The Secret of High CEO Pay and Other Mysteries of the Corporation

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Former Disney/ABC CEO Michael Eisner remains a poster boy for runaway greed in the corporate suite…with total pay approaching well in excess of a trillion dollars for his years at the helm. Just from 1998 thru 2000 he pocketed $680 million, high even by US CEO standards. He left the company in 2004. (See our related story: Michael Eisner vs. Vietnamese Laborers, for further details on this rather typical business tycoon, and The Best Temp Gig in History, below, our second feature.)

By Dean Baker | [print_link]

According to the conservative nanny state mythology (both the creationist and intelligent design variants), corporations were set on the earth at the same time as humans. They peacefully co-existed in the state of nature until the government stepped in and tried to interfere with the natural order by doing things like regulating and taxing corporations. The nanny state conservatives want the government to step back and allow corporations a freer hand to do what comes naturally: make profits. They rant about the threat posed by government regulation, and even worse “double taxation” – the fact that corporate profits are taxed when corporations earn the money, and then also taxed when they are paid out as dividends to shareholders.

The mythology may be moving, emotionally and politically, but it suffers both as a historical account and in its logic. To get a realistic view of the relationship between the government, corporations, and society, it’s necessary to discard the conservative nanny state mythology about the origins of corporations and apply a little common sense. However painful it may be to the nanny state conservatives, a serious discussion must begin with a basic truth: the corporation does not exist in a free market, it is a creation of the government.

Why Governments Create Corporations

The fact that corporations are a creation of the government is not debatable. In the absence of government intervention, individuals are free to do any sort of business deals they want. They trade goods, buy and sell labor, lend money, form partnerships, and engage in an almost infinite variety of transactions. But they cannot form a corporation – a legal entity that exists independently of its owners. This requires the government.

Corporations are a great invention of government. They make it possible to raise vast amounts of capital for major business ventures like building car factories, laying telecommunications lines, or operating an airline. Corporations can raise capital far more effectively than business partnerships because the government gives them the privilege of limited liability. This means that the owners of the corporation, its shareholders, only stand to lose what they have invested in a company’s stock. They cannot be held personally liable for any debts of the company if the company ends up in bankruptcy.

This means, for example, that if a company that engages in accounting fraud, like Enron or WorldCom, ends up owing its suppliers and creditors billions of dollars more than its assets can cover, the individual shareholders do not risk losing their homes or bank accounts. Their only loss is what they invested in Enron stock. The same principle applies to companies that may have destroyed their workers’ health by exposing them to asbestos, while 39 concealing evidence that the material was extremely dangerous. Stockholders also don’t have to worry about their personal assets if General Motors, Ford, or United Airlines can’t make good on their commitments to their workers’ pensions and retirement health care benefits. They can only lose the money that they have invested in the company’s stock, and not a penny more.

If these companies had merely been groups of individuals, not corporations with stockholders, then all of the owners would be personally liable for making good on contractual commitments that they had made and the damage they had caused. They could be forced to surrender their home, their personal assets, and their savings in order to pay off debts resulting from their business operations. It takes a conservative nanny state to create an institution, like a corporation, that allows investors to cause harm and not be held accountable.

Historically, the government issued charters of incorporation only to advance specific public purposes. In England, a company could only gain a charter of incorporation through a special act of Parliament. These charters were usually issued to companies involved in the building and maintenance of transportation routes. In the 18th century this typically meant canals and turnpikes. In the first half of the 19th century, railroads were the main recipients of charters of incorporation. Parliament also gave charters of incorporation to the big trading companies that England established to promote trade in its colonies: the British East India Company and the South Sea Company. England did not have laws setting out general rules of incorporation until 1844. Prior to that point, a company seeking corporate status had to apply for a special act of Parliament.

The United States adopted laws creating general rules for incorporation somewhat earlier, with New York leading the way in 1811.1 The states had originally accepted the English approach to corporate status, restricting it to companies that were felt to be performing a specific public purpose. However, a burst of industrialization around the War of 1812 created an environment in which many companies wanted the benefits of corporate status in order to make it easier to raise capital.

The logic of creating general rules of incorporation actually directly followed the prior logic of granting corporate status only for specific purposes. The basis for setting general rules under which anyone can establish a corporation is that there is a general public interest in promoting wealth, and corporations exist to increase wealth. Therefore, the government is granting a special privilege in order to advance a public good. 

The Gift Giver Gets to Set the Rules

The gift of limited liability is a hugely valuable benefit from the government to corporations and their shareholders.2 The immediate evidence for the value of corporate status is the money raised from the corporate income tax ($278 billion in 2005).3 The corporate income tax is an entirely voluntary tax. The government does not force anyone to establish a corporation. Any group of individuals engaged in a business operation are free to organize themselves as a partnership, which would not require them to pay the corporate income tax, they would only be liable for individual income taxes. The fact that businesses have voluntarily chosen to organize themselves as corporations means that they view the benefits of corporate status to be greater than the burden of the corporate income tax. All of the country’s major corporations (or their shareholders) have effectively voted with their feet. They all believe that the benefits that the conservative nanny state gives them by allowing them to establish corporations must be at least as large as the taxes that the government imposes on corporations.

The fact that the government is giving something of great value when it allows firms to incorporate is very important when considering the rules that the government imposes on corporations. In effect, the rules placed on corporate conduct are part of quid pro quo involved in establishing a corporation. The reason that the government allows individuals to form corporations is that it wants to facilitate economic growth, but the government will be less effective in promoting this goal if it does not put in place the right set of rules for corporate governance.

As it stands, there are already extensive sets of rules regarding corporate governance. The government imposes a long list of requirements on corporations regarding issues such as financial disclosure, elections of corporate boards, and protection of minority shareholders. Most of these rules are not controversial; they are seen as laying the groundwork for the effective operation of a modern market economy. There would be few people anxious to buy shares in a company if they couldn’t obtain financial information on the company and have some assurance that its reported profits, assets, and liabilitieswere accurate measures of its financial situation. In the same vein, if the majority of shareholders (or whoever happened to take control of the company) were able to seize the wealth of the company, and leave nothing for the rest of the shareholders, few people would want to risk buying stock. Government rules on corporate governance prevent such events, and thereby give the public assurance about the soundness of investing in shares of stock.

This is useful background in thinking about high CEO pay. What is it that allowed Michael Eisner to earn $680 million in the years from 1998 to 2000 when he was the CEO of the Disney Corporation, or Robert Grasso to pocket $140 million from running the New York Stock Exchange? The conservative nanny state crew wants us to believe that it was their incredible skill and hard work that allowed these CEOs to earn such vast sums. The more obvious answer is that badly designed rules of corporate governance allow CEOs to pilfer large amounts of money from the corporations they manage, because there is no one with both the interest and power to challenge them.

CEO pay has exploded in the last quarter century, rising far more rapidly than either the pay of typical workers or the overall rate of productivity growth. The average pay of a corporate CEO was less than 40 times the pay of a typical worker in the late seventies. This ratio rose to 300 to 1 at the peak of the stock bubble in the late nineties, as the value of compensation packages heavily laden with stock options went through the roof. But even as the stock market has fallen back to more reasonable levels, CEO pay is still close to 200 times the pay of a typical worker.4

This explosion in CEO pay is not tied in any obvious way to their effective management, even by the narrow measure of increasing corporate profits. A recent study that examined the pay of the top five executives in 1500 corporations found that the pay over the period 1993-2003 increased almost twice as rapidly as could be explained by profit growth or other standard measures of corporate success (Bebchuk and Grinstein, 2005).

Furthermore, this explosion in CEO pay is almost exclusively an American phenomenon. There has been no comparable increase in CEO pay in Canadian, European, or Japanese corporations. The pay of CEOs in the United States in 2003 was 2.5 times the average pay of CEOs in Canada, more than 3 times the pay of CEOs in France, and almost five times the average pay of CEOS in Japan.5 It would be difficult to argue that foreign corporations have been poorly managed by incompetent CEOs in an era in which they have managed to seize market share from their U.S. competitors in the auto industry, the aerospace industry, and other large sectors of the economy.

CEO pay in the United States has exploded for the simple reason that CEOs largely get to write their own checks. CEO pay is determined by corporate compensation boards, most of the members of which are put there with the blessing of the CEOs themselves. Usually the CEOs have a large voice in determining who sits on the corporate boards that ultimately have responsibility for the operation of the corporation. These corporate boards then appoint a committee that determines CEO pay. In effect, we allow the CEO to pick a group of friends to decide how much money he should earn. When they are sitting on the boards of corporations that control tens of billions of dollars in revenue, their friends are likely to be very generous. 

In principle, the shareholders can organize and put in place directors who will take a harder line on CEO pay, but organizing shareholders is a very time-consuming process, it’s just like running a campaign for public office. Furthermore, most corporate charters stack the deck against anyone seeking to challenge management’s plans. They allow the company to count stock proxies that are not returned as votes in support of management’s position. This hugely tilts the scales in any election in favor of management. It is comparable to allowing political incumbents to count all the people who don’t turn out to vote as voting in their favor. Few challengers would win elections under these rules. Similarly, there are not many occasions where outsiders can overturn corporate management’s decisions, especially on something like CEO pay, which will not make that much difference on the bottom line.6 It’s much easier to just sell the stock if you don’t like what’s going on.

Interestingly, the nanny state conservatives do believe that there are situations in which seemingly democratic institutions can produce unfair outcomes. The nanny state conservatives have launched efforts nationally, and in several states, to change the terms under which union officials can use members’ funds in political campaigns. Under the law, it is illegal to use union dues for political campaigns, however, unions can use voluntary contributions from their members for this purpose. Unions often assess their members’ fees for the union’s political action committee. Under many contracts, these fees can be directly deducted from workers’ paychecks, but they are refundable to members who request that their money not be used for political campaigns.

Many nanny state conservatives have argued that this arrangement is not fair to union members, since many may object to having their money used for political campaigns, but may not be willing to take the time and effort to get a refund. The nanny state conservatives argue that the union should only be able to get money from members who have explicitly indicated that they want the union to get their money. This switch, from the default being that the union gets the money to the default being that the union doesn’t get the money, would probably have a substantial impact on the amount of money collected.

The extent to which this switch would affect the ability of unions to be important actors in political campaigns is not important in this context, what is important is that the nanny state conservatives are very much aware of how changes in the ground rules can affect the balance of power. In a world where corporate CEOs can virtually write their own paychecks, there is something seriously wrong with the balance of power. 

To redress this imbalance, we can just steal an item from the nanny state conservative’s agenda. They called their measure to require unions to get explicit permission from workers to deduct money from their paycheck for political campaigns the “paycheck protection act.” In the same vein, to keep a rein on CEO pay, it would be a simple matter to require that the pay packages for the top 5-10 executives be submitted to shareholders at regular intervals for approval. In this vote, share proxies that are not returned would not count, so that the pay package would actually have to win majority approval among those voting.7 Perhaps Michael Eisner would still be able to earn hundred million dollar paychecks with these new rules, but the deck would be less heavily stacked in his favor.

There is a better argument to require this sort of shareholder majority voting rule than for the paycheck protection act. After all, union officers are directly or indirectly elected by a democratic vote of their members, in which non-voters do not count. Also, it is much easier to sell stock than change jobs.

Since workers will be reluctant to change jobs, union members who are unhappy with the way their union is run have far more incentive to get involved than do shareholders who are unhappy with the way their corporation is run.

There would seem to be a much more pressing need to rebalance the scales in corporate elections than in union paycheck deductions – that is, if the nanny state conservatives were actually concerned about matters of principle. But the more important issue is that the government can and must set the rules for corporate governance. The government creates corporations and sets the rules under which they operate. This is essential, and, as noted earlier, is for the benefit of the corporations themselves. No one would buy shares in a corporation if he or she thought that the management was free to simply steal their money.

For a variety of reasons, the mechanisms that once placed a check on the ability of corporate management to pilfer money for its own use have broken down. This may be partly attributable to the spread of share ownership, so that instances where a single family maintains control of a major corporation (and therefore can keep its management in line) are less common. It may also be partly attributable to changing morals in the larger society, so that unchecked greed is more acceptable. But the causes of the breakdown don’t matter as much as the remedies. And the most effective remedies are changing the rules to ensure that CEO power is held in check.

It is possible that the requirement that all CEO pay packages must be stated explicitly and approved by a majority of shareholders would not be sufficient to rein in CEO pay. There are additional measures to help rein in CEO pay; for example, corporations could tie incentive pay, such as stock options, to the performance of the industry group as a whole. There is no reason that the CEO of Exxon-Mobil deserves a huge pay increase because the price of oil has tripled, sending the price of Exxon-Mobil stock through the roof along with the stock price of all other oil companies. For some reason, the idea that CEO performance can be best judged in comparison with a reference group has apparently not occurred to most executive compensation committees.

In the same vein, it might be reasonable to cap total stock-linked compensation, or impose a schedule that is likely to limit truly exorbitant payouts. It is possible that some CEOs will walk away if they know that their compensation from their work is limited to $50 million a year, but there are probably not too many CEOs in this situation. Similarly, if compensation packages were structured so that CEOs only got half of the gain on their stock options once they passed $20 million, or one-fifth of the gain once they passed $50 million, most CEOs would probably still take the job.

The key to containing CEO compensation is not laws from Congress that mandate lower pay; the best route is changing the rules that determine the accountability that corporate directors have to shareholders. Congress has changed these rules often in the past. For example, in 1995 it passed legislation that made it more difficult for shareholders to sue corporate directors or officers for stock manipulation, in effect substantially increasing the power of corporate management relative to its shareholders.8 If the law explicitly stated that corporate boards have an obligation to contain CEO pay to market levels, and that directors could be held personally liable for failing to take this responsibility seriously, then the growth of CEO pay would likely be much lower in the future. This would not involve the government stepping in and determining CEO salaries. Rather, shareholders would use the courts to obtain compensation from corporate directors who did not take their responsibilities seriously, and who wrote a blank check to the CEO.

Of course, it is also important to keep in mind that any changes in corporate governance would be voluntary for shareholders. If the new rules prove unacceptable to them for whatever reason, they would have the same option that they have now to reconstitute their business as a partnership and apply whatever governance rules they consider best. But if they want the privileges that the government grants to corporations, then they have to be prepared to abide by the rules that the government sets.

Moving Beyond Double Taxation

Once we recognize that granting corporate status is a benefit granted by the government to shareholders, then the whining of the nanny state conservatives about double-taxation takes on a very different appearance. There is no “double-taxation” taking place. The corporate income tax is essentially a fee that shareholders pay the government in exchange for the benefits of corporate status. If they don’t feel that the benefits of corporate status are as large as the income tax that the corporation must pay, then they are free to reconstitute their corporation as a partnership. Every corporation that does not become a partnership has opted to pay the corporate income tax rather than surrender the privileges of corporate status.

It is understandable that shareholders do not want their corporations to pay tax, and they don’t want to pay taxes on their dividend and capital gain income. Most people would rather not pay tax at all. People would also rather not pay for their food, electricity, or home mortgage. But in the real world, there are no free lunches. If the government collects less money from corporate taxes, then it must collect more money through other taxes. The corporate income tax is a relatively progressive tax, since taxes on corporate profits come primarily out of the pockets of shareholders, and stock is held disproportionately by the wealthy. It also has the advantage of being voluntary, since no one is forced to hold shares in a corporation. Given that the government needs revenue, a voluntary progressive tax like the corporate income tax is probably a good place to start.

This is an excerpt (ch. 3) from the book The Conservative Nanny State by Dean Baker. Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He is co-author of Social Security: The Phony Crisis (with Mark Weisbrot, University of Chicago Press, 1999), coauthor of The Benefits of Full Employment (with Jared Bernstein, Economic Policy Institute, 2004), and author of The History of the United States Since 1980 (Cambridge University Press, forthcoming 2006). He received his Ph.D. in economics from the University of Michigan. His blog, Beat the Press, provides commentary on economic reporting. The Conservative Nanny State is available as a free PDF download or in HTML format at .


1 The adoption of general laws of incorporation is discussed in Blackford (1998) and Horwitz


2 Limited liability is not the only benefit of corporate status. The corporate structure allows shareholders to freely come and go in a way that would not be possible with a partnership (the other partners may place restrictions on when and how a partner could dispose of her interest in the partnership). The corporate structure also allows individuals to preserve anonymity in a way that is not often possible in a partnership. This can allow individuals to invest in ways that they may not want publicly known, for example, owning shares in companies that distribute pornography or sell tobacco. Corporate share ownership allows anonymity in ways that are not in general possible in a partnership.

3 Congressional Budget Office (2006, Table 4-2). 41

4 These data are taken from Mishel et al. (2005, Figure 2-25).

5 Mishel et al. (2005, Table 2.47).

6 Even the highest CEO salaries tend not to be very large relative to corporate revenue or even corporate profit. For example, in the years from 1998-2000, when Michael Eisner pocketed $680 million as CEO of Disney, after-tax profits of the Disney corporation were almost $11 billion. This means that if Eisner’s pay had been reduced by 90 percent, it would have only boosted profits by 6 percent. This increase is not trivial, but Eisner’s compensation package was extreme, even in a world of hugely inflated CEO pay.

7 Actually, it would be a reasonable policy to require that all proxy votes be decided by a majority of those voting. Management always enjoys a substantial advantage in access to information, the ability to disseminate information to shareholders, and setting the timing of proxy votes. There is no obvious justification for also giving them the benefit of the votes of those who do not take the time to return their proxies. Ensuring that key corporate decisions and officers better represent the shareholders could lead to better corporate management. It might also be reasonable to require that long-term employees gain representation on corporate boards, but that is an issue best left for another book.

In 1995, Congress passed the “Private Securities Litigation Reform Act,” which made it far more difficult to prove a case of stock price manipulation; essentially, the law required actual evidence in the form of a conversation or written document showing that an officer or director had actively manipulated the stock price. Patterns in the movement of stock prices and stock transactions by specific officers or directors would not be a sufficient basis for a suit. The bill was vetoed by President Clinton, but Congress overrode his veto.


The best temp gig in history

Posted Sep 30 2008, 12:47 PM by Kim Peterson

Congress wants to crack down on CEO mega-salaries for banks participating in the bailout. And while the politicians argue how best to do that, Alan Fishman of Washington Mutual is headed for the doors with $19 million in his pocket.

If that wasn’t outrageous enough, consider this: Fishman started the job three weeks ago. I never saw the employment ad Fishman answered, but it must have read something like this:

WANTED: Top executive for train-wreck bank about to be seized by federal regulators. Must be able to look busy while FDIC sells business from under you. Previous experience with angry shareholders sitting on worthless stock a plus. Perks: $7.5 million hiring bonus and $11.6 million cash severance.

Fishman got the best temp gig in history. He gets to keep the bonus and severance pay, though he must stay on the job while JPMorgan Chasecompletes its purchase of WaMu’s banking assets.

To be fair, Fishman wasn’t the one that took WaMu down a path lined with toxic mortgages and other bad assets. No, that role belonged to former CEO Kerry Killinger, who received $54 million over five years before leaving earlier this month. He’s eligible for around $20 million in severance pay.

Other execs are also cashing in big. President Stephen Rotella gets $12.7 million in cash if he’s terminated or quits with “good reason,” according to the Portland Business Journal. And CFO Thomas Casey would get a cash severance of $6.3 million.

And WaMu shareholders got huge payments of…oh, wait. The stock is worthless. Shareholders got wiped out. 

Related reading:

As banks broke down, CEOs cashed in

Bailout, shmailout. Executive pay still safe 

CEO pay crackdown is toothless


This is just nuts! why do CEO and CFO get rewarded for screwing things up. I understand that Alan Fishman just started this job with WaMu and is not to blame for the downfall, however why should be be given such a large amount of money for basically being in training. Why not give the shareholders of WaMu stock that money.. they deserve it more than him, or the previous CEO.


Senator – CEO – Senator – CEO – and so on

It’s merry go round so you will never see the legislature do anything to limit CEO pay. Each one of them is waiting for a return to COE type positions and wont act to limit their own greed. The best example is Cheney. I have to think Haliburton will have a cushy mega million a year position waiting for him when his tenure as VICE-president ends (emphasis on the VICE). The rest of us are just sources of income to these elitists.

I tell ya all the bailout money shouldn;t even be seen by the senate or the congress it should go straight to the people. Then let the people pay the banks and the governemnt and the big businesses. They pay the banks what they owe them and taxes and what ever is left over they keep. In case of a recession.

Kent I couldn’t agree with you more.. Take the 700 billion or more and give an amount to everyone that has a total yearly income of 100k or less.. Then we could pay off loans, credit card debt and spend some to stimulate the economy.

Why bail out companies who only have themselves to blame for the situation they are in. Give me the money and other citizen and let us spend it.

This is the only country in the world that so richly rewards thieves and liars. Of course I suppose that shouldn’t come as a huge surprise. Look to our leader! What a joke! Can’t wait to hear what history has to say about this clown!

The greed of company executives is what really has gotten us to this point, the bad mortgages are secondary…just a result of their self-centered greed.

Perhaps another great depression would get us all motivated enough to revolt, build some guillotines, and….off with their heads!

Bet there are more qualified people who are able to do what fishman has done!!!!!!! think small business owners with college mbas running small closely held corporations and have less than 25 employees! i’m one but don’t hobnob or go to bed with the corporate elite (ho’s). but for a temp like that i’d seriously think about it. i’d like to be the pok-er than the pok-ee, at least once more, for a mega buck golden parachute.

That Alan Fishman is a good man…He got my back.

And Barney Frank gets a pass because he’s a Democrat?  We only elect scumbags again and again because we really don’t want honesty and integrity.  Let’s see, Kennedy(Chappaquitic), Pelosi (Red China), Cheney(he was supposed to be the VICE president, not the boss), Bush(yikes), Kerry(stab your buddies in the back), Gore(invented the internet, Gates) – what a bunch of self-interested clowns.  But we elect them again and again, and wonder why the state of affairs is always getting worse.  They’re in bed with the “executives” and are plenty fat.  You reward bad behavior, what do you think youll keep getting.

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