock price fluctuations.

Here is a bar graph which shows the number of days between discretionary and non-discretionary news releases and CEO equity sales:

This quite clearly shows that discretionary news has a significant impact on the timing of CEO equity sales whereas non-discretionary news has almost no impact.

In conclusion, this research shows that CEOs strategically time the disclosure of discretionary news so that it coincides with the vesting date of their stock-based compensation and that these news releases have a strong tendency to have a positive tone.  These positive news releases lead to temporary increases in equity prices which CEOs exploit, with a median CEO selling all of the vesting equity within 7 days of a discretionary news release in a vesting month.  The study also gives us a sense that the equity market playing field is far from level and that corporations have done whatever possible to misalign the interests of management and shareholders.

Corporate America: CEO Compensation versus Corporate Taxes

The Center for Effective Government and the Institute for Policy Studies have released a rather interesting report, "Fleecing Uncle Sam", a look at Corporate America (remember, it's a person too) and how a growing number of corporations render less to the federal taxman than they pay their executives.  Here are a few of the highlights, starting with a summary of the results.

1.) Of America's 30 biggest corporations, seven pay their CEOs more than they remitted in federal income taxes in 2013.  In total, these companies reported more than $74 billion in pre-tax profits but, through provisions in the current tax code, they were able to get a total refund from the IRS of $1.9 billion.  This resulted in a tax rate of negative 2.5 percent.

2.) On average, the seven aforementioned CEOs were paid $17.3 million in 2013.

3.) Of the 100 highest paid CEOs in America in 2013, 29 received more pay than their company paid in federal taxes in 2013.  On average, these CEO's made an average of $32 million in 2013 at the same time as their corporations earned $24 billion in pre-tax profits and received $238 million in tax refunds, paying an average effective tax rate of negative 1 percent.

4.) Combined, the 29 companies operate 237 subsidiaries in tax havens with the largest number being owned by Abbott Laboratories who had 79 tax haven subsidiaries.

5.) Of the 29 companies, the company that received the largest tax refund was Citigroup which received an IRS refund of $260 million in 2013 at the same time as they paid their CEO $18 million.

6.) The average CEO pay among those working at companies that paid its CEO more than it remitted to the IRS has grown from $16.7 million in 2010 to $20.6 million in 2011 to $32 million in 2013.

To help us put the following posting into perspective for those of us who don't work in the corner office, here is a graph from FRED showing the labor share (i.e the sweat share) of income:

It's quite obvious that labor's share of income has declined to a multi-decade low as a share of total income earned in the United States, largely because of changes in technology, increased globalization and trade openness.  This has been one of the chief causes of income inequality in the United States as top households earn an ever-increasing share of total household income.

Let's go back to the "Fleecing Uncle Sam" report.  Corporations in the United States are quite happy to complain about the 35 percent headline corporate tax rate; it makes them uncompetitive, it's the highest in the industrial world and so on ad nauseous.  In fact, the average corporate tax rate paid by the largest corporations in the United States between 2008 and 2012 is just 19.4 percent.  As shown on this graph, even though after-tax corporate profits set a new record in 2013 of $1.842 trillion as shown here:

...and corporate taxes are still below levels seen before the Great Recession as shown here:

  

...apparently, there's still plenty of room to complain.  In this time of both high underemployment and high levels of discouraged, unemployed workers who are no longer part of the "system", rather than investing their profits in creating more jobs, Corporate America has chosen to buy back shares and increased yields.  According to this study, between 2003 and 2012, companies used 54 percent of their earnings to buy back stock on the open market.  An additional 37 percent of earnings were used to pay dividends, leaving a rather insignificant 9 percent of profits available for job creation and higher levels of compensation for employees.

Let's get to the meat of the matter, who's getting paid more than the IRS?  Here is a chart showing the seven companies among the 30 largest in the U.S. that paid their CEOs more than they remitted in federal income taxes:

Let's look at Boeing for a moment.  Boeing is one of the federal government's top contractors, receiving $20 billion in contracts in fiscal 2013 and an additional $603 million in subsidies over the years from 2008 to 2012 to pay for the company's R and D costs.  In fact, the Export-Import Bank, an 80 year-old federal institution that helps American companies sell their goods and services overseas by guaranteeing loans, among other things, provided Boeing with loan-guarantees in fiscal 2013 that totalled 65 percent of all loan guarantees made by the Ex-Im Bank, to help the manufacturer sell 106 of its planes to foreign airlines.  This has resulted in the Ex-Im Bank being referred to as the "Bank of Boeing".  In 2013, Boeing made $5.946 billion in profits, was handed a federal tax refund of $82 million which resulted in a negative effective tax rate of 1.4 percent at the same time as they paid the company's CEO, W. James McNercy, Jr. total compensation of $23.3 million.  From Boeing's 2013 Proxy Statement, here is a breakdown of his compensation for 2013 and the two previous years:

Here is a further breakdown of his total non-equity incentive plan compensation for 2013 and previous years:

On top of all of this, here is a breakdown of his "other compensation" for 2013:

His "other personal benefits" included $305,382 for the use of the company aircraft for personal travel, $67,755 for personal use of company aircraft associated with attendance at outside board meetings, $51,728 for personal use of ground transportation services, $43,775 for tax preparation and planning services and $26,000 in gift matching donations.

If all seven of the top thirty corporations in the United States that paid their CEOs more than they remitted in federal income taxes paid tax at the 35 percent headline corporate tax rate, instead of getting $1.893 billion in refunds, they would have paid $25.9 billion in federal taxes, a total difference of $27.8 billion.  According to the report, this would have paid for:

1.) the resurfacing of 22,240 miles of four lane highway or nearly half of the U.S. interstate highway system.

2.) running the Department of Veterans Affairs for two months.

3.) hiring an additional 370,667 teachers at a salary of $75,000 each including benefits.

And Washington wonders why there's anger in the streets and avenues of Main Street U.S.A.