Fairness Dictates That Workers Should Be Paid More

The size of executive compensation pay packages seems to be an issue at least once a year after information is provided on the average CEO compensation versus the average pay for a worker. It's not just a fairness issue. Every so often we hear about a CEO who was involved in financial fraud or a coverup leaving the company with a huge pay package. This is a right versus wrong issue.

A case in point is Boeing Co's disgraced CEO, Dennis Muilenburg, who left the company with $62 million in compensation and pension benefits, but received no severance pay, in the wake of the 737 MAX airline crashes. He knew about the safety problems but ignored them. The size of his pay package did not reflect his failure to admit to the safety problems, even in front of Congress, and fix them right away after the first crash rather than after a second incident. The total number of dead was 346. The failures at Boeing serve as an example of corporate irresponsibility.

When is Enough, Enough?

The annual Executive Paywatch Report, a comprehensive database tracking CEO-to-worker pay ratios for over 20 years, reveals that S&P 500 CEOs averaged $18.3 million in compensation for 2021—324 times the median worker's pay, and higher than both 2020's pay ratio (299-to-1) and 2019's ratio (264-to-1). This means the average worker earns about $56,482 using the 324:1 metric.

The size of pay packages in 2021 is stunning. The top five earners in total compensation, including salaries, cash bonuses, and stock options, were: (1) Peter Kern (Expedia Group) $296m; (2) Andrew Jassey (Amazon) $213m; (3) Patrick Gelsinger (Intel) $179m; (4) William McDermott (Service Now) $166m; and (5) Tim Cook (Apple) $99m. This raises the ethical question: There appear to be no limits on how much some CEOs get paid.

The Tax Excessive CEO Pay Act of 2021

It's no wonder there is an effort underway to tax corporations on excessive pay packages. Introduced in the U.S. Senate on 03/17/2021 as S.794 (The Tax Excessive CEO Pay Act of 2021), this bill increases the current 21% income tax rate of corporations whose ratio of compensation of their principal executive officers or other highest compensated employees to median worker compensation is more than 50 to 1, in which case the increase is 0.5%. The bill has been read twice and referred to the Committee on Finance for further action.

The Tax Act is designed to reign in what many believe is out of hand pay packages. It is up to the board of directors to approve pay packages but in most cases the board simply goes along with what the CEO wants. Shareholders can voice their displeasure about the size of pay packages, but it is just advisory and has no force in law. It is an expression of discontent.

“Say-on-Pay”

The checks and balances in the system come from the board of directors that make the final decision on CEO compensation. If the board approves a specific pay package, then regardless of the (excessive) amount of compensation, the pay packages meet corporate governance standards, although pressure oftentimes exists from institutional investors to change those standards.

Investors have a right to exercise a “Say-on-Pay vote” on the compensation of the top executives of the company – the CEO, the Chief Financial Officer, and at least three other most highly compensated executives. (These are called the “named executive officers.”) Companies are not required to use any specific language in asking for shareholder approval. Instead, each company has the flexibility to craft the exact language of the non-binding resolution that its shareholders will vote on.

The Harvard Law School Forum on Corporate Governance issued a report, CEO Pay Proposals Face Growing Investor Disapproval, and found that investors rejected CEO compensation proposals through Say-on-Pay votes at a record rate in the 2021 proxy season, even though pay remained flat in FY2020. This is good news but there needs to be a change in corporate governance to make these votes more than advisory.

IRS Notice 2018-68 

On August 21, 2018, the IRS issued Notice 2018-68 with guidance on changes made to the tax deductibility of executive compensation under Internal Revenue Code Section 162(m), particularly as regards performance-based awards. Stricter limits on deducting executive pay were part of the Tax Cuts and Jobs Act, passed at the end of 2017.

Section 162(m) prohibits publicly held companies from deducting more than $1 million per year in compensation paid to senior executive officers. The tax act removed an exemption for commission- and performance-based pay. This is important since corporations have been using these performance-based measures to skirt the $1 million amount. The legislation also expanded the scope of covered individuals to include CFOs, along with an organization's CEO and three highest-paid employees, beginning in 2018.

"The exemption for performance-based compensation turned out to be a far bigger loophole than had been imagined" when Section 162(m) was enacted in 1993, explained John Lowell, a partner with October Three Consulting in Atlanta. "Many companies saw this as a license to offer base pay of $1 million to their CEO while offering incentive pay—some only very loosely incentive-based—without limits while taking current deductions."

Worker Dividends

Recently, some efforts have been made to level the playing field regarding executive compensation and average worker pay. As I have previously blogged about, France has used a worker dividend over the years to promote profit-sharing. The benefits range from increased production to higher worker motivation.

Here is how a “workers dividend” would work. For every $1 million passed on to shareholders in the form of stock buybacks or dividends, corporations would have to pass on $1 to every worker. All public corporations would be required to pay it. This may not be the answer to the fairness issue but does illustrate that it goes beyond the U.S.

The Problem with Stock Buybacks

Stock buybacks benefit large shareholders and corporate executives, whose pay packages include significant stock compensation. Over the past decade, corporate stock buybacks have soared. Corporations use stock buybacks to withhold profits from workers, and instead keep more and more profits for their CEOs and Wall Street investors. On July 3, 2019, Senator Sherrod Brown (D-OH) introduced legislation to require profit-sharing with workers in the form of a dividend for workers. Unfortunately, it hasn’t had any traction in Congress.

According to Senator Brown, “Wall Street is obsessed with shareholder equity, but workers have equity in a company, too – it’s called sweat equity, and it’s time workers are rewarded for it. “Corporate greed is fundamental to the Wall Street business model – we know that. Workers aren’t going to get their fair share until we change it – we know that too. My proposal is simple: if corporations want to transfer wealth to Wall Street, workers have to get a proportionate share of the pie.”

Profitable companies have long had the option of kicking cash to shareholders in the form of dividends. Buybacks were simply a new tool to accomplish that same goal, and in many ways, they were a better tool because for much of that period, the capital gains tax rate was lower than the dividend tax rate.

Why? There are two reasons. One is that it puts cash in the hands of those shareholders who choose to sell in the buyback. And two, it decreases the number of shares, potentially hiking up company’s share price.

Ethical Concerns

Shareholder skepticism for executive pay packages reflects an ethic of fairness. How can CEOs make so much when the average employee makes so little – and the disparity shows no sign of decreasing any time soon.

It’s a shame that Congress relies on new legislation to reign in the ever-growing appetite of CEOs for executive compensation. In an ideal world, the CEOs and boards of directors would be at the forefront of leveling the playing field. The workers deserve greater compensation. However, the disparity between that and CEOs probably will not change without legislation. It’s time to better reward workers who, after all, are the heartbeat of any organization.

Blog posted by Dr. Steven Mintz, The Ethics Sage, on November 29, 2022. You can sign up for Steve’s newsletter and learn more about his activities on his website  (https://www.stevenmintzethics.com/) and by following him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.