CEO pay is getting out of hand

Rick Hanton

It was back in the eighth grade that I first started investing in the stock market for fun and profit. I’ve always been interested in making money in whatever way I can. After doing chores for my parents for years, I accumulated a hefty sum in my savings account, but some articles I read revealed that I could earn more in CDs — certificates of deposit, not compact disks — or in the stock market with my cash than the few pennies the bank paid me to hold onto it. So, after working for a year or so on my strategy and following stock prices in the paper, I told my dad that I wanted to play the market.

He set up an account for me — being far under 18, I couldn’t have my own account — and I made my first investment in a corporate giant, the Target Corporation. I felt that I did pretty well, eventually netting about a 50 percent gain on my investment during high school. By that time I was invested in more companies, and over the years I have owned a small piece of more than 20 companies, sharing in their gains and losses.

But, while I have made gains from the market, I have also shared angst with my fellow investors over the increasing levels of CEO pay over the last decade. Paying the executive of a corporation massive amounts of money is not a new thing — just ask the railroad barons of the late 1800s, many of whom were worth the equivalent of billions today at the time of their deaths.

But, after a crackdown on the railroads in the early 1900s and following the use of very high income taxes on the income of the richest CEOs, average executive pay dropped to about $500,000 per year for most of the 20th century. A number of decades ago when executives paid about 90 percent of their earnings in taxes, executive pay only increased about 0.8 percent per year, even when their companies were growing enormously.

Those rates rose when executives were able to move more pay into pay incentives with lower tax rates and kept climbing until average year-over-year executive pay raises reached about 10 percent during the 1990s. Now for those of you that don’t know the joys of compound interest, now is the time to learn. A 10-percent-per-year increase in pay means that a CEO who starts off being paid $2 million per year is paid $2.2 million one year later, $3.22 million five years later and $5.2 million 10 years later. In the short run this isn’t too bad, but in the long run it gets ridiculous — pay reaches $13.5 million in 20 years, $34.9 million in 30 years.

Comparatively, if pay increases were instead kept at the high average inflation rate estimate of 3 percent, the $2 million in pay would only reach $2.7 million in 10 years, $3.6 million in 20 years, or $4.9 million in 30 years. That’s very reasonable when you note that in this situation, $2 million today would be equivalent to a value between $3.6 and $4.9 million 30 years later if inflation remains approximately constant. On the other hand, on the 10-percent plan, the $34.9 million earned during year 30 means that at 2 to 3 percent inflation, the CEO makes seven times more money — with inflation factored in — during year 30 than he or she did that first year.

So that means that the CEO must be doing a 7 percent better job each year to be earning 7 percent more money above the rate of inflation each year. Otherwise, why would he or she be paid so much more for running the company?

The problem is that this is not the case. CEOs are not making more money because they are doing a spectacular job. Just look at the CEOs who dug the big Wall Street banks into such a ditch during recent years. As the government bailed out the banks, these CEOs still took home millions of dollars in pay and incentives. We wouldn’t want them to have to sell one of their beachfront properties, would we?

The real problem is the corporate boards are generally the ones to vote on executive pay packages. But, who is on these boards? Investors of course, but many of these investors are CEOs of other corporations, meaning that it is in their best interest to keep executive pay packages as large as possible, as long as the company’s CEO is not paid so well that they are incentivized to do something stupid with the board’s investments that reside in that company. The high pay at the company, where they sit on the board, will help build the case to the board member’s own corporate board that he or she needs higher pay as well. This is the endless cycle that the Fortune 500 is caught in.

Investors across the country are unhappy, but are able to do little about the situation besides band together to try to force companies to adopt measures that let individual investors vote to show their approval or disapproval of executive pay at yearly meetings. These measures are generally not supported by some of the biggest investors in the companies, so few have been enacted, but the government has expressed interest in mandating these “say-on-pay” measures for all U.S. corporations.

My problem in the end revolves around the question of “what you do with all the money when you make millions of dollars per year?” Do you just buy bigger and fancier yachts like Paul Allen or Roman Abramovich? Do you spend millions donating to charity — and is that more effective than the government spending your millions? Maybe you spend a few million putting your name on a building at a university like ours.

My point is that I think that CEOs like Gregory B. Maffei of Liberty Media, who earned $87 million last year, could probably survive on $1 million or maybe $500,000 per year. If he did so, perhaps he could afford to pay each of the company’s 22,000 employees $4,000 more per year to help them out in this tough economy. He might not be able to use as many private airplanes, or have as many yachts and second homes as he used to, but I’m sure he would survive just fine.

So what do you think? Should well-paid CEOs take a pay cut? Write to the Daily and tell us what you think.