Magazine February 10, 2020, Issue

California’s Crusade against CEOs

(Roman Genn)
Trends in household income are little correlated with those in executive compensation

As the Second Amendment protests loomed in Virginia, one Democrat in the state senate scoffed that right-wing groups were getting their members — and their donors — riled up over silly legislative proposals that were unlikely ever to become law. There is some question-begging in that: What happens at the margins of the political debate matters, and sometimes matters a great deal, because it helps to define the universe of policy possibilities.

An additional consideration is that there exists a place called “California,” which under single-party Democratic rule today functions as the nation’s great loopy clearinghouse for dotty left-wing ideas — and, in today’s California, these stand a reasonably good chance of eventually becoming law. That fact should be of some concern to gentlemen such as Tim Cook and Mark Zuckerberg and other executives of California-based companies that are being targeted for a new regime of punitive taxation as part of the progressive crusade against “income inequality,” the pejorative term for the reality, uncontroversial outside doctrinaire Marxist circles, that some jobs pay more than others. 

Under legislation put forward by a state senator and Democratic whip with the wondrously Dickensian name “Nancy Skinner” and relentlessly hawked by Abigail Disney, a trust-fund doofus who has grown bored of flying around in her father’s 737, the largest California-based companies would face a heavy corporate-tax surcharge if they did not keep to Sacramento’s preferred ratio of CEO pay to median worker pay. Nonconforming companies would pay a tax rate of 14.84 percent rather than the 10.84 percent levied on those that knuckled under to the state’s political mandate. At the higher rate, California would have the nation’s highest corporate tax, along with the nation’s highest state income tax and highest state sales tax.

The measure, Senate Bill 37, is unlikely to raise a great deal of revenue, but this tax bill is not about taxes per se — it is about weaponizing the tax code for moralistic political purposes. It is, in effect, a sin tax on CEO pay — a sin tax on “obscenity,” according to Skinner. “We must shrink the obscene gap between what wealthy CEOs make these days and what the average worker takes home,” she says. 

There are three problems with Skinner’s analysis, to the extent that this half-digested bolus of self-righteous preening can be described as an analysis. The first problem is that the more important variable in the ratio of CEO pay to median worker pay is worker pay, which varies much more greatly than does CEO pay among firms according to their lines of business: A company with 10,000 cannery workers typically will have a lower median wage than one with 800 software developers. The second problem, related to the first, is that it is not the case that the median worker in any given firm earns less because the chief executive earns more; labor markets are complex, and firms do not enjoy the plenipotentiary power to set wages at will. The third problem is that Skinner ignores the genuinely meaningful correlation: Workers in the subset of companies under consideration in this debate tend to earn much more at firms that are smaller, whether measured by revenue or by number of employees, while executive compensation moves in the opposite direction, with the bosses at the biggest firms earning much more than their smaller-firm counterparts. 

The reasons for that are easy enough to understand and do not fit into Skinner’s adolescent moralistic narrative. This is attested to by the data gathered by scholars at the Harvard Law School Forum on Corporate Governance for a study of the compensation data from 2018, the first year for which the relevant disclosures are available under the Dodd-Frank Act. 

Globalization has, simply by increasing the size of markets, greatly increased returns for successful investors and managers — and, giving the cynics their due, for those who are able to convince corporate compensation committees that they are likely to be successful managers. Small gains in efficiency or growth in a $1 trillion market typically will bring bigger rewards than similar gains in a $1 billion market. But very large, complex, global firms typically have workforces that are paid less relative to other publicly traded companies, often because their workforces are disproportionately seasonal and located abroad. 

So it is no surprise to learn from the Harvard study that the CEOs whose compensation was highest relative to the median worker were also those with the largest share of overseas workers on their payrolls and the largest firms overall by revenue. The chief executives who earned the most relative to the median worker were not Wall Street bankers or Silicon Valley nerds but the CEOs of big consumer-goods companies: CEOs in the consumer-discretionary sector earned on average 384 times what the median firm worker did, and those in the consumer-staples sector earned 295 times what the median worker did. The ratio for CEOs in information technology was less than half that (140 times the median), and it was even lower for energy (80 times the median) and financials (67 times the median). 

Firms with revenue of less than $300 million had CEOs who were paid on average about 32 times what the median worker earned, but firms at the $10 billion mark had CEOs earning nearly 300 times what the median worker took home. 

There is not very much reason to believe that a California tax provision is going to have the effect of raising wages at a paper-goods factory in China enough to change the compensation ratio that interests Skinner, though it could conceivably have some effect on corporate-domiciling decisions. 

The CEO–median ratio is pronounced among consumer-goods companies, but similar trends hold true across large firms in general: Companies with fewer than 500 employees had a median wage of $127,000, but those with more than 10,000 paid a median wage of only $56,000. “The difference is likely the result of large overseas and part-time workforces inherent in larger companies,” the authors of the Harvard study conclude.

Interestingly, the consumer-discretionary and consumer-staples sectors were the only two corporate groupings with CEO–median ratios above the average of 144. Every other sector came in below that average, meaning that a disproportionate chunk of the difference between CEO pay and median worker pay is being driven by a relatively small number of firms in a narrow slice of the economy — the one that simultaneously has the most to gain and the most to lose from globalization, and the one that has the sort of “good, middle-class” factory jobs that politicians are always talking about.

The trend in household income does not seem to be very much correlated with developments in executive compensation. The turn of the century was marked by two recessions, one of them relatively mild and one of them very deep. The median real household income began a steep decline in 2000 and went into formal recession in 2001. In real (which is to say, inflation-adjusted) terms, household incomes did not exceed their 2000 levels until 2016, having plunged by a tenth from 2007 to 2012 before rising sharply from 2014 until now. (I forgo the convention of tracking household income by presidencies, because I am not a superstitious boob who believes that the magical priest-king makes the crops grow by propitiating the gods.)

There are many factors at work there, from globalization to changing social norms (the workforce-participation rate of men 25 to 54 has declined just a smidgen since 1998, but the workforce-participation rate of men 20 to 24 has declined by a tenth) to catastrophically stupid experiments with subsidizing subprime mortgages and then basing a whole bunch of economic assumptions on the resulting asset bubble. During that time, CEO compensation at the big firms went up and down, too — it fell by half from 2000 to 2002, to a measly $10.3 million! — but what executive pay at publicly traded companies tends to track most closely is, no great surprise, the performance of the S&P 500, as data from the Economic Policy Institute and others confirm. 

The California proposal is nonsensical from an economic point of view, and it is unlikely to do the thing that its sponsors say they want it to do, which is to raise wages for workers with modest earnings. But the data brought to bear in this discussion do suggest a desirable course of action for American workers: Get a job at a company that is required to file Dodd-Frank disclosures. The average annual wage for a worker in the United States was just under $50,000 in 2018, but the average pay of workers at the companies required to make disclosures under Dodd-Frank was nearly $81,000. 

It is not obvious from that figure that their CEOs are victimizing their employees. 

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