Why We Need to Limit Executive Compensation

The cancer of excessive CEO pay is at the core of America's economic woes, and it demands government attention

By Leo Hindery Jr.

Confronted with the daunting array of economic failures confronting the nation, it may seem improbable for me to say that excessive executive compensation is one of the issues needing the early attention of the next President and next Congress. Yes this particular cancer—which has been growing exponentially for almost two decades—is at the core of many of our nation's economic ills.

And it is a cancer that the average worker finally understands. During the worst days of the recent stock-market, bank, and credit-market upheaval, a raw nerve was struck on Main Street when workers generally became aware, many for the first time, of the huge salaries being earned on Wall Street and on other streets far removed from Main Street.

Wherever earned, excessive executive and CEO compensation, simply by being "excessive," belies the principles of a meritocracy, which is what corporations should be. Managers rise to something akin to royalty when their compensation is at unjustified levels and when the rewards of employment are not more commonly and fairly shared with the general employee base.

Primacy of Profits

Way back on Sept. 13, 1970, just as I was starting my second year at Stanford Business School, Milton Friedman authored his seminal opinion piece in The New York Times entitled "The Social Responsibility of Business is to Increase Its Profits." But unlike many of Friedman's other writings, this particular opinion piece was only modestly embraced, and was embraced by almost no one credible.

In fact, from the end of World War II until the mid 1990s, prominent public and private company CEOs almost universally viewed their responsibilities as being equally split among shareholders, employees, customers, and the nation. This broad sense of corporate responsibility was actually so widely and comfortably held that in 1981, the Business Roundtable, which is the key public policy arm of the nation's largest public companies and their CEOs, officially endorsed a policy that said that shareholder returns had to be balanced against other considerations.

However, just as the Business Roundtable was making its policy statement, the deregulation and laissez-faire era that was born in the Reagan Administration was starting to chip away at the statement's core contention. And by 2004—even after many of the myriad scandals and outright thefts that have hallmarked the last decade of American business had already come to light—the Roundtable amended its position. It said, just as Friedman did in 1970, that the job of business is only to maximize the wealth of shareholders. And at that point, because of the prevalence of stock option and restricted stock grants, shareholders included many if not most senior managers at a large number of publicly traded companies.

And this narrow single-mindedness has taken Corporate America down a very bad path that has resulted in executive compensation that is truly excessive.

For most of the past century, CEOs earned roughly 20 times as much as the average employee, according to the Economic Policy Institute, as quoted in The New York Times on Dec. 18, 2005, and again on Jan. 1, 2006. And also for much of the past century, there was nothing like the excesses within the financial industry that we see today, which enable its managers to earn almost obscene levels of compensation—and then get favorable income tax treatment to boot.

Frothy Trough

Today, however, average public company CEO compensation is 400 times that of the average employee. And thousands of senior managers in addition to CEOs are drinking at the same frothy trough, especially, as we have all just seen, senior managers in the financial services industry. (By contrast, the ratio of CEO pay to that of the average employee has remained around 22 in Britain, 20 in Canada, and 11 in Japan.) And with such U.S. exalted compensation, management has so elevated itself above average employees as to have become, in my opinion, a constituency unto itself—and one that, to compound the inequity, largely sets its own compensation.