 If we want to, we can structure the market differently. Chief executive officers are among the highest paid people in the country. The issue, to my mind at least, is whether CEO pay corresponds to, in effect, their contribution to the economy, that they actually are in some sense worth their pay, or whether, in effect, that they're vastly overpaid. And my argument is going to be that they are vastly overpaid, that they don't contribute to the economy at all proportionate to their pay. I'll go through five main points. It's very clear CEO pay has exploded in the last four decades relative to the pay of the average worker. The second, the alternative explanations of CEO pay that they're actually worth their keep as opposed to CEO pay as a result of a corruption of the corporate governance process that determines their pay. Third, the evidence shows CEOs don't earn their pay. The fourth one, why CEO pay matters. So one could ask, okay, we don't have that many CEOs. We have 500, 1,000 large companies in the economy. That's not that many people. Well, I'm going to argue actually that matters a lot, that CEO pay has a big impact on pay scales in the economy. Then lastly, outline some possible fixes that have been suggested and that I think are at least plausible ways to get CEO pay more in line with where it had been in prior decades. Okay. So first off, what's happened to CEO pay relative to the pay of the ordinary worker? And what this graph is showing is two different measures CEO pay. One is to simply look at the value at the time they're issued. The other one is to value them when they're realized. So when a CEO actually caches in the option after three years or five years, whatever time frame is on the option. It generally is the case that if you measure the value of the options when they're realized, when they cash them in, that their pay is considerably higher. But either way, you get the same story. CEO pay relative to the pay of ordinary workers has exploded. If we go back to the 60s, it was around 20 to one. By the end of the 70s, it was close to 30 to one. Then in the 80s, it really began to skyrocket and we get to the 2000s where it's well over 200 to one by either measure. It's bigger. It's higher if you use the value of options when they're realized, but even if you take the more conservative measure, the value of options at the time they're issued, you're still looking at CEO pay that's well over 200 times the pay of an ordinary worker. And again, if we go back to the 60s, it was 20 times the pay of the ordinary worker. So the question is, are today's CEOs 10 times as productive as they were back in the 60s? Okay. So the conventional view, if you believe that CEOs are in effect worth their pay is that they are hugely productive, that they produce enormous returns to shareholders. Ultimately, the shareholders are the ones to decide who is the CEO, how much they get paid. The shareholders have authority over that. So the question is, are they worth that money to shareholders? And the conventional view would be, yeah, they're the CEOs. You look at a major company, a general electric, an IBM, or Microsoft, whatever it might be for the shareholders, it's worth it to pay the CEO 20 or 30 or 40 million, whatever they end up paying, because if you paid someone less, you would get less, because they're so productive that the economy would really be hurt if they got paid substantially less. Chief financial officer, the other very top people, people often refer to the C-suite, the top five paid executives, those are also very, very talented people. So they get 8 million, 10 million, they're worth it. The alternative view is the corporate governance process is corrupted, that the CEOs largely control the boards that determine their pay. So what I like to say is imagine that you had your friends that were sitting on huge piles of money, because that's really the story here. If you have the board of Exxon or IBM or any major company, so your friends are sitting on a huge pile of money and you're asking them, how much should you get? Well, they're your friends, so they'll probably give you a lot of money. So that would be a story of corrupted corporate governance. So maybe the CEO of a major company is getting 20 million dollars, clearly it's hard work. I mean, you couldn't just grab someone off the street and make them the top executive at Microsoft. You need someone who knows the industry, but there might be a lot of people who could do that and they'd be happy to do it for 2 million, maybe 3 million. You don't have to pay someone 20 million. So in that story, the CEO is not producing some outsized return to shareholders. And the implication is shareholders are getting ripped off, that shareholders are paying someone 20 million and they could pay someone 2 million, 3 million. The next echelon of corporate executives, they're getting 10 million, well, you could pay someone 1.5 million and they don't get a return that is at all corresponding to what they're paying them. Okay, so evidence on whether CEO pay is justified. Well, there was a great study, this is some years ago now, they looked at CEO pay and whether it's affected by events that were beyond their control. My favorite example here is world oil prices. And in principle, CEO pay should neither benefit from good luck or suffer from bad luck. If you're running Exxon and oil prices double, well, you didn't do that or at least presumably you didn't. So why should you get higher pay? On the other hand, suppose they fell, well, that really isn't your fault either. So in principle, you'd like to say that CEO pay would not be affected by events beyond the control of the CEO. Well, guess what? They found that it was affected in a really big way by events beyond the control of the CEO. It does look like CEO pay is determined not by their skill, what they produce for shareholders, but in this case, to a very large extent by luck. People go, oh, well, what can they do? What are they supposed to do? Of course, their options are worth more when the price of oil goes up. You could write contracts, so that's not that way. So you could tie the pay of the executives at Exxon, not just to Exxon stock price, but Exxon stock price relative to Shell, relative to other oil companies. That's almost never done, but they can do that. That would prevent this sort of luck leading to huge pay raises for CEOs. Second story, there's a number of measures that experts on corporate governance associate with good governance. So just to give one example, if you have the whole board come up for a vote at the same time, so that way, if investors decide that company is being poorly managed, they can replace whole board at once. So that's considered a good governance rule. They came up with an index of good governance and they found that this index was associated with lower CEO pay. Okay, again, if we thought that corporate governance was in general very good, there shouldn't really be much correlation between better governance and lower CEO pay. They might be very weakly related. They found a very strong relationship. The Barnhart-Spivy and Alexander study looked at CEO pay in states with stronger takeover laws. So takeover laws means it's more difficult if you have a poorly run company for someone to come in, take over the company and presumably make it a better run company. So that gives, in effect, the top management more leeway because they know it's harder for someone to say, hey, we don't like the way things are going, we're going to take it over. Well, again, if companies are in general well run, CEO pay corresponds to their contribution to the company, it really shouldn't matter whether companies are a threat of being taken over. But this study found a very strong relationship that states with stronger anti-takeover laws, companies that are chartered there had higher pay. Okay, another study, the Quigley-Crossland Campbell study, they looked at cases where you had accidental deaths of CEOs. And this is interesting, there's a little more roast. But the point here is that, suppose we have a CEO that we know is sick, Steve Jobs example, that where he had cancer. And so people buying Apple stock, investors knew Steve Jobs was sick, he was likely not to live that long. So that would be priced into a stock's price. So you don't want to look at cases like that. What they looked at was accidental deaths. So people didn't know that a CEO was going to be in a plane crash, again, assuming they weren't in on it or whatever. We could safely assume these were events that were not captured in the stock price. So if we thought that CEOs were really outstanding figures, that they couldn't easily be replaced, we'd expect to see a sharp drop in the stock price after a CEO dies. What they found was there was some downward movement in stock price, but in very few cases were there sharp drops. So that suggests that the markets generally don't feel that the CEOs are irreplaceable. That if it turns out through some fluke event that the CEO ends up dying, well, the person next in line, they'll probably do just as good a job. Jessica Scheider and myself did a study where we looked at the change in tax deductibility and whether it had an impact on CEO pay. So what we did was we took advantage of a provision in the Affordable Care Act that went into effect in 2013 where it limited the deductibility of CEO pay in the health insurance industry. So the reason why this matters is prior to 2013, companies could deduct the full amount of CEO pay. What that meant was that if they're in the 35% bracket, which they were, that in effect they're only paying $0.65 on the dollar. So they're paying the CEO $20 million. They're only actually kicking out 65% of that because they could write 35% off on their taxes. After 2013, they couldn't write anything above $1 million off in their taxes. And of course, these CEOs are getting paid much more than $1 million. Now, if CEO pay bared any close relationship to their returns to shareholders, this should have meant a reduction in CEO pay in the health insurance industry relative to their pay in other industries. We could find no evidence that the change in tax deductibility had any negative impact on CEO pay whatsoever. And again, that's even after controlling for everything. So that's something hard to explain if it's the case that CEO pay is closely related to their return to shareholders. OK, next story. We have great failures. I'm just mentioning a few. I could give you a very, very long list. But these were some prominent examples. Robert Nardelli was the CEO of Home Depot back in the early part of the 2000s. He left in 2007. He walked away with over $210 million, which would be about $300 billion in today's dollar, I'm sorry, million, not billion, $300 million in today's dollars. It wasn't quite that overpaid. OK, so what do you do for Home Depot? Well, Home Depot's stock plunged in this period. It fell about 50%. Its main competitor in the home improvement industry is Lowe's. Lowe's stock soared. John Stumpf, he was the CEO of Wells Fargo for a number of years. Stumpf was involved in the scandal where they were issuing phony accounts to people. Most people didn't even know they had these accounts so that they could boast about the number of accounts they were issuing. So this would look good for the financial markets. Well, Stumpf seemed to have known about this, seemed to have been at the center of it. And even if he didn't know about it, it was on a very large scale, so he surely should have. But in any case, he ended up leaving the company because of the scandal, put them in a horrible situation in terms of their reputation, which they built up over the years. But he's still got a $130 million pay package. A third example, a more recent one, Dennis Mullenberg stepped down in 2020. He was the CEO of Boeing. He ignored warnings about the safety of their new plane, the 737 MAX. There were two major crashes involving the 737 MAX, killed several hundred people. And again, this was a predictable event that there were warnings about safety risk, which he chose to ignore. And he went ahead with getting this plane out as quickly as possible. A lot of people died. And again, it was a huge cost to the company because of course, obviously any airliner's reputation depends hugely on its safety record. I should also point out their planes were grounded. I think they're now operating again, but these planes were, of course, grounded until they could thoroughly evaluate the problem and develop a work around. He walks away with $62 million. Was Mullenberg worth $62 million to Boeing shareholders? That'd be pretty hard to say. And again, just to be fair, the way this was structured was he had already earned this money. You could write contracts so that you don't get $62 million if you walk away from a company because you had done some major harm like not taking heed of safety warnings, causing hundreds of people to die. They didn't write the contract that way, but you can. The next question I'm asking is just a very simple one. What have been the returns to shareholders? So if CEOs are worth their pay, we should expect to see exceptional returns to shareholders in the period of very high CEO pay. And what I'm doing is I'm looking back over 20-year trailing averages. This is a common method for economists when they're looking at financial markets because, well, among other things, we know financial markets are hugely erratic. So I could pick a year and just say, oh, look, returns in 2021 were great. But we want to know over a long term. And if we do that, we see, well, returns to shareholders over the prior 20-year period. They're not particularly high. If we go back to the 50s and 60s, returns to shareholders were actually much higher when they were paying CEOs considerably less. With the exception of we have a couple peaks, 1999-2000, the peak of the stock bubble during that period. So just at this simple, most basic measure, it doesn't look like CEOs are earning their keep. OK, so why might we think CEOs get paid so much if it's the case that they're not really worth it? All right, my story is one of corruption of corporate governance. These are the people, the boards of directors are the ones who most immediately determine CEO pay. In principle, if we accept kind of the standard conventional economic story, they're not going to pay a CEO way more than what they're worth to the company. OK, well, why might that not be the case? Well, first off, boards are largely appointed by top management. So it's not the board running around looking who's a good person. It's not the shareholders saying, oh, we're going to put up this person on board. People whose pay they're supposed to be controlling are the ones who are selecting the board. OK, that's a serious problem in my view. Second one is that boards nominate their directors for reelection. This is probably worse than what you had in the old Soviet Union, where people were nominated by the party always won, while there were some occasions where they didn't. But those were very few and far between. Well, it's the same story with boards and directors. So you have a vote of the shareholders, but it's very, very difficult to organize shareholders to vote against the person who the board had recommended for reelection. So over 99% of the time, you can almost count on one hand the board members who come up for reelection and are turned down in any given year. Third point about this, board members are paid a lot of money. You get paid over 100,000 a year for being a board, oftentimes 300,000 or 400,000 a year. And there's a great book by Stephen Clifford that looks like he was a board member of several major companies, so he's kind of talking from the inside. He puts the amount of work at around 150 hours a year. As I say, good work if you can get it. So point being that if you're a member of a corporate board, you're getting a real good deal on it. You're looking at a situation where it might be paid over $1,000 for an hour of work. That's a really good deal. That means you probably want to stay on the board. So what does that mean? Well, you probably don't have a really strong incentive to say, hey, our CEO really isn't very good. Because you know everyone else on the board is friends with the CEO. So do you really want to go around to the other people on the board and say, hey, Joe's really not doing a very good job for us. Can't we get someone who's just as good for maybe half the price? Or maybe we should just give him half the pay? They don't do that. Because you're going to piss off the other members of the board. So do you want to be someone that they don't nominate for reelection? Directors have very little incentive to question CEO pay. And keeping with this, there was a great study done by Bovay and its co-authors at the University of Texas where simply surveyed, just asked board members, something in commas often do too rarely, do you see limiting CEO pay as a part of your job? And the overwhelming majority of board members didn't even see it as part of their job. They actually saw promoting the goals of top management as being the main purpose. I think this is very damning because even if they did see it as part of their job, maybe we'd look at them and say, well, you're really not doing a very good job. Okay, so why does it matter? CEO pay is a reference point for pay scales throughout the economy. Why do I think that's so important? Well, one, if you have people who are getting paid 20 million a year when they're only producing, say, two million a year for the shareholders, then we don't have an economy that's based in any close way and people's actual productivity. But if it's the case that CEOs are getting paid 20 million and they're only worth two million shareholders, well, the implications of the shareholders are being ripped off. Okay, so to my view, that's really a very fundamental question. If the shareholders are getting ripped off, they should be allies in lowering CEO pay. Okay, so how do you remedy CEO pay? One issue that people have to understand is corporations don't exist in a free market. Corporations are creations of the government. So we could all form partnerships and we could agree we're gonna collaborate, but we don't create a separate legal entity. That's something the government has to do. And when it does that, it sets rules. Most of the rules have to do with protecting minority rights. And by that, I'm not talking about minority groups as we usually think of, minority shareholders. So you can't have a story where 51% of the shareholders take over a company and they tell the other 49% they're out of luck. I can get together, we get 51% of the shareholders, but whatever we get, the other 49% have to get also. That's what most rules are about. But there are other rules and the government could change those rules. How can it change those rules in ways that are likely to bring down CEO pay? Well, one of my favorite, because it's simple, is that back in 2010, the Dodd-Fernick Financial Reform Act, that created something and it's often referred to say on pay. Say on pay means that every three years, the CEO's pay package is sent out for a vote of shareholders. You could have shareholders voted down and it's just telling the board that the shareholders think the CEO was paid too much. Boards could do whatever they like with that, but there's no direct impact on that. You could change that. Just to be clear, this is something that happens very rarely. So it's about 2% of pay packages are voted down and that's because it's very hard to organize shareholders. So every now and then you'll see someone, usually an activist investor that has a large amount of the company. They organize the shareholders and they get them to vote down pay package. Again, suppose you said instead they're just being no consequence, the board could just go, that's interesting. You say, okay, the shareholders voted down your pay package. Your job, whether they like it or not, is to restrain the pay of CEOs. So if you gave your CEO a pay package, that's so outlandish that a majority of shareholders voted it down, you lose your pay. Well, my guess is that that would cause directors to think a lot more carefully about what they're paying their CEOs. And again, I don't think it would have to happen too many times. You could also put into the rules that boards get an incentive to lower CEO pay and companies could do this voluntarily. They could say, okay, if our stock price keeps pace with our competitors, so go back to Lowe's and Home Depot. You say, okay, if Home Depot's stock price keeps pace with Lowe's, we've been paying our CEO 20 million a year, we're gonna lower that to 10 million a year, and we're gonna split that 10 million, okay? That would be a very good incentive for them to lower the pay of CEOs. Okay, a fourth thing, take away the proxy votes for third parties. Most important here is mutual funds. If you look at any major company, a very large share, often well over 50% of the stock, is held by mutual funds. So oftentimes the mutual fund representative at a company, at a general electric or IBM or Microsoft or whatever it might be, they're often friends with the top executives at the company, because they wanna get information from them. They very rarely vote against say on pay packages, less than most shareholders. So if you have money with a 401K, you have money with a Vanguard or a Fidelity, whatever it might be, it's your money, it's not their money. So you might say, okay, since they're not actually the ones who own it, they don't get to vote on it. Now typically most mutual funds say, okay, you authorized them to vote on your behalf. You could say that isn't good enough, because they don't have a direct interest that the person who actually owns the shares does. Another route is higher marginal tax rates. Okay, so it's worth noting, and you can decide how much importance you wanna place on this, that CO pay tends to rise hugely when marginal tax rates for top owners fell. So if we go back to the start of the 1980s, top marginal tax rate was 70%. It fell in the 80s to 28% for a period of time, then it rose back to 40% under President Clinton, fell again under the second President Bush, rose again to about 40% under President Obama, and then fell again under Donald Trump to 37%. Well, there's an argument here that having a high marginal tax rates will tend to put downward pressure on CO pay for the simple reason that the CO is not keeping most of it. So in a world where you're being taxed 70% or 90% on a dollar of income, you don't keep most of their income. So that means COs have less incentive to try to get really high pay. The last thing to mention is that if we look at the nonprofit sector, well, the government subsidizes the nonprofit sector because we give a tax credit. So that means if I'm a real rich person, I decide to give a million dollars to a university or a charity I like or whatever. Well, the government, in effect, it gives me a tax subsidy. So we have a 37% top rate, and anyone who's giving a million dollars to a university is surely in the top tax bracket. That means that they're picking up 370,000 of the tab, okay? So I can give a million high in effect only to pay 630,000. Government's paying the other 370,000. Okay, well, that means that the government could set conditions on that. Okay, so if Harvard says, oh, we want to pay our president $2 million, well, they can go ahead and do it. We just say to them, okay, but you're not going to get the charitable deduction. Okay, if you get the charitable deduction, you only get 400,000 a year. Okay, or that's the most you could pay your president. Okay, so you could set that as a condition for nonprofits. That, to my view, would go a long way towards bringing down pay there. And just to be clear, where I'm getting 400,000 a year, if it's not obvious to people, that's the pay of the president of the United States. Okay, so to sum up, what I would just say is it's unambiguous. CEO pay has exploded over the last four decades. I should also point out in this respect that you have large companies in Europe, in East Asia, in Japan, in Korea, they're not paid anywhere near as much as our CEOs. Their pay's been rising as well, I think partly because of the pressure of CEO pay in the US. But if you look at France, Germany, their CEOs and major companies might get 3, 4, 5 million. It's very rare you'll find one getting 20 million. Okay, and those companies also do quite well. Insofar as we could say this is a story of a corrupted corporate governance process, then this is a big source of upward redistribution in the economy. It's not a market story. It's a problem with how we structured the market, how we structured the rules of corporate governance.