Wednesday, June 19, 2013

CEO Pay and Growing Income Inequality in America

As a shareholder in a wide variety of companies, both Canadian and American, I'm well aware that it is annual meeting time for the majority of corporations.  I generally like to punish myself by taking a few minutes to read through the material, particularly the executive compensation section of the Proxy Statement.  As someone who spent nearly three decades in private industry, I can recall when being a senior executive was a job that was worthy of an elevated salary and a handful of perquisites, but I also remember thinking that the person in the corner office certainly wasn't making obscene fistfuls of cash for his/her efforts.  Such is no longer the case.

A report by the Economic Policy Institute examines how income inequality has been driven by both executive compensation levels and pay in the financial sector.  The report looks at the role of both executives and the financial sector in income growth of the top 1 percent and 0.1 percent of earners between 1979 and 2007.

Between 1979 and 2007:

1.) The average annual earnings of the top 1 percent of wage earners grew by 156 percent.

2.) The average annual earnings of the top 0.1 percent of wage earners grew by 362 percent.

3.) The average annual earnings of the 90th to 95 percentile of wage earners grew by 34 percent.

4.) The average annual earnings of the bottom 90 percent (i.e. the vast majority of Americans (and Canadians for that matter)) grew by 17 percent.

In 2007, this led to the average annual incomes of the top 1 percent of American households being 42 times greater than the income of the bottom 90 percent, up from 14 times in 1979.  The 2007 average annual income of the top 0.1 percent of American households was 220 times greater than the bottom 90 percent, up from 47 times in 1979.

Who is getting all of this money?  Executives and workers in finance accounted for 58 percent of the expansion of income in the top 1 percent and 67 percent of the increase in the top 0.1 percent from 1979 to 2005.  CEOs, on the other hand, saw their compensation rise by a stunning 725 percent between 1978 and 2011.  Just in case you care, over the same time period, workers saw their compensation "rise" by 5.7 percent.

Here is a table summarizing EPI's analysis:

The total share of all American household income earned by the top 1 percent more than doubled from 9.7 percent in 1979 to 21 percent in 2005.  Income increases at the top of the social heap were driven by households that were headed by either an executive or in the financial sector.  Together, both of these groups accounted for 58 percent of the growth in income for the top 1.0 percent of households.

Let's look at several decades of data on CEO earnings from the top 350 firms as ranked by sales and compare their earnings to those of the relatively sweaty masses in a bit more detail and compare this to the changes in the level of S&P 500 and the Dow Jones:

Options realized compensation includes salary, bonuses, restricted stock, options exercised and long-term incentives.  Options granted includes all of the above excluding options exercised and includes options granted.

CEO compensation when measured against worker compensation grew by leaps and bounds in the late-1990s when it hit a peak 383.4 times (options realized).  The level fell back during the later part of the first decade of the new millennium as the stock market imploded, however, it fell to a level of "only" 193.2 times, still 3.3 times the level as late as 1989 and nearly 10 times the level in the early 1970s as shown on this graph:

If we look at the bottom part of the second chart, we see that, over the period between 1978 and 2011, the CEO-to-worker compensation ratio was a whopping 182.9 times, down from its peak of 384.9 times between 1978 and 2000 but still, overly healthy.  The divergence between worker pay and CEO pay over the nearly four decade period is both stunning and nauseating.  The only factor that has kept CEO compensation from rising continuously over the past decade is that a hefty portion of their pay relies on the gains made from their stock options which have generally not been stellar performers since the beginning of the Great Recession.

As an aside, here is a graph showing the Gini Ratio for American households since 1965:

As the Gini ratio rises, household income inequality rises; if income distribution was equal, the Gini ratio would be zero.  With the data from this posting in mind, the rising Gini ratio in the United States should not be a shock to anyone.

I find that I get more than a little perturbed when I read through the Executive Compensation Committee reports in Proxy Statements.  Now I know why.  Sure, corporations have to pay attractive levels of compensation to attract and retain good corner office material.  Unfortunately, many corporate leaders seem to forget that the fortunes of the company that they head don't just rise on their efforts alone.  Without all of those poorly compensated schlubs working hard for them, their personal efforts would mean relatively little.

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