US chief executives still cashing in

Browse the proxy statements of the nation's largest corporations and you'll find the instruction manuals for this apparatus explaining how to finely calibrate the pay of top executives with company performance.

The Coca-Cola board, for example, lays out the formula that set the 2013 cash bonus for Muhtar Kent, its chief executive (base salary x base salary factor x business performance factor). It explains how a failure to achieve certain goals helped limit the bonus to $US2 million ($2.1 million), but also describes how Mr. Kent got millions more in stock and options. It notes that under his leadership, Coke had "continued to gain value share globally in nonalcoholic ready-to-drink beverages," and tells shareholders why the board might require him to fly on the company jet ("to allow travel time to be used productively for the Company"). What was all that worth? A tidy $US18 million.

But putting aside whether those particular metrics for aligning pay with performance make sense, the elegant machine itself would seem to have a dark side. Some say, in fact, that it is the main engine of inequality in America today.

The current system of executive compensation, with its emphasis on performance, can theoretically constrain pay, but in practice it has not stopped companies from paying their top executives more and more. The median compensation of a chief executive in 2013 was $US13.9 million, up 9 per cent from 2012, according the Equilar 100 CEO Pay Study, conducted for The New York Times. The 100 CEOs in the survey took home a combined $US1.5 billion last year, a slight rise from 2012. And the pay-for-performance metrics — particularly the idea of paying executives with stock to align their interests with shareholders — may even have amplified that trend. In some ways, the corporate meritocrat has become a new class of aristocrat.

Economists have long known that high executive pay has contributed to the widening gap between the very rich and everyone else. But the role of executive compensation may be far larger than previously realized.

In "Capital in the 21st Century," (Belknap Press), a new best seller that is the talk of economics circles, Thomas Piketty of the Paris School of Economics makes a staggering observation. His numbers show that two-thirds of the increase in American income inequality over the last four decades can be attributed to a steep rise in wages among the highest earners in society. This, of course, means people like the CEOs in the Equilar survey, but also includes a broader class of highly paid executives. Mr. Piketty calls them "supermanagers" earning "supersalaries."

"The system is pretty much out of control in many ways," he said in an interview.

This is not to say that boards always bow to CEOs; some boards will swat executives who fail to meet their metrics. Among CEOs of the 100 largest companies (by revenue) that had filed proxies by April 4, some 26 had been given a pay cut, according to Equilar, an executive compensation data firm. One was Mr. Kent of Coca-Cola, who took a 16 per cent cut and may not ultimately get all of his 2013 award if targets aren't met. But even if they made less money, chief executives were making extraordinary sums. Some received substantial raises: David N. Farr, the CEO of Emerson Electric, the industrial giant, took home $US25.3 million, up 264 per cent from 2012. (Mr. Farr got most of his pay, $US21.6 million, in stock.) Mark Polzin, an Emerson spokesman, said that if the company is doing well, the structure of the package might cause a spike in Mr. Farr's pay every few years.

The stocks of many companies posted robust performance in 2013, which could also help drive CEO pay higher.

The pay of John T. Chambers, the long-serving chief executive of Cisco Systems, jumped 80 per cent, to $US21 million, most of it in stock. The strong returns on Cisco's shares — up 63 per cent during the company's 2013 fiscal year — played a substantial role in determining his raise.

Rupert Murdoch of 21st Century Fox made $US26.1 million for the 2013 fiscal year, during which his company's stock rose 46 per cent. Disney's shares didn't fare quite as well, gaining 23 per cent, and its chief executive, Robert A. Iger, was given a 7 per cent pay cut. Still, he made $US34.3 million, the second-highest total in the survey. Zenia Mucha, a Disney spokeswoman, said in an email that 93 per cent of Mr. Iger's compensation was based on performance.

(Many large companies had not filed proxies by the April 4 survey deadline, including CBS, which filed last week. The CBS chief executive, Leslie Moonves, made more than $US65 million in 2013, according to the filings.

Wall Street executives are still royally rewarded, but the CEOs of financial firms did not often figure in the upper echelons of the pay survey. Lloyd C. Blankfein of Goldman Sachs, who made nearly $US20 million, was the highest-paid chief executive at a regulated Wall Street firm. But Mr. Blankfein's compensation was a mere fraction of some of his peers' in the so-called shadow-banking sector, where regulation is much lighter. Publicly tradedprivate equity firms like Blackstone and Apollo Global Management were not included on the list because their revenue was too low, but their chief executives made a fortune last year. Leon D. Black of Apollo earned more than a half-billion dollars in 2013, according to data in company filings, though that included income that would not have been counted in Equilar's survey.

Of the 100 executives on the Equilar list, only nine were women. The highest-paid, Phebe N. Novakovic of General Dynamics, earned $US18.8 million, an amount that placed her behind 20 men in the ranking.

The two lowest-paid executives in the survey were Warren E. Buffett of Berkshire Hathaway and Larry Page of Google — with Mr. Page earning a symbolic $US1. But they aren't hurting financially: Both are founders and own stakes in their companies that are worth many billions.

No Perfect Incentives

Executive pay has undergone many changes in recent years to make it more shareholder-friendly. As well as including a plethora of performance metrics, proxies have become more transparent and easier to understand. And shareholders have been given ways to express dissatisfaction over compensation in "say on pay" votes.

"We have pay for performance as we've designed it," said James E. Kim, a managing director at Frederic W. Cooke, a compensation consulting firm. "And it is much better than it was when I started in the business 15 years ago."

But to some skeptics, the new metrics have become an elaborate means to rationalize excessive pay. "The problem with the pay-for-performance approach is that it is simply impossible to create perfect incentives," Lynn Stout, a law professor at Cornell and a critic of the current compensation system. "And if you try, you may in fact create bad incentives."

Ms. Stout places much blame on a crucial tax-code change made in the early 1990s. The rule eliminated tax deductions on compensation above $US1 million that wasn't linked to performance. The change, she said, helped prompt widespread use of pay-for-performance metrics. But as that trend grew, pay kept climbing even when shareholder returns suffered.

"I think it's fair to say that the experiment has failed," Ms. Stout said.

Stock-based compensation — options and shares combined — has risen as a per centage of overall pay in recent years. It was 63 per cent of the total in 2013, up from 60.2 per cent in 2006, according to Equilar. This is meant to be a good thing: Paying in stock can motivate executives to get the share price higher, which, of course, will benefit shareholders.

But as corporate boards place their faith in stock-based plans, they may decide to award even more stock, and when the market is rising, that can lead to enormous paydays when executives eventually cash out. The compensation apparatus, despite its checks and balances, ends up pushing pay ever higher.

"It has always been difficult for shareholders to properly control their managers," Mr. Piketty, the economist, said. "I am not sure that has changed much."

Government policy makers can continue to leave the pay machine alone, in the belief that they should do little to influence the rules of business. But that stance may be harder to maintain if executive pay continues to be the main cause of income inequality, as Mr. Piketty says.

In 1960, the top 10 per cent of earners in the United States took in 33.5 per cent of all income, which includes wages and investment returns, according to data in Mr. Piketty's book that is derived from decades of income tax records. By 2010, that share had risen to 47.9 per cent. Higher wages were behind two-thirds of that increase, according to his data. Mr. Piketty says that a ballooning of senior executive pay can explain a large proportion of that wage climb.

One remedy might be to extend potentially attractive stock and options awards deeper into the ranks. That already happens at some technology companies, but is not as widespread in companies with lower-paid work forces.

Coca-Cola's new stock plan, for instance, is available to only 5 per cent of its work force, a point raised by a critic of the company's compensation, David J. Winters of Wintergreen Advisers, an investment firm. "That's worrisome," he said. "You want people who are motivated and you don't want people who resent the top people."

In response, Gloria K. Bowden, a Coca-Cola associate general counsel, said, "This plan covers a large number of employees — 6,400 employees, currently — and it's just one method we have to provide stock ownership to employees." The company, for instance, encourages stock ownership through its 401(k) plans.

Some rank-and-file employees aren't interested in gambling on the upside of stock. They would just like to be paid more in cash. One is Charles Jordan, a longtime part-time worker for United Parcel Service at a depot in the Bronx, and a shop steward for the Teamsters union. UPS's chief executive, D. Scott Davis, earned $US10.3 million last year.

"I don't think there is anyone who's doing a job that's worth that amount," said Mr. Jordan, who favors more profit-sharing for workers. "The business structures in this country have just got to change so there is more profit-sharing."Andy McGowan, a spokesman for UPS, said that "we are 107 years old and we've always been a pay-for-performance company."

In coming months, a new corporate disclosure could add fuel to the debate over executive pay and inequality. In 2010, as part of the Dodd-Frank Act, Congress passed a rule that requires public companies to disclose the ratio of the CEO's pay to the median compensation at the firm. The main objective was to give shareholders a yardstick for comparing pay practices across companies, said Senator Robert Menendez, Democrat of New Jersey, who sponsored the provision.

But he acknowledged that the ratio could serve another function. "Productivity can't come from the person at the top of the pyramid alone," Mr. Menendez said. "You want a well-compensated work force to bring productivity and the execution to improve the bottom line."

The ratio has plenty of opponents in corporate America, who argue that it will be expensive to calculate and won't provide useful insight into how companies are really paying workers. Even some people who are skeptical about the status quo don't like it, including Ms. Stout at Cornell. She suggested an alternative ratio that would compare the chief executive's pay to the federal minimum wage, a number that would not cost companies anything to calculate. It could also serve another function: She proposes eliminating any tax deductibility for executive compensation that is more than 100 times the minimum wage. "It is simple and sweet," she said.

Mr. Piketty favors a measure that has a bit more tang.

He supports a substantially higher tax rate for top earners. And while he acknowledges that this is an imperfect tool, he rejects the argument that such a tax could dent the morale of executives and cause their companies to underperform.

"It is possible to find hard-working managers who are willing to be paid 20 times the average wage at their company rather than 100 to 200 times," he said.

The fact that Congress is highly unlikely to approve a higher tax rate anytime soon does not discourage Mr. Piketty.

"Things," he said, "can change faster than we think."

The New York Times