Justice in Executive Compensation

There is a growing consensus that the top executives of our corporations appear to be overly compensated and that something needs to be done about this. The Federal Reserve chairman, Alan Greenspan, has spoken about infectious greed in American corporate leadership.Business Weekhas pointed out that while rank-and-file wages increased over the last decade by just 36 percent, pay for chief executive officers climbed 340 percent. The magazine commented, When C.E.O.’s can clear $1 billion during their tenures, executive pay is clearly too high. A commission appointed by the business-oriented Conference Board has similarly noted the public’s anger over excessive executive compensation. It argued that limits must be instituted in order to restore the confidence that the American public has lost in corporations.

Executive compensation is often criticized as too highsometimes even called obscene. But is it immoral or sinful? While I am not prepared to label it sinful, I believe that Catholic social teaching offers insights into how we should look at, evaluate and even limit executive compensation.


Two Asides

Before turning to the basic issue, there are two matters that should be mentioned. First, regardless of whether high salaries are in themselves sinful, it seems clear that they can present a temptationan occasion of sin, as we used to say. The biggest corporate scandals of the last few years resulted from situations in which corporate managers reaped immense rewards when it appeared that their companies would continue to be profitable. Managers yielded to this temptation by cheating in ways that made the business appear more profitable. This temptation to inflate the apparent profitability of a company should in itself be a reason to consider limits on executive compensation.

Second, executive compensation should be reported and accounted for properly. It appears that even Jack Welch (no relation), often cited as a paragon of corporate leadership, was not properly reporting all the perks he received as C.E.O. of General Electric. Further, tax laws do not currently require that corporations record stock options as expenses. When the Financial Accounting Standards Board recommended a few years ago that this be changed, business interests in Congress exerted pressure to prevent such a change. Any discussion of executive compensation must start with the assumption that compensation will be reported accurately and accounted for properly.

Principles of Social Justice

Jesus taught us that we will be judged by how we treat the least of our brothers and sisters. Catholic social teaching emphasizes such values as solidarity and the common good. The U.S. bishops have told us that we should judge an institution by how it treats the least of its members. Applying these principles to compensation suggests that executive salaries should be judged by how they compare to the lowest salaries in the same companies. To begin, however, I would suggest that we first look at the average salaries (rather than the lowest ) in a corporation and limit executive compensation to some multiple of that average.

Estimates indicate the C.E.O.’s of large American corporations make 400 to 500 times the compensation of average workers. This is up from about 42 times the average compensation in 1980 and 15 to 20 times the average compensation in Japan and Germany today. Business Week quotes both Plato, who suggested that no one in a community should earn more than five times the income of an ordinary worker, and Peter Drucker, who in the 1980’s argued that no leader should make more than 20 times the lowest-paid employee.

Let’s assume that we would limit the compensation of American C.E.O.’s to, say, 100 times the compensation of the average worker in their companies. Data from the Bureau of Labor Statistics suggest that for the manufacturing industry this would give C.E.O.’s a salary of roughly $5 million per year. In finance, this figure would be close to $6 million and in retail trade closer to $2.4 million. While this would be a big reduction for some people, certainly it is not a bad living. Most C.E.O.’s would be able, at that rate, to provide for themselves and their families and save something for retirement and to pass on to family heirs as well.

If we applied the same limits to all American companies, we would have no need to worry about competing for the best people, because everyone would be working under the same limits. As the data above suggests, we would also not need to worry about competition from abroad, since these limits would bring us back in line with the rest of the world.

Limits would create an incentive for executives to move companies in directions that would ultimately benefit both those who work there and those who contribute to their success. To take one example, it would reward executives for building companies with a solid long-term future. And this would not diminish executives’ responsibility to shareholders; they would still have to satisfy the shareholders or risk losing their jobs. C.E.O.’s would also continue to feel an incentive to help their business make money. The more money the business makes, the more opportunity there will be for C.E.O.’s to increase their earnings. This would, however, require C.E.O.’s to share the success of the company with all the employees. The better they all do, the more the executives can be paid.

We Can Do It

Can we really do this? Could we put such a cap on what corporations are allowed to pay their executives? Yes. There is no legal reason why we could not. But while the impediments are purely political, they are also serious. It is the very people who earn these colossal salaries who give large amounts of money to politicians in both parties. They would undoubtedly resist limits in every way possible. It would therefore take a consensus of an overwhelming majority of Americans to change the current system. Still, since almost all Americans would benefit by such an arrangement, it should be possible.

While an absolute cap would be the best approach, there are other alternatives to which we could turn as a beginning. Tax incentives are one approach that have been used in similar situations. Such incentives limit the extent to which certain expenses can be declared as deductions for income tax purposes. In fact, tax law now limits to $1 million the amount of an executive’s salary that a corporation can deduct as an expense for tax purposes. Thus, while a corporation can pay an executive $1.5 million, it can deduct only $1 million of this when calculating its income tax liability. (Deductions are an incentive because they reduce the taxes that companies pay.)

The problem with the current limit is that it excludes stock options. This is one reason companies have relied on them so heavily. We could, of course, amend the tax law and require that stock options be included under the $1 million limit. But what I am suggesting is more modest. All compensation would be treated the same, and the total could not exceed 100 times the pay of the average worker in the company. Any amount in excess would not be tax deductible. This falls short of an absolute limit but nevertheless creates a strong incentive, allowing companies to exceed the limit when they think it necessary but forcing them to think long and hard before doing so.

At the very least we should require corporations in their annual reports not only to publish the total compensation paid to executives but also to show how these figures compare with the average compensation of all employees. Investors, employees, unions and customers could then judge for themselves whether companies were behaving appropriately. Also, charitable organizations, churches and pension plans and investment funds that strive to invest in socially responsible companies could use this information as an investment criterion.

Principles in Practice

Christian principles and the more specific teachings of the Catholic Church give us a beautiful description of the kind of social justice for which we should aim. But such principles are useless unless we put them into practice in our social, political and economic lives. If we take these principles seriously, we should look to them to guide our society in dealing with social and economic issues.

In this particular case, Catholic social teaching may offer a solution to a problem that bedevils many parts of our society. The business community is trying to regain the public’s confidence after an embarrassing series of bank scandals. And politicians are being hounded to do something in response to the corporate scandals. One of the most basic teachings of Christ is that we will be judged by how we treat the least among us. Why not start by evaluating business leaders by what they do for everyoneinvolvedin their enterprise?

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11 years 11 months ago
The artwork by Bill Tsukuda for the article on “Justice in Executive Compensation,” by Edward M. Welch, (5/19) resembles the Anasazi energy wheel symbol. I wonder if power and energy are visualized similarly by different generations and tribal groups.


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