Episode 682: When CEO Pay Exploded

Jun 22, 2018

Note: This episode originally ran in 2016.

This year, 2018, publicly traded corporations had to start reporting the ratio between CEO pay and median workers' wages. Some of the numbers are eye-popping. The New York Times calculated that an employee at Walmart making the company's median salary would have to work for more than 1,000 years to make as much as Walmart's CEO earned in 2017.

How did this gap get so vast? There's a precise moment in the 1990s when CEO pay started going up--way up.

Today on the show, we go on a quest to find out why it happened. The story starts with a promise that Bill Clinton made on the campaign trail to tie CEO pay to company performance. We meet an economist who had a smart plan for how to do that--and then, we hear how he watched companies take that plan way too far. We meet the board members who thought they were getting something for nothing, and the compensation consultants who tried to show them the truth. And, we learn why Silicon Valley workers took to the streets to protest an accounting rule.

Music: "Love To Go" and "Second Line Stomp."

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UNIDENTIFIED PERSON #1: Quick warning - there is some profanity in this episode.


Hey, it's Stacey Vanek Smith. Today's show originally aired in 2016. It is about CEO pay. And we've gotten a lot of new really interesting information about CEO pay because of this rule put in place as part of the Dodd-Frank law, which was the big 2010 banking regulation law that was put in place after the financial crisis. And the rule meant that this year, some big companies had to report their pay ratios basically comparing how much money CEOs make to how much the median worker at the company makes.

And those numbers show - no surprise - that CEOs get paid way more than other workers do. The New York Times calculated that an employee at Walmart making the company's median salary would have to work for more than a thousand years to make as much money as Walmart's CEO got in 2017. So here's our episode looking at how we got here. Here's the show.



Stacey, the other day, I was looking at this chart. I've brought it into the studio. The chart is average pay for CEOs at big U.S. corporations over the past several decades. And I saw something really surprising. I'd always assumed, you know, that CEO pay just goes up and up and up at kind of a steady way year after year. But what this chart clearly shows is in fact there is this one moment - I can put my finger on it here; it's right in the mid-1990s - where CEO pay goes bananas, right? Before then, it's kind of inching along, and then just all of a sudden - mid-'90s, boom - straight up. And, you know, when I say it goes bananas, I don't even mean that in, like, a value judgment kind of way. I just mean whatever you think about CEO pay, anybody would look at this chart, point to this moment in history and say, what happened right here?


VANEK SMITH: Hello, and welcome to PLANET MONEY. I'm Stacey Vanek Smith.

GOLDSTEIN: And I'm Jacob Goldstein. Today on the show - that's our show. What happened with CEO pay right here?


GOLDSTEIN: The story of this moment when CEO pay started going up really fast - among other things, it's like a story of unintended consequences. And it starts - or at least we're going to start it a few years before things go bananas. We're going to start at around 1990.

VANEK SMITH: There was this economist named Kevin Murphy. And he was looking at this, and he wasn't so much concerned with how much CEOs were getting paid as he was with how they were getting paid. He thought a lot of CEOs were getting paid a lot of money basically to just sit around.

KEVIN MURPHY: The biggest sole determinate of your compensation was how big of company you were running. And it was a - turned out to be just a lousy way to do business.

GOLDSTEIN: If a CEO had a great year, they got paid - CEO had a terrible year, also got paid - didn't really matter. So as a result, Murphy says, there was this tendency for CEOs to just kind of be on autopilot. You know, go to work; take home a nice big paycheck.

VANEK SMITH: So Murphy co-wrote this really influential paper where he basically argued that the way CEOs were being paid was wrong. CEO pay, he said, should be based on performance. If the company does well, the CEO should get more. If the company doesn't do so well, CEOs should get less. It's a really logical idea, and he wrote the paper at just the right time for it to get a lot of attention.

MURPHY: The U.S. was going through a recession, not a major recession but a recession where executives were getting rich at the same time they were laying off their employees. And of course that's a minefield.

GOLDSTEIN: It's a minefield if you're a CEO making millions of dollars a year. But if you are, say, a young governor running for president, this is a gift.


BILL CLINTON: If companies want to overpay their executives, they shouldn't get any special treatment from Uncle Sam.


VANEK SMITH: Oh, I know that voice.

GOLDSTEIN: Young Bill Clinton - and listen here because this is not just one more sort of abstract campaign rant about CEO pay. Clinton here is making an actual policy proposal.


CLINTON: There are millions of good people in business in this country today making the free enterprise system go, but our tax system does not reward them. Instead it rewards unlimited executive compensation. And I tell you we need a new responsibility ethic in our tax system, no incentives for executive compensation that's excessive or moving our plants overseas.


GOLDSTEIN: Bill Clinton - spoiler alert - wins the election and in 1993 decides he's going to make good on that campaign promise and change the tax code.

VANEK SMITH: Here is how the tax code works. If you're a company, to figure how much income you have to pay taxes on, you need to take all the money you make and then subtract your expenses. If you rent office space, you can subtract that. If you buy a bunch of computers, you can subtract that. And all of the money you pay your employees, including the CEO - you can subtract that, too. It's an expense like anything else.

GOLDSTEIN: And with the help of Congress, Clinton made a little change to the tax code. He put a limit on how much CEO pay companies could subtract. He limited how much they could deduct. That limit - $1 million.

VANEK SMITH: So if you pay your CEO a million dollars, you can deduct that as an expense. But if you pay them $2 million or $5 million or $10 million, you can only deduct the first million. It was a nudge from the federal government to pay CEOs less.

GOLDSTEIN: There was also a second nudge in this new part of the tax code, and this one was tied to the idea that that economist Kevin Murphy had been pushing, the idea that CEOs should be paid for performance. That made it into the tax code, too.

VANEK SMITH: Specifically, it is sub-paragraph 4c, perhaps the most important subparagraph in the history (laughter) of taxes. Is that fair to say?

GOLDSTEIN: Sure. Let's say CEO pay.

VANEK SMITH: OK, CEO pay - and that subparagraph says this million-dollar cap does not apply to pay that is tied to performance.

GOLDSTEIN: So the government here is, like, hey, you want to keep paying those multimillion dollar salaries for CEOs just showing up and collecting a paycheck? You're going to pay a tax penalty for that. But you want to try out this new idea, this pay-for-performance thing? We like that. As long as the pay is clearly tied to performance, there is no limit. No matter how much you pay, you can deduct it all.

VANEK SMITH: Bill White remembers when the tax law changed. White at the time was the CEO of a company called Bell & Howell and served on various boards of directors.

>>GOLDSTEIN The law that created this rule - was that a big deal?

BILL WHITE: You know, at the time, it probably didn't look like it. But in retrospect, it was huge.

GOLDSTEIN: Yuge (ph).


WHITE: Well, it was huge because it changed the way that, you know, we compensated our top executives.

VANEK SMITH: Bill says compensation committees, the part of the board that sets the pay for the CEO, looked at this new tax code and said, OK, let's tie out CEO's pay to performance.

WHITE: The compensation committees where I served, you know, immediately starting thinking about how we will change the pay system for our top executive, for our CEO. And the obvious way to move was to move to stock options.

GOLDSTEIN: Because of that law.

WHITE: Correct.

GOLDSTEIN: Stock options - a stock option gives you, as the name suggests, the option to buy a share of stock. So little quasi-real world example, Stacey - let's say you get promoted to be CEO of PLANET MONEY Worldwide Enterprises.

VANEK SMITH: Oh, I'm your boss.

GOLDSTEIN: You're my boss. Don't throw it in my face.

VANEK SMITH: (Laughter).

GOLDSTEIN: So our stock right now is trading at, say, $10 a share, OK? As part of your pay, I'm going to give you one stock option, just one. And this gives you the right to buy one share of PLANET MONEY stock for $10 at some point in the future.


GOLDSTEIN: So now let's say you're doing your job. You're doing great. Stock in PLANET MONEY Enterprises goes up. It goes up from $10 a share to $15 a share.

VANEK SMITH: I want to cash out. How do I cash out?

GOLDSTEIN: You can. So what you do is you use your option. You exercise your right to buy a share of PLANET MONEY stock for $10, and then you turn around and sell it for the market price, sell it for $15. You get to pocket $5.

VANEK SMITH: Which, in Midtown Manhattan will buy me...

GOLDSTEIN: Half a sandwich.

VANEK SMITH: Yeah, half a sandwich (laughter). I want a raise.

GOLDSTEIN: OK, so that is the good-case scenario. That's if things go well, right?


GOLDSTEIN: Say you do a terrible job as CEO of PLANET MONEY. Not that you would, but say you do. Say you launch a 10-part series on the history of the penny. Our stock goes down to $8 a share. Now that stock option at 10 - it is not going to do anything for you. We've effectively tied your pay to the performance of PLANET MONEY Enterprises.

VANEK SMITH: I like this penny idea.

GOLDSTEIN: (Laughter) All right.

VANEK SMITH: (Laughter).

GOLDSTEIN: Anyways, this pay-for-performance idea - it seems sensible enough. And Kevin Murphy, the economist who'd been pushing the idea - his hope was companies would pay CEOs more with options and less through base pay.

VANEK SMITH: And after that law passed, companies did pay more with options. But that other part, the cutting the base pay part...

WHITE: No, that's not going to happen in the real world.

GOLDSTEIN: (Laughter) Why not?

VANEK SMITH: This is Bill White, the former CEO and board member.

WHITE: It's a very nice concept, but if you're on a - if you're a CEO, you're not going to want that happen. And if you're on the board of directors and you have a good CEO, the last thing you're going to do is go to them and say, you know, we're going to take away some of your base comp, no.

GOLDSTEIN: The rise in payments through options - this was not, like, just happening at one company here and another there. It was happening at lots and lots of companies.

VANEK SMITH: Don Delves was a compensation consultant at the time. And before, options payments to CEOs had been growing at a couple percent a year. After Bill Clinton signed that tax law, they exploded. He remembers looking at this one survey in the mid-'90s.

DON DELVES: We looked at the survey and said, oh, my gosh, stock options have gone up by 40 percent. And we were kind of floored. And we said this must be wrong.

GOLDSTEIN: So you're saying you actually looked at this number, and you thought, no, this must be a typo, or somebody must've made a math error.

DELVES: Right, right, yeah. This must be a mistake.

GOLDSTEIN: It wasn't a mistake.

VANEK SMITH: Between 1992 and 1996, average pay for CEOs at 500 of the biggest U.S. corporations roughly doubled from $4 million to 8 million. This is that moment on the chart where CEO pay takes off or when it starts to take off.

GOLDSTEIN: Yeah. After this, it just keeps going up and up and up. And that happens for a few reasons. The first one is kind of surprising. A lot of companies are giving their CEOs a set number of options as part of their pay every year. So say a company gives a CEO a hundred options as part of their pay in, say, 1996. In 1997, there's a good chance that that company is going to give the CEO another hundred options as part of their pay package for that year, which, you know, seems reasonable on its face. But the stock market at the time was going up a lot, and the higher the market got, the more those options were worth. It meant that the value of the pay packages of a lot of CEOs was essentially automatically increasing every year. But there's a second reason that CEO pay took off around this time - way more interesting. I learned it essentially doing the reporting for this story. I asked everybody, you know, why around this time were companies giving out so many options? And they all mentioned this thing that really seems to come down to five words.

BARBARA FRANKLIN: We thought they were free.

VANEK SMITH: We thought they were free - five words.

GOLDSTEIN: This is Barbara Franklin. She has served on corporate boards for decades. She went to Harvard Business School. She's also a former secretary of commerce for the United States of America. And she told me what a lot of people told me. Back in the '90s, almost everybody thought options were free.

FRANKLIN: We thought they were free. That was the bottom line.

GOLDSTEIN: And did you really think they were free?

FRANKLIN: Well, sure.


FRANKLIN: I think we did.

VANEK SMITH: The idea that options were free had nothing to do with that tax law passed under Bill Clinton. It has to do with an accounting rule that had been in place for decades. Under that accounting rule, when companies issued their financial statements, they didn't have to account for stock options the way they had to account for other kinds of pay.

GOLDSTEIN: Yeah. Under that accounting rule, options kind of were free, and you can sort of see why. Like, think about it like this. If you're a company and you pay someone a salary, you write them a check. You are giving them money. That is obviously not free. But a stock option - I mean, a stock option - I don't have to take any money out of the company bank account to give it to you. And if you decide to use it in the future to buy that share of stock, I can just create a new stock for you out of thin air. That also doesn't cost us anything.

VANEK SMITH: Of course, the truth is that does cost something. Stock options are not free. Someone ends up paying, specifically every other person who owns stock in the company. Every time a new share is created, all of the existing shares of stock are worth a little less.

GOLDSTEIN: So if, say, you have a retirement fund, some of your retirement fund is in stock - this extra pay for the CEO, these options - they're coming from you.

VANEK SMITH: Don Delves, the compensation consultant, said he kept trying to explain this to people at the time.

DELVES: First of all, we built this fairly elaborate model to try to show people, look; this is what's happening. You know you're hurting your shareholders. You're hurting the value of the company. You know, they'd look at it, and they'd say, nah, we don't need that. They're really free. The options are really free.

VANEK SMITH: He finally found one company that was willing to listen, that really wanted to understand what was going on.

DELVES: And we took them through it in detail. Look; this is what your stock options are costing you. This is what they're costing your shareholders. And they, you know - they understood it. They understood it. And then we got to the end of the meeting, and they said, well, thank you, but we're still going to go ahead and grant the options.

VANEK SMITH: They said they had to do it because everybody else was doing it.

GOLDSTEIN: Once options took off like this in the '90s, the group that sets the accounting rules for U.S. companies looked at that old rule that made options feel free, and they said, oh, obviously this is wrong, and we're going to change the rule so that companies cannot keep pretending that options are free.

VANEK SMITH: Companies went ballistic. Here is a local news broadcast from 1994 covering a protest in San Jose.


UNIDENTIFIED PERSON #2: If the marching band doesn't get your attention, maybe the signs will. A couple of thousand Silicon Valley workers are fighting mad about losing their stock options because of the FASB, or fazbee (ph).

GOLDSTEIN: FASB is the Financial Accounting Standards Board, that group that wants to change the rules. And all these people are coming out to protest because stock options were not just being given out to CEOs and executives. Especially in the tech industry, they were being given out to lots and lots of workers. And in this news spot, you see people marching with signs that say stock options equal jobs. You see people wearing these red buttons in the shape of stop signs that say stop FASB.

VANEK SMITH: And they did stop FASB. They were enough protests and enough political pressure that FASB backed off. Options were still treated as free, and CEOs kept getting more of them. CEO pay kept going up.

GOLDSTEIN: Yeah, I asked Don Delves, the compensation consultant, what it was like to be doing his job at this moment.

How are you feeling at this point? Like, you're in the middle of this.

DELVES: Right.

GOLDSTEIN: How do you feel doing your job in the late '90s?

DELVES: (Laughter) That's a very good question, Jacob. Let me just think about that for a second - uncomfortable, very uncomfortable.

GOLDSTEIN: Did you feel like because of the job you had, you were contributing to this problem?

DELVES: Yes, absolutely, absolutely, and it caused me great concern.

VANEK SMITH: Kevin Murphy, the economist who had argued that CEOs should get more options, also wasn't feeling so great. He says he felt like a doctor who recommends a glass of wine every night, and suddenly companies are giving their CEOs and their workers a bottle of wine every night and saying, drink up; it's good for you.

MURPHY: I started being worried about watching in real time the largest transfer of wealth from shareholders to workers that we'd ever seen in corporate America.

VANEK SMITH: Average pay for CEOs at big corporations, which had been at $4 million in 1992, hit $19 million in the year 2000. It had almost quintupled in less than a decade.

GOLDSTEIN: And then it stopped going up.


VANEK SMITH: What happened after the break.


VANEK SMITH: Eventually CEO pay did start to come down, and this happened for a bunch of reasons.

GOLDSTEIN: The dot-com bubble popped. The whole stock market plunged, and shareholders finally started noticing and caring about all those stock options companies were giving out. They started saying, hey, that's our money you're giving away.

VANEK SMITH: Suddenly boards of directors were a lot more interested in what Don Delves, that compensation consultant, had to say.

GOLDSTEIN: He remembers this one call he got around this time from a board of directors that was starting to worry about how much they'd been paying their top executives.

DELVES: They came in and they say, can you just show us a little bit? And I said - and so we - you know, they just wanted, like, a five-page report. We gave them a hundred-page report. And we started calling it the holy-shit moment because...

GOLDSTEIN: (Laughter).

DELVES: ...They kept flipping the pages. And each one, they'd go oh, holy shit.

GOLDSTEIN: (Laughter).

DELVES: And then they'd flip the page again and go, oh, holy shit.

GOLDSTEIN: (Laughter) Meaning what?

DELVES: Meaning they didn't realize how vastly overpaid their executive team was and how it had gotten out of control.

VANEK SMITH: That board wound up cutting its CEO's pay in half. And also FASB, the accounting rules people, finally had the support for what they wanted to do. They changed that accounting rule so companies could no longer treat stock options as free.

GOLDSTEIN: The most surprising thing to me in this whole story happens now. Right around this time, CEO pay goes down, which I never would have guessed, you know? I always assumed CEO pay just goes up and up and up forever, but no, when you look at the average pay of the CEOs of the biggest U.S. corporations, it has actually fallen.

VANEK SMITH: From $19 million in 2000 to $12 million in 2014.

GOLDSTEIN: At the end of all the interviews I did for this story, I asked everybody the same question. How do you feel about how much CEOs are paid today? And some of them said well, it depends on the CEO. You know, these people are running corporations that are worth billions of dollars, so somebody who can make that company a little bit better is worth a lot of money. But a lot of the people I talked to did say, yeah, CEOs today - still overpaid.

VANEK SMITH: And to be clear, CEO pay has gone down but not nearly as much as it went up.

GOLDSTEIN: CEO pay today is still much, much higher than it was back in the early '90s.


GOLDSTEIN: Quick data note - the numbers we use in the story for CEO pay - they are adjusted for inflation. They are in 2014 dollars. They are based on CEOs of companies that are in the S&P 500, and they come from Kevin Murphy, the economist we talked to in the story who is now a professor at USC. Don Delves, the compensation consultant in the story - he is still a compensation consultant. He works at a firm called Willis Towers Watson.

VANEK SMITH: We always love to hear what you think of the show. Send us an email - planetmoney@npr.org. Or find us on Facebook. You can give us your two cents.

GOLDSTEIN: Our episode today was produced by Nick Fountain. Thanks also to Brian Dunn, a compensation consultant who I talked with for the story but did not make it into the show. I'm Jacob Goldstein.

VANEK SMITH: And I'm Stacey Vanek Smith. Thanks for listening.

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