Executive compensation in the United States

Based on Wikipedia: Executive compensation in the United States

In 1978, a typical chief executive officer at a major American company earned about forty times what their average worker made. By 2018, that multiple had exploded to roughly three hundred and twelve times. The chief executive's pay had grown by nine hundred and forty percent over those four decades, while the typical worker's compensation crept up by just under twelve percent.

That gap is not a typo. And it represents something genuinely unprecedented in the history of capitalism.

The Anatomy of a Pay Package

Before we can understand how executive pay reached these heights, we need to understand what executives actually get paid. It turns out to be far more complicated than a salary.

A typical compensation package for a chief executive at a large publicly traded company includes several distinct components. There's the base salary, which is often capped at one million dollars for tax reasons we'll explore later. Then come short-term bonuses, usually tied to annual performance targets. Long-term incentives typically arrive as stock options or restricted shares. On top of all that, executives receive enhanced benefits packages, including something called a Supplemental Executive Retirement Plan, along with various perquisites—the corporate world's term for perks like company cars and club memberships. Many packages also include substantial deferred compensation, money set aside to be paid out later.

Forbes magazine estimated that for Fortune 500 chief executives in 2003, roughly half their total compensation came from cash pay and bonuses, with the other half arriving through vested restricted stock and gains from exercising stock options.

The complexity serves a purpose. Each component has different tax implications, different timing, and different ties to company performance. An executive might negotiate for years over the precise formula that determines their bonus, the vesting schedule for their stock grants, or the guaranteed payments they'll receive if they're fired.

The One Million Dollar Limit That Wasn't

Here's an interesting piece of regulatory history. In 1993, Congress passed a law limiting the tax deductibility of executive compensation to one million dollars, unless the pay above that threshold was "performance-based." The thinking was straightforward: if companies wanted to pay their executives more than a million dollars, fine, but the taxpayers wouldn't subsidize it through tax deductions unless those payments were genuinely tied to performance.

The law had an unintended consequence. Rather than constraining executive pay, it helped transform it.

Companies responded by restructuring compensation packages to qualify as "performance-based." Stock options became enormously popular because they seemed to fit the requirement perfectly—the executive only made money if the stock price went up, which theoretically meant shareholders were benefiting too. Base salaries at large companies settled right around one million dollars, while the real money moved into bonuses and equity compensation.

Some of the most successful corporations in America took this logic to its extreme. Google, Apple, Capital One Financial, and Pixar all paid their chief executives a base salary of exactly one dollar. Everything else came through options, bonuses, and other forms of compensation. This wasn't corporate altruism—it was tax optimization combined with public relations.

The Principal-Agent Problem

To understand why executive pay has proven so difficult to control, you need to understand a concept economists call the "principal-agent problem."

In most large American corporations, the people who own the company—the shareholders—are different from the people who run it—the executives. The shareholders are the "principals" who theoretically call the shots. The executives are the "agents" who act on their behalf.

But here's the problem. The agents know vastly more about what's actually happening inside the company than the principals do. They control the information flow. They set the agendas for board meetings. They recommend their own compensation packages. And their interests often diverge sharply from those of the shareholders they supposedly serve.

Ideally, executive pay would be set through what economists call "arm's length" negotiation—the executive trying to get the best possible deal while an independent board of directors fights to protect shareholder interests. In practice, the arms are often not very long at all.

Board members frequently owe their positions to the chief executive who nominated them. Executive compensation consultants, hired to provide objective advice, know that their next engagement depends on keeping executives happy. The entire system is riddled with conflicts of interest that tilt the playing field toward higher pay.

When Bonuses Aren't Really Bonuses

The word "bonus" suggests a reward for exceptional performance. Something extra, earned through extraordinary effort.

In the world of executive compensation, the word has lost much of that meaning.

In 2011, ninety-seven percent of American companies paid their executives bonuses. When nearly everyone gets a bonus, it's not really a bonus anymore—it's just another component of expected compensation.

The formulas that determine bonuses often get rewritten when executives are in danger of missing their targets. At Coca-Cola in 2002, when executives failed to hit their annual earnings growth target of fifteen percent, the company simply lowered the bar to eleven percent. The practice became more common after the 2008 financial crisis. When the economy struggled, so did company performance—but executive bonuses somehow kept flowing.

Consider this remarkable case. In 2011, the chief executive of Alpha Natural Resources oversaw the company's biggest annual loss in history. The compensation formula set by the board said he shouldn't receive a bonus. He received half a million dollars anyway, justified by his "tremendous" efforts to improve worker safety.

Perhaps even more creative was Verizon Communications' approach in the 1990s. The company used pension fund earnings as the basis for executive bonuses—money that existed only on paper as projected future returns on pension investments. When the actual corporate earnings were negative, executives could still point to pension fund "income" to justify their bonuses. Verizon once transformed a three billion dollar loss into one point eight billion dollars of pension income by projecting optimistic future returns of nine and a quarter percent on pension assets. That paper income then got added to actual operating results to turn a corporate loss into a two hundred eighty-nine million dollar profit—and justify executive bonuses.

The Stock Option Revolution

Stock options became the defining feature of executive compensation in the 1990s and 2000s. The concept seems elegant: give executives the right to buy company stock at today's price sometime in the future. If the stock goes up, they profit. If it goes down, the options are worthless. Their interests are perfectly aligned with shareholders, or so the theory goes.

The largest stock option grant ever given to an employee was probably the package amassed by William McGuire, the chief executive of UnitedHealth Group. By 2004, his accumulated options were worth one point six billion dollars. He later returned a substantial portion as part of a legal settlement involving questions about how the options had been dated.

That legal settlement hints at one of the problems with options. Executives found ways to game the system.

Some companies engaged in "backdating"—selecting grant dates retroactively to give executives a lower strike price than they would have received with honest timing. Others timed the release of good or bad news to maximize the value of option grants. Since executives controlled the information flow, they could often manipulate stock prices in ways that benefited their compensation packages.

The legendary investor Warren Buffett was blunt about the situation. "There is no question in my mind," he said, "that mediocre CEOs are getting incredibly overpaid. And the way it's being done is through stock options."

Research supported his skepticism. A study of companies in the S&P 500 found that those relying heavily on stock options to compensate employees actually underperformed in share price compared to those that didn't.

The Golden Hello

One of the more peculiar features of executive compensation is the "golden hello"—a massive signing bonus paid to lure an executive from a rival company.

The logic behind these payments is straightforward. An executive at Company A has accumulated valuable stock options that will be forfeited if they leave before they vest. Company B wants to hire them. To make the move worthwhile, Company B has to compensate for those lost options. The result is an upfront payment that can reach staggering sums.

Gary Wendt received forty-five million dollars when he joined the insurance and finance company Conseco as chief executive in June 2000. Kmart promised ten million dollars to Thomas Conaway. Global Crossing gave Robert Annunziata a ten million dollar signing bonus in 1999—none of which he was required to return, even though he held the position for only thirteen months.

Perhaps the most cautionary tale involves Ron Johnson, whom J.C. Penney hired with a signing bonus of fifty-two point seven million dollars in company shares. During his tenure, Penney's stock price dropped by fifty percent. He was fired seventeen months later.

The practice has accelerated. In 2012, forty-one companies made upfront payments to top executives. By 2013, that number had risen to seventy.

The Numbers in Perspective

Let's step back and look at the aggregate picture.

Between 1993 and 2003, the share of corporate income devoted to compensating just the five highest-paid executives at each public company more than doubled—from four point eight percent to ten point three percent. The total compensation paid to the top five executives at each of America's largest fifteen hundred companies over the decade from 1994 to 2004 is estimated at five hundred billion dollars in 2005 dollars.

In 2012, Larry Ellison of Oracle earned ninety-six point two million dollars, making him the highest-paid chief executive in America that year. The top two hundred executives collectively earned three billion dollars. The median cash compensation was five point three million, with median stock and option grants adding another nine million.

Six years later, in 2018, the record had been shattered. Elon Musk earned two point three billion dollars in total compensation from Tesla—though most of that came through stock options tied to extraordinary performance targets that the company ultimately met.

By 2020, even amid a global pandemic, median pay for executives at three hundred of the biggest American companies reached thirteen point seven million dollars, up from twelve point eight million the year before. The highest paid chief executive on the S&P 500 was Chad Richison of Paycom. For companies not on that index, Alexander Carp of Palantir Technologies and Tony Xu of DoorDash each earned packages valued at over one billion dollars.

It's Not Just the CEO

The explosion in executive compensation extends well beyond chief executives. About forty percent of Americans in the top one-tenth of one percent of income earners are executives, managers, or supervisors—and that figure excludes the financial industry entirely.

For context, management occupations make up less than five percent of the working population. Yet they account for forty percent of the very highest earners. Something about the American economy has tilted dramatically toward rewarding those at the top of corporate hierarchies.

Mutual fund pioneer John Bogle calculated that between 1980 and 2004, total chief executive compensation grew at eight and a half percent annually—compared to corporate profit growth of just two point nine percent and per capita income growth of three point one percent. Executive pay was growing nearly three times faster than the profits of the companies they ran and the incomes of the workers they employed.

By 2006, the typical chief executive at a large company made four hundred times what the average worker earned. In 1965, that multiple had been just twenty to one.

Why This Matters

The debate over executive compensation isn't just about fairness, though fairness certainly enters into it. Critics argue that the system distorts corporate decision-making in dangerous ways.

When executives can earn fortunes through short-term stock price increases, they have powerful incentives to boost those prices by any means available—even if those means harm the company's long-term health. Accounting can be made "aggressive." Costs can be cut in ways that save money this quarter but create problems next year. Risks can be taken that offer big rewards if they pay off, with someone else left holding the bag if they don't.

The Enron scandal became a symbol of these perverse incentives. Executives there became fabulously wealthy by manipulating earnings per share, which Fortune magazine noted "can be manipulated in a thousand unholy ways" to inflate stock prices temporarily.

There's also the question of what economists might call allocative efficiency. When so much corporate income flows to executives, less remains for investment, for worker wages, for research and development, for the thousand other uses that might make companies more productive and the economy more prosperous.

And then there's the simply human question of what it does to a society when the people at the top earn hundreds of times what everyone else makes. The gap between executives and workers has become a central fact of American inequality, shaping politics, culture, and the basic fabric of social trust.

Public and Private

One important distinction often gets lost in discussions of executive pay: the difference between publicly traded and privately held companies.

At a privately held company, there are no public shareholders to worry about, no Securities and Exchange Commission filings to make, no stock options in the traditional sense because there's no publicly traded stock. The owner can pay executives whatever they want, and it's nobody else's business.

The controversy centers almost entirely on publicly traded companies, where management and ownership are separate, where executives are supposed to be working on behalf of shareholders who have entrusted them with their savings. These are the companies subject to disclosure requirements and regulatory oversight.

The regulations have grown more stringent over the decades. The Securities and Exchange Commission now requires detailed disclosure of executive compensation in standardized formats. The one million dollar deductibility limit, whatever its unintended consequences, represented an attempt to use tax policy to influence pay practices. Various rules govern how stock options must be accounted for and disclosed.

Yet the pay has kept climbing. The regulations seem to have changed the form of executive compensation far more than its level.

The Uncomfortable Question

At the heart of all this lies an uncomfortable question that economists and policy makers have debated for decades: Is executive pay set by genuine market forces, reflecting the scarcity of world-class managerial talent? Or is it primarily the result of a broken system where executives effectively set their own pay?

Those who defend current pay levels argue that the market for executive talent is intensely competitive. Companies that underpay will lose their best people to rivals willing to pay more. The stratospheric compensation simply reflects what it costs to attract and retain the rare individuals capable of running complex global enterprises worth billions of dollars.

Critics counter that the evidence doesn't support this story. Pay has risen far faster than company performance. Many highly paid executives have presided over disasters. The correlation between pay and results is far weaker than the market theory would predict. What looks like a competitive market, they argue, is actually a clubby system where boards populated by other executives approve pay packages that set precedents for their own future compensation.

The truth likely contains elements of both perspectives. There probably is genuine competition for executive talent, and that competition probably does drive some of the increase in pay. But the system also has features—the conflicts of interest, the information asymmetries, the complexity that obscures what's really happening—that allow pay to drift far above what any truly competitive market would produce.

The question that haunts discussions of executive compensation is ultimately not just about money. It's about power—who has it, how they use it, and whether our economic institutions are working for everyone or only for those at the very top.