The Advisors' Blog

– Broc Romanek, CompensationStandards.com

Cydney Posner of Cooley recently wrote this alert::

You might be interested in this Special Report from the Washington Post entitled “Breakaway Wealth.” Although it’s been known for quite some time that the gap between rich and poor has been widening in the U.S., what accounted for the spectacular increase was not well known. The speculation was that most of it was going to folks like LeBron, Shaquille and Brangelina. Not so, according to a number of recent studies cited in the Post’s Report. Recent significant research into this topic attributes a substantial component of the rising income disparity to hikes in executive pay: “The largest single chunk of the highest-income earners, it turns out, are executives and other managers in firms, according to a landmark analysis of tax returns by economists Jon Bakija, Adam Cole and Bradley T. Heim. These are not just executives from Wall Street, either, but from companies in even relatively mundane fields such as the milk business.”

According to the Report, 41% of the top 0.1% of earners -those making about $1.7 million or more, including capital gains — were executives, managers and supervisors at non-financial companies, and an additional 18% were managers at financial firms or financial professionals at other firms. In total, almost 60% of all top 0.1% of earners were one of those two categories. It turns out that pay for media and sports figures represented only 3% of the total, hardly the significant proportion of very high-income earners that many believed.

Other recent research highlights the data underlying the growth in income disparity. This data shows that executive compensation at the nation’s largest firms has roughly quadrupled in real terms since the 1970s, while pay for the remaining 90% has remained flat or even declined. Anecdotally, the Post reports that, for one milk producer, “[o]ver the period from the ’70s until today, while pay for [the company’s] chief executives was rising 10 times over, wages for the unionized workers actually declined slightly. The hourly wage rate for the people who process, pasteurize and package the milk at the company’s dairies declined by 9 percent in real terms, according to union contract records. It is now about $23 an hour.”

The statistics show that in 1975, the top 0.1% of earners — roughly 140,000 earners — earned about 2.5% of U.S. income, including capital gains, according to data collected by UC economist Emmanuel Saez. By 2008, the top 0.1% earned 10.4%, more than four times the percentage in 1975. Over the same period, the share earned by the top 0.01% — representing about 15,000 families — rose from 0.85% to 5.03%, approximately $27M each on average. According to the Post, that data puts the U.S. in league, not with Europe, the UK and other developed countries, but rather with countries like Cameroon, Ivory Coast, Uganda and Jamaica.

Some commentators have attributed the rise in executive pay to the increase in the size and complexity of companies. However, the Post reports, recent research by economists from MIT and the Federal Reserve shows “that while executive pay at the largest U.S. companies was relatively flat in the ’50s and ’60s, it began a rapid ascent sometime in the ’70s.

“As it happens, this was about the same time that income inequality began to widen in the United States, according to the Saez figures. “More importantly, however, the finding that executive pay was flat in the ’50s and ’60s, when firms were growing, appears to contradict the idea that executive pay should naturally rise when companies grow.”

Instead, the Post reports, some economists are now suggesting a possible alternative explanation for the rise in executive pay: “changes in the social norms that once reined in executive pay have disappeared.” The argument is that norms that would at one time have called into question excessive executive pay increases as unseemly or potentially harmful to employee morale no longer hold the same sway.

A similar theme regarding executive pay excesses is reflected in this column by Gretchen Morgensen in yesterday’s New York Times. The column suggests that the failure to provide stockholders with more context when describing executive pay may account for the overwhelming proportion of favorable say-on-pay votes. Describing recent research, the author suggests that total executive pay should be compared to overall labor costs or disclosed as a percentage of marketing or R&D expenditures, depending on the drivers of the company’s business. Citing recent studies, the column reports that there were 24 companies last year where cash compensation –just salary and bonus – was equivalent to 2% or more of the company’s net income from continuing operations. Similarly, 11 companies analyzed in the study gave top executives a combined pay package amounting to 1% or more of the companies’ average market value over the course of the year. The column notes that “[t]otal executive pay increased by 13.9 percent in 2010 among the 483 companies where data was available for the analysis. The total pay for those companies’ 2,591 named executives, before taxes, was $14.3 billion….[an amount that] is almost equal to the gross domestic product of Tajikistan, which has a population of more than 7 million.”

These articles appear as the SEC begins to mull rules implementing executive pay-ratio disclosure and some members of Congress consider, in light of complaints from corporate lobbyists and trade associations, whether to water down provisions of Dodd-Frank. Whether articles like these will have any impact on legislation or regulations remains to be seen.