Friday, August 21, 2015

The hypocrisy of executive pay

Listen to any CEO and they'll tell you that if you keep CEO pay high, you'll attract top talent and get better performance. Unfortunately the same CEO will also tell you that "good help is hard to find", yet they will never tell you that employees perform better with less pay.

This 2009 study from the Wall Street Journal shows a very clear negative relationship between CEO pay and performance. Here is the abstract of that report:
We find evidence that industry and size adjusted CEO pay is negatively related to future
shareholder wealth changes for periods up to five years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs. 
So the top 10% saw a negative return of company performance of 13%? That doesn't correlate with the line that top CEO pay attracts top CEO talent.

The report goes on to say that investors often are not privy to all of the terms of the contract and therefore cannot see all of the effects of the contract. In sum, there is almost zero expectation of transparency in CEO compensation packages, preventing shareholders from determining the fair value of the contract with the CEO. The lack of transparency also allows the CEO to extracts rents from the shareholders, a fancy way of saying they steal from the shareholders.

So top tier CEO compensation doesn't correspond with performance. How about employees? Do employees perform better with a raise? There is anecdotal evidence and some studies to suggest they do, but it's more than just pay. The question seems to turn on attitudes. Does management see employees as costs or drivers of growth?

If you work at Costco, you're a driver of growth and you contribute to the bottom line. Management invests in your value as an employee with education, training, and other benefits. If you work at WalMart, well, not so much. At WalMart, you're just a liability with costs externalized to the state. Who makes a better profit? The company with happier employees empowered to do their jobs.

CEOs will often complain that good help is hard to find. They say that there is a skills gap. That there are not enough qualified people to do the job they are seeking to fill. Noted economist Dean Baker had this to say in 2012:
[I]f there is a shortage of qualified workers then we should expect to see rapidly rising wages. The point here is straight-forward. If an employer wants to hire qualified workers and can’t get them by offering the current wage, then she offers a higher wage in the hope of luring qualified workers away from competitors. This is a simple example of “supply and demand.” If demand exceeds supply in typical free markets, then the price of the item should rise. In this case, an insufficient supply should mean that the wages of manufacturing workers is rising rapidly.
That was back in 2012 4 years after the bottom of the recession. Wages are still flat now as they were then. What this means is that if there is a skills gap, it has almost nothing to do with the lack of skills. Anyone familiar with the travails of the STEM crowd know that having a post-graduate degree in science, technology, engineering or mathematics, will not guarantee a good paying job. What that means is that when employers complain of a skills gap, it means that they are not willing to pay enough money to fill the job.

To put it bluntly, management often would rather support the bloated pay of the C-class with lower employee pay than to pay more money for employees that can fill the jobs and perform well. As companies like Costco and Trader Joe's have shown us, companies that pay more have happier employees and contribute to the bottom line.

Baker also offers the following point in his report:
[W]e should not be blaming the workers [for the skills gap]. It is always good for people to have more skills so that they can be more productive wherever they work, but the data do not suggest that the reason so many people are out of work is because they lack skills. Instead, the real reason that they are out of work is that our policy makers have not done what’s needed to create enough jobs.
The lack of demand for labor is a feature not a bug. The lack of demand for labor is a result of public policy that is written by the 1% for the 1%. The primary purpose of public policy has been, for at least the last 40 years, engineering the economy so that it will support bloated CEO pay rather than higher wages for the working class.

What can we do about this condition? First, we can vote and vote progressive. Studies have shown that a lack of voter participation can lead to inequality. Second, we can support progressive candidates for office like Bernie Sanders and Elizabeth Warren. There is hope, but to hope without taking any action is futile.

Action is the magic word, for when we change our behavior, our political and economic adversaries will have no other option but to change their behavior.
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