In 1965 the average CEO earned 20 times what the average worker took home. Now, with globalization expanding the reach of CEOs and depressing the wages of factory-floor workers, that ratio is over 300-to-1. This rise in inequality has caused critics of the American capitalist system to begin to question just how our corporations are governed. And whether our current market-based economic system is fit for purpose in a globalized economy.
We’ve been there before. In the 1930s Mussolini's fascist system made the trains run on time, Hitler's National Socialism revived the German economy, and Stalin's communist utopia made a successful dash towards industrialization. Each in its turn attracted supporters who, oblivious to the horrors of these other systems, would replace America's then-staggering economic system. After World War II, it was Sweden's "middle way" that became the model which many Americans, mostly on the left, hoped would replace ours. And now it is China's centrally managed, high-growth economy that has caught the eye not only of Americans unhappy with our sluggish recovery but with what they see as rising inequality here, never mind that corruption has produced even greater wealth disparities in the People's Republic.
Many of these issues will be fought out in the presidential and congressional campaigns that start in earnest now that both parties have had their conventions. But with a new twist from the point of view of corporate America: Both parties want to re-enact Glass Steagall and break up the big banks; both parties say that big business is oppressing the middle class; neither party is a friend of America's corpocracy. The Republican party has been captured by a candidate in the "come home America" tradition of George McGovern, one who feels it would be proper for him to tell corporate CEOs which factories they can build overseas and which they must bring home to the good old USA, and the Democratic Party has been tugged left by an avowed socialist whose campaign persuaded six out of ten Democrats that they would be willing to install a socialist in the White House, and the party's nominee to consider imposing profit sharing on America's leading companies.
This shift to favor government intrusion in corporate boardrooms is not unique to America. Theresa May, Britain's new Conservative, yes, Conservative prime minister wants workers represented on corporate boards in order to restore trust between voters and the private sector, and to rein in executive pay. "There is an irrational, unhealthy and growing gap between what these companies pay their workers and what they pay their bosses," May believes.
When once-business-friendly parties on both sides of the ocean, the homes of what the French deride as capitalisme anglo-saxon, turn against the heads of their largest companies, CEOs take notice. In America, a group of CEOs of our largest corporations, leavened by an activist investor and some institutional investors, released a set of "Commonsense Corporate Governance Principles" earlier this month in the hope of starting one of those national "conversations" that are increasingly popular substitutes for action. Among other things, boards are to "articulate how their approach links [executive] compensation to performance…". But they are not to disallow the circumstance of two of the signatories of the principles, Jamie Dimon, who serves as both chairman and CEO of JP Morgan Chase, and Warren Buffett who holds both posts at Berkshire Hathaway. This arrangement leaves it to a senior board member to make certain that when the chairman, representing the shareholders, assures himself that the CEO, a member of the management team, is performing up to snuff, he has overcome the inherent conflict of interest.
Unfortunately for the well-intentioned signatories, the day after the CEO group trumpeted its principles in full page ads, consultants at MSCI ESG Research released a report in which Linda-Eling Lee and Rick Marshall analyzed the relation between incentive awards to CEOs and financial returns to the owners of 429 of America's largest companies from 2005 to 2015. "Has CEO pay reflected long-term stock performance? In a word, 'no'." Consider the recent highly publicized case of the sale of Yahoo to Verizon. Fortune magazine's Stephen Gandel, with the help of compensation consultant Brian Foley, estimates that CEO Marissa Mayer's contract with Yahoo will net her in excess of $100 million as a result of the company's sale to Verizon, even though the value of Yahoo's business (excluding the run-up in the price of its holdings in Alibaba), has declined by over $2 billion.
In Britain, the "Executive Remuneration Working Group", which includes company and shareholder representatives, also issued its report this month. The Group acknowledges that it is responding, among other things, to the new prime minister's focus on "inequality, executive pay and trust between businesses and society…", and found that "the current levels of executive pay and its complexity … [lead] to levels of remuneration which are very difficult to justify." It wants boards to explain why the ratio between the pay of the CEO and the median employee "is appropriate for the company".
This is all easier said than done. Computing a meaningful average pay, or identifying some "median employee" in a multinational company employing tens of thousands of workers will be an expensive exercise, providing employment for compensation consultants and accounting firms. And given the use of complex compensation schemes for CEOs, the total values of which cannot meaningfully be determined until they retire, will not be easy. We won't even know Ms. Mayer's compensation until the sale to Yahoo is completed.
But that's a quibble. A more important ripple effect of this new emphasis on CEO compensation is the closer examination of the composition of the boards of directors that are supposed to determine that compensation. Leave aside the desire of every board to make certain that "its CEO" is not paid less than the average of CEOs in comparable companies, which leads to an upward ratcheting of compensation. Consider instead whether long-serving board members might become "compromised", in the words of one pension fund, by the chumminess with the CEO that comes from long service together. In 2005, according to a survey by the Wall Street Journal, long-serving directors made up a majority at 11 percent of the largest U.S. companies; that figure is now 24 percent. Just 7 percent of the 4,500 board members of S&P 500 companies turn over every year. Only Facebook and TripAdvisor have boards with a median age below 50. "The tenure issue is one that is bubbling below the surface," says Douglas Chia of the Conference Board. Feminist groups, eager to make room for more women directors, are bringing that issue to a boil.
All of which proves that no corporation is an island entire of itself. Rising inequality in society becomes an issue for CEO pay, gender, and racial concerns are forcing boards to limit the tenure of old white guys to make way for new arrivals. The bell is indeed tolling for the existing rules of corporate governance.