CEO Pay and the Moral Decline of Economic Elites

Over the weekend, The Washington Post actually committed journalism with a report about the growing income and wealth gap in the U.S. To place it in historical context, they compared two CEOs, one from the 1970s and the current CEO. Here's the blast from the past (italics mine):

It was the 1970s, and the chief executive of a leading U.S. dairy company, Kenneth J. Douglas, lived the good life. He earned the equivalent of about $1 million today. He and his family moved from a three-bedroom home to a four-bedroom home, about a half-mile away, in River Forest, Ill., an upscale Chicago suburb. He joined a country club. The company gave him a Cadillac. The money was good enough, in fact, that he sometimes turned down raises. He said making too much was bad for morale...

But critics question why so much of the growth in income should go to the wealthiest. Douglas, the Dean Foods chief from the '70s, died in 2007. But his son, Andrew Douglas, said his father viewed wages in part as a moral issue.

If his father had seen how much executives were making today, Andrew Douglas said, he'd be "spinning in his grave. My dad just believed that after a while, what else would you need the money for?"

Now, let's compare to the new breed (italics mine):

From 1970 to 1979, while Douglas was the chief executive, sales at Dean Foods tripled and profits increased tenfold, to $9.8 million, according to company records. Similarly, from 2000 to 2009, sales at what would be Dean Foods had roughly doubled, and so had profits, to $228 million. (Engles became chief executive after the company he led bought Dean Foods in 2001 and adopted its name.)

Yet there are vast differences in the way the two men were paid, even when you adjust for the effects of inflation.

In the late 70s -- 1977, 1978 and 1979 -- Douglas made about $1 million annually in today's dollars. The largest part of that was a salary; some came from a long-term incentive based on the stock price that would not mature until he retired.

By contrast, in the late 2000s -- 2007, 2008 and 2009 -- Engles averaged $10.5 million annually, most of it in stock and options awards and other incentive pay, according to proxy statements. After '09, which was a particularly bad year, Engles's compensation dropped to $4 million in 2010. If profits return, so will his higher earnings.

That's right--after a bad year Engles' receives four times the pay his predecessor did. Does this have an effect? You betcha:

Over at Dean Foods, Kenneth Douglas was likewise resistant to making more. Most years, board members at Dean Foods wanted to give Douglas a raise. But more than once, Douglas, a former FBI agent who literally married the girl next door, refused.

"He would object to the pay we gave him sometimes -- not because he thought it was too little; he thought it was too much," said Alexander J. Vogl, a members of the Dean Foods board at the time and the chair of its compensation committee. "He was afraid it would be bad for morale, him getting a big bump like that."

"He believed the reward went to the shareholders, not to any one man," said John P. Frazee, another former board member. "Today we get cults of personality around the CEO, but then there was not a cult of personality."

Outside one of the Dean Foods dairies recently, the workers at the plant for the most part only rolled their eyes when asked about Engles's salary. But they spoke admiringly of Douglas.

"People back then thought enough was enough," said Ron Smith, 63, who maintains the machines at the plant.

Meanwhile, these brilliant executives aren't helping at all (italics mine):

Let's begin with the view from 30,000 feet. Total 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.

That's some pile of pay, right? But Mr. Ciesielski puts it into perspective by noting that the total is almost equal to the gross domestic product of Tajikistan, which has a population of more than 7 million.

Warming to his subject, Mr. Ciesielski also determined that 158 companies paid more in cash compensation to their top guys and gals last year than they paid in audit fees to their accounting firms. Thirty-two companies paid their top executives more in 2010 than they paid in cash income taxes.

The report also blows a hole in the argument that stock grants to executives align the interests of managers with those of shareholders. The report calculated that at 179 companies in the study, the average value of stockholders' stakes fell between 2008 and 2010 while the top executives at those companies received raises...

Moving on to R.& D. costs, the report examined the 62 technology companies in its sampling that reported such an expense, excluding certain costs associated with acquisitions.

Mr. Ciesielski found that the median level of executive pay was equal to 5.3 percent of these companies' R.& D. expenditures.

Topping the pack was Jabil Circuit, a manufacturer of electronic circuits and boards for computer, communications and automotive markets. In 2010, its $27.7 million in total executive pay almost matched the $28.1 million it spent on R.& D. While last year may have been an outlier, over the past four years, Jabil's pay equaled 57.2 percent of the amount it spent on research and development....

Eleven companies analyzed in the report gave top executives a combined pay package amounting to 1 percent or more of the companies' average market value over the course of the year. The Janus Capital Group, the mutual fund concern, topped the list, with pay totaling almost $41 million for five executives. This accounted for 1.95 percent of the company's average market value over 2010.

"To earn their keep," the report said, "managers would have to create stock market value in the full amount of their pay."

So, to summarize: harming the public treasury (executive salaries can be deducted), decreasing money spend on research (and long-term company health), and harming investors. What's not to like? Here's another case study:

We'll concede that it has been a rough several years for the financial services industry and for the market as a whole. Here's a five-year chart comparing Goldman to the S&P 500 and to the KBW Bank Index. Over the past five years, Goldman has outperformed the sad sack bank index by a significant margin but has underperformed the S&P 500. Goldman survived the 2008 panic in better shape than most of its rivals, in part because the Federal Reserve let it and other highly leveraged investment banks access funds. But Goldman didn't exactly light it up as the credit and stock markets bounced back. (Here's a two-year chart of Goldman against the S&P 500 and the KBW Bank Index.)

Besides, Goldman would be insulted if it were to be compared to the typical member of the KBW Bank Index. This isn't some small-time, sleepy institution that takes deposits and lends money here and there. Goldman is an elite global institution, with the best minds and systems money can buy. It bestrides the globe like a colossus. It works harder and smarter than all the other firms. It has a culture in which failure and mediocrity aren't tolerated, much less rewarded. Up or out.

So imagine a bunch of senior Goldman executives hired an expensive portfolio manager and tasked him with creating positive returns. Next, imagine that the manager came back year after year and informed the executives that the best he could do was flat returns -- but that he nonetheless deserved a multimillion-dollar payday. They'd laugh.

And yet while Goldman's returns have been subpar, CEO Lloyd Blankfein is getting paid like he's crushing the market.

A couple of decades ago, Christopher Lasch wrote a book, The Betrayal of the Elites, which focused mostly on how the upper class of U.S. society was setting a bad example on social issues (i.e., a more comprehensive 'Murphy Brown' argument). I always thought that argument was overblown: the true hallmark of the upper class' moral and ethical degeneracy was demonstrated by how they treated their employees (increasingly shabbily).

We are ruled by greedy sociopaths.