Investors and CEO Pay: The Fix Is Still In

In this election season, reining in Wall Street is clearly a burning issue for many voters. The passion for Wall Street reform is closely wrapped up with working class anger and anxiety driven by wage stagnation and economic insecurity, all within a climate of accelerating wealth and income inequality. When it turns out that median wages and household incomes are still lagging behind pre-recession levels while the bailed-out banks have flourished and virtually all of the income gains generated by our economy in recent years have accrued to the top 1 percent, led by financial elites, you have a crystal clear case for the argument that our economy is “rigged.” Millions of Americans rightly have the feeling that our economy has become something close to a zero-sum game set up by the rich for their own benefit alone, using rules of their own making. 

The solution that speaks loudest to today’s popular anger is to “break up the banks.” In fact, much of the current debate on financial reform, on and off the campaign trail, continues to focus on the “too big to fail” problems, namely, the regulatory problems around reducing systemic risk, in order to prevent future crashes and bailouts. While breaking up the big banks may be necessary, at some point, for ending “too big to fail” (it might also be a good idea for other important reasons, like reducing the big banks’ political power), such an approach would probably do very little to remedy how Wall Street is rigging the wider economy, and it is no panacea for the problem of accelerating inequality. Yet, if breaking up the banks is not the answer for inequality, this doesn’t mean that financial system reform, targeted in other ways, is not absolutely critical from the standpoint of equity. Reining in Wall Street in other ways may in fact be the single most effective answer for reducing inequality. But, in order to get there, we need a different starting place in our analysis, focusing on how Wall Street has come to control, or distort, large parts of the non-financial “real” economy of production, wages, and employment, a problem that Demos and others term financialization. Rana Foroohar’s analysis in her essential new book Makers and Takers maps out the substantial scope of financialization, finding that as much as 85 percent of the dollars in our economy are tied up with finance in one way or another; Wall Street takes about 25 percent of corporate profits while creating only 4 percent of American jobs, for example. 

Software entrepreneur-turned-investor Stephen Silberstein is one leader who is putting the pieces together. A vocal and active supporter of raising the wage floor, through the Fight for $15 and other minimum wage campaigns (and also as executive producer of the documentary Inequality for All, starring Robert Reich), Silberstein is now taking the fight to the heart of Wall Street, BlackRock Inc., to challenge the other side of inequality: extreme CEO pay. Silberstein had previously spearheaded an unsuccessful legislative effort in California targeting CEO pay by tying state corporate income tax rates to the pay ratio between a firm’s CEO and its median worker (i.e. lower rates for firms with lower pay ratios). But as a shareholder in BlackRock, the world’s largest investment management company, with approximately $4.6 trillion in assets (by comparison, the mighty California Public Employees’ Retirement System [CALPERS] manages about $300 billion in assets), Silberstein saw that CEO pay could also be targeted by the voting power of investors, which has been boosted in small but not insignificant ways through the Dodd-Frank banking reforms and other laws passed in the wake of the financial crisis. [Full disclosure: Mr. Silberstein is a supporter of Demos, where I am research director].   

As Gretchen Morgenson recently reported in the New York Times, when Silberstein learned that BlackRock, which is invested in approximately 15,000 companies, voted yes on CEO compensation packages at a rate of 96 percent in the year between July 1, 2014, and June 30, 2015, seemingly a virtual rubber stamp, he decided he needed to take action. (Shareholders’ “Say on Pay” was established in a provision of Dodd-Frank). While BlackRock’s CEO pay approval rate is mostly comparable with other big investment firms like Fidelity and Vanguard, pension funds and socially-responsible funds such as Domini and Calvert typically vote ‘yes’ on CEO pay far less frequently. New York City’s municipal pension funds, for example, have voted ‘yes’ at a rate of only 33 percent in recent years. As Morgenson points out, perhaps BlackRock is so friendly to CEO pay because its own executives get paid just as well if not better than many of the CEOs they are supposed to be monitoring. BlackRock Chairman and CEO Larry Fink was given compensation of $26 million in 2015, an 8 percent increase, compared to the company’s net income gain of only 2.7 percent, Morgenson notes. 

It’s no wonder that investors are starting to get active in corporate governance around CEO pay and other issues: the situation has truly spiraled out of control, with the CEO-to-worker pay ratio in America’s biggest companies standing at nearly 300:1 in 2014, compared to 30:1 only a few decades ago. As Demos has shown, things are even worse in low-wage sectors. In the fast food industry, the ratio is closer to 1000:1, which painfully reflects how corporate inequality is particularly detrimental for people of color and especially women of color, who are disproportionately employed in fast food and other low-wage sectors.

Such inequality at the firm level mirrors and is also a driver of the larger inequalities we see across society, even as skyrocketing CEO pay has also become less and less correlated with firm performance. So, in other words, it is bad for both workers and investors simultaneously. Even worse, the majority of CEO pay is now provided not in cash wages but in various forms of corporate equity, a trend (driven by changes in corporate income tax policy passed in the 1990s) which has ended up grossly distorting management incentives in favor of strategies often solely designed to boost short-term share price. Ironically, Larry Fink, who apparently almost never sees a CEO pay package he doesn’t like, has been an outspoken critic of the most destructive of these short-term strategies, “share buybacks”—that is, when a company purchases its own shares out of the open market, almost always with the intent of raising its share value and price by shrinking the pool of outstanding shares.         

If share buybacks are not exactly (or entirely) the big smoking gun linking financialization to inequality (William Lazonick’s essential and widely covered research on share buybacks has sometimes been interpreted in this way), the numbers are truly staggering and far from immaterial to rising inequality and other serious economic problems. Undoubtedly, the rapid escalation of share buybacks among publicly traded U.S. companies since the practice was given “safe harbor” from SEC anti-fraud provisions in 1982 is not merely a symptom of the growing divide between financial interests and the real economy. Rather, share buybacks are clearly a driver of this growing divide, pitting short-term shareholders and equity-rich managers against long-term enterprise strategies that raise costs in the short term, such as workforce investments and research for innovation. Indeed, according to recent research from the National Bureau of Economic Research and the University of Illinois, managers who buy back their own company shares in order to achieve earnings targets they otherwise would have missed trade off opportunities to invest in capital, workers, and R&D. Windfalls for shareholders and declining innovation, wages, and employment stability for everyone else are the result. 

In the wake of the Great Recession, debates about financial reform policy have downplayed Wall Street’s extractive dynamics in the real economy of production, jobs, and wages, instead, as noted above, emphasizing concerns about risk and volatility in the banking sector itself. The massive, mostly unchecked flow of corporate earnings to shareholders in recent years reflects this extractive logic, in a policy context and political environment of permissive abandon in favor of narrow elite interests. Between 2003 and 2012, according to Lazonick’s research, approximately 90 percent of corporate earnings in the S&P 500—which supports about one-third of U.S. jobs—went to shareholders. In 2014, S&P 500 companies spent over $553 billion on share repurchases, approximately 58 percent of the group’s total earnings for the year. When combined with $350 billion spent on dividends (now the secondary vehicle for shareholder payouts), firms spent a record $904 billion—95 percent of earnings—returning cash to shareholders in 2014. Strikingly, Apple, which we normally think of as an innovation-driven company, is at the top of the list for share buybacks in 2015 and 2016.  

Sane investors, let alone responsible ones, should be doing more to help America put a stop to these destructive financialization trends. Larry Fink and other critics of financial short-termism and especially share buybacks should join forces with Senators Tammy Baldwin and Elizabeth Warren (and hopefully the next president as well), who are putting a spotlight on the practice, potentially toward the goal of forcing SEC policy changes that would close the safe harbor and re-regulate open market share buybacks as a form of price manipulation. Another approach could be to reverse the trend toward equity compensation by changing the tax incentives that have driven the trend, thereby possibly de-linking share buybacks from executive self-interest. Next month, Stephen Silberstein will take up the fight against extreme CEO pay on the voting floor in BlackRock’s annual shareholder meeting, with a proposal requiring BlackRock’s board to come up with a new framework and rationale for determining whether pay is linked to performance and for determining BlackRock’s advisory votes on CEO pay. BlackRock tried to stop the proposal, but the SEC ruled that the proposal should get a vote.

While Silberstein’s idea of establishing a new framework for investor accountability on CEO pay is only one step in the right direction, it could help to change an environment in which Wall Street and big business are encouraged and enabled by the existing rules and related incentives to effectively collude in taking most of our economy’s wealth for themselves, at a huge social cost and even at the risk of their own businesses.