Income Inequality and the inflation of CEO compensation: causes and - - PowerPoint PPT Presentation

Income Inequality and the inflation

• f CEO compensation: causes and

remedies Tim Hazledine University of Auckland

for Executive Remuneration Conference Auckland Business School August 13, 2012

“Corporate Governance” is the

• xymoron of the age

Top Pay is out of control:

• - too high
• - over-incentivised

As a major factor in the hollowing out of the income distribution, this has become a bi- or multi-partisan issue Survival of the mixed market economic system threatened? [David Mayes]

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The basic idea

CEOs are highly talented, skilled individuals doing an essential job But no evidence that they’ve become much more talented and skilled over past quarter century, whilst their pay has increased, a lot So, unless they were underpaid then, they are seriously overpaid now We need to push towards a rebalancing of the earned income distribution

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The setting: A post-war “Golden Age”

Over the quarter century to 1973, the Western capitalist economies grew faster than ever before Per capita real incomes increased 2-3% per annum in the English-speaking countries; 4-5% Western Europe; 8% Japan Income differentials narrowed; inequality reduced; many families joined the economic middle classes

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Why did it end?

Political backlash against Keynesian social democratic welfare state:

• - not enough unemployment  inflation
• - unions too powerful
• - taxes too high

Monetarists/neoliberals stormed the commanding heights of capitalism: “Class war? Of course there’s a class war. And now our class is winning again!” (Thatcherite)

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How did it change?

• - Imposition of neoliberal/Washington

Consensus “reforms”

• - Globalization and forced “free” trade
• - Identity Politics sapped resistance from the

Left

• - New Managerialism based on Agency Theory
• - Tax cuts for the better off, sold as the “rising

tide that raises all boats” (Ronald Reagan’s “trickle down” theory)

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Hollowing Out

“Between 1979 and 2006, the top 1 per cent of earners in the US more than doubled their share

• f national income, from 10 to 23 per cent…

mainly because of the astronomical increase in executive pay” Real hourly wages for US workers increased 0.4 per cent per year, 1973-2006 Multiple: CEO compensation to factory floor worker wage up from x30-40 to x300-400

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NZ experience not so extreme: eg: CEO salaries up 23%; average wages up 11%, 1996-2004 (in real terms) But our top-1% share has about doubled, from 5 to 10 per cent, 1986-2006 Associated with increase in Gini coefficient of Income Inequality (NZ biggest increase in OECD!)

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Income shares in NZ (Atkinson & Leigh)

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One of the most unequal countries in the high income world

Gini Coefficient – measure of inequality 0 = everyone equal; 100 = one person has all the income



New Zealand had the fastest rising income inequality in the OECD in the 1980s and 1990s



Now around 10th highest income inequality out of 34 countries in the OECD

Source: OECD (2010) , Treasury

The Globalization Puzzle

Two questions:

• -What is a prime cause of the downward squeeze
• n jobs and incomes of unskilled workers?

and:

• - What is the cause of the upward spiral in CEO

incomes over the same period? Same answer: globalization! [Globalisation of product markets squeezed manufacturing wages/globalisation of the market for CEOs increased their bargaining power] [Julie Gore: bargain relative to benchmarks/peers]

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Unforeseen consequences?

Recall 1968:

• - JK Galbraith’s New Industrial State: the

modern corporation would be run by an almost priestly “technostructure” of professional managers, pursuing goals other than profits

• - technical excellence, increased sales,

planning, social responsibility… Milton Friedman was cross: “The only social responsibility of the executives running firms is to maximize the profits of their shareholders”

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But instead…

Neither Galbraith nor Friedman had even an inkling of what was actually going to happen: The technostructure decided it would be more fun instead to maximise “profits” for itself! By the 1980s, the upward spiral of CEO and

• ther top executive compensation packages was

under way Sort of Marx reversed: the workers exploiting the capitalists…

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Why Worry?

We don’t mind people getting extremely rich through starting a new business Many of us buy Lotto tickets… So why should we worry about CEOs getting quite rich running existing businesses? And can’t the owners look after themselves? Anyway, the new breed of professional CEOs/managers have probably improved the productivity of those existing businesses, right?

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Haven’t they earned it?

They, and other members of the Top-1% Club, have appropriated much of the increase in per capita GDP since mid 1980s

• - but there is little evidence that the value of

their output has gone up to justify this [Lucian

Bebchuk, et al -- cf Randall Thomas]

So, the problem is: if you think CEOs were worth what they got paid, say, 30 years ago Then they cannot be worth what they get paid now (on average) [what are they worth?]

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Rent-seeking

It’s not (just) about whether the high-powered incentive schemes (bonuses, options, etc) “work” in “aligning” incentives It’s the total lack of evidence that, overall, the huge increase in CEO remuneration has generated more wealth than it has taken Or even generated any additional wealth at all

• - polite word for this is “rent seeking”
• - not-so polite word is “plunder” or …

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Capitalism in Peril?

This is what I meant by the “collapse in CEO productivity” in my original title for this talk It’s not that they are working less efficiently (though they may be less effective, because of the bloating of corporate size) [but cf. Susan Doughty – smaller head office teams…] It’s that we now need to spend a lot more money to get the same managerial output And that this must require a squeezing of the incomes of workers further down the ladder

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Capitalism in Peril!

In Why Nations Fail, Acemoglu & Robinson demonstrate the harmful economic effects, across countries, and through history, of the plundering of property and disrespect for property rights And a working (and now middle) class struggling to flourish or even survive on squeezed household incomes in a prosperous society is not just morally wrong but threatens social cohesion and long-run economic viability.

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Action: What not to do

The three orthodox remedies are:

• - educate/up-skill the workers
• - use tax system + government spending to

“redistribute” incomes

• - reform CEO compensation to align incentives

I suggest none will work, in New Zealand, and each would likely make matters worse!

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The Education Fallacies

“More-educated people earn more, so the solution to low incomes is more education” Not so! It is true that the people who currently choose to go to university will probably earn more (though not necessarily enough more to compensate for the time & money spent) But this doesn’t mean everyone would benefit:

• Selection fallacy (horses for courses)
• Fallacy of composition (signalling/sorting)

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The redistribution fallacies

Basically, once high-income people have got their mitts on the booty, it’s very hard to claw it back

• Increasing marginal income tax rate reduces

(declared) taxable income of top-1%

• Very little effect on total tax take
• Plus “leaky bucket” effect – can’t move money

around with losing some of it And, the top 1 per cent of income earners in the US already pay 40% of the income tax! They will resist paying more…

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“These new taxes will fundamentally change the way we avoid them”

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Income shares in NZ (Atkinson & Leigh)

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Fancier Compensation Schemes

We have heard today of the pitfalls and disappointments of “high-powered” monetary incentive schemes

• They drive out intrinsic motivation
• They become very expensive
• Not that the performance targets won’t be

met, but that they will, at the expense of goals not written down or quantifiable

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“These new compensation schemes will fundamentally change the way we game them”

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The Big Goal: economically & socially sustainable employment

Higher wages (and perhaps lower taxes, because less social failure to rectify – police, prisons, health system, transfer payments, even education)

• Keep pushing up minimum wage (cf France)
• “Reshoring”/”Insourcing” of blue/pink collar jobs

– “compete for the domestic market”

• Better child day care facilities/lower benefits
• Aggressive competition and/or regulatory policies

to squeeze out rents/keep prices low

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And at the other end….

• Simpler, salary based compensation schemes

in private sector (bonuses only long term?)

• Salary-only in public sector
• Roll back public sector top pay to 1992 levels +

increases since then in average wages, with simpler structure (max = $400K for Treasury Secretary, Vice Chancellor, Supreme Court …)

• Break or weaken salary-”job size” link
• Aggressive competition and/or regulatory

policies to squeeze out rents/keep prices low

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We can’t wait for the world

We can’t wait for the world to “coordinate” action on these matters Need to “think and act locally” We do have some freedom of manouevre

• - cf. the non-English speaking world now, plus
• ur own past…

Thank you!

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