The Arithmetic of Avarice

Sam Pizzigati

How much do America’s big-time corporate CEOs make? Such a simple question, right? Not quite. Economist Larry Mishel has been working to get the answer right — for decades. And now Mishel, a former president and currently a distinguished fellow at the Washington, D.C.-based Economic Policy Institute, has just released his latest take on the corporate pay universe, a set of newly revised stats that track the past half-century of executive compensation.

Media coverage of Mishel’s dramatic new numbers, prepared with researcher Jori Kandra, has mostly focused on the top exec pay figures EPI is showing for last year.

“Average CEO pay increased 14% in 2019 to $21.3 million,” announced the CNBC headline over the network’s report coverage. The Fox Business lead picked the same numbers: “CEOs at the top 350 firms in the US were paid $21.3 million on average last year, a 14% increase over the year before, as top executives continue to see their compensation skyrocket.”

But the new 2019 CEO pay stats tell only part of the story Mishel and Kandra have to tell. Their most valuable contribution comes from the detailed historical context they provide: CEOs today aren’t just pulling down phenomenal sums. They’re pulling down phenomenally more than top execs used to pocket.

How phenomenally? Between 1978 and 2019, EPI calculates, the CEOs of America’s top 350 corporations realized — after taking inflation into account — an amazing 1,167 percent increase in their compensation. Worker pay after inflation averaged a miniscule 13.7 percent increase over the span of the same 41 years.

The new EPI calculations also reveal that the gap between executive pay decades ago and executive pay today is running even wider than previously thought. What explains this expanding gap? What’s made accurately calculating executive pay so devilishly difficult? A simple structural reality: Top execs today don’t get most of their pay from their paychecks.

Most of the rest of us, of course, do get most of our compensation from our paychecks. Add up the numbers on our paycheck stubs and you have the annual income we earn from our jobs.

Corporate chiefs, to be sure, do get paychecks. They all have fixed annual salaries. But these salaries account for just a small fraction of the compensation corporations bestow upon them. CEOs get the vast bulk of their pay — 79 percent last year — in the form of stock-based compensation. For top execs, this stock-based compensation has worked out wonderfully. For statisticians, this stock-based compensation has created nothing but endless headaches.

The problems come whenever analysts try to pin a dollar value on the stock-based compensation that top execs are receiving.

Some of this compensation comes as stock options. These options give executives the right to buy their company’s shares in the future at the current price, the price at the moment of the option award. If their firm’s share price increases, top execs can “exercise” their option to buy shares at the old low price and then sell them at the higher new one, snatching a tidy personal profit in the process.

So how should analysts value these stock options? The standard accounting practice has been to assign these options a “fair value” at the time companies hand them out. That fair value gets calculated via a formula that tries to forecast what options will eventually help executives clear.

But execs — in real corporate life — regularly clear far more than these “fair value” calculations. So Mishel and other analysts have rejected the traditional accounting route and have instead been including options in a CEO’s annual pay only when the options become “realized.”

Companies, meanwhile, seem to be moving away from awarding stock options. They’re increasingly awarding their execs outright shares of stock. These grants typically only take full effect — “vest” — several years after they initially get awarded.

Stock grants also raise valuation problems. Let’s say a CEO this year gets a grant of 100,000 shares currently worth $100 each. The shares will vest in three years. Before this year, the EPI approach to calculating annual CEO pay figures would have credited the current value of these shares — $10 million — to the exec’s 2020 compensation.

But what if these shares, when they vest three years from now, turn out to be worth $150 each? In that case, the exec will have gained another $5 million that goes unrecorded.

EPI’s new approach to calculating executive pay fixes this problem. The Institute is now only including the “realized” value of both stock options and stock grants in its calculations. And EPI’s new report applies this new methodology to CEO pay figures back over four decades.

This new EPI methodology has produced the stunning 1,167 percent increase in CEO pay noted above, the after-inflation explosion in big-time CEO pay since 1978. Under the previous EPI methodology, this increase would have been a still striking but smaller 1,033 percent.

The gap between the results the old and new methodologies generate has grown more pronounced as stock grants have made up a larger share of annual CEO pay. Under the previous EPI methodological approach, CEO pay at the nation’s top 350 companies rose 36 percent between 2009 and 2019. The new EPI methodology, with its focus on realized pay for both stock options and stock grants, shows that CEO pay increased at almost triple that rate, at 105 percent.

All this talk about methodology, unfortunately, can add to the confusion around executive pay. America’s top execs love this confusion. They can use it to distract attention from the windfalls they continue to receive, even during a pandemic that has the American economy reeling.

One example: This spring, top execs across the United States proudly announced they would be significantly cutting their salaries during the coronavirus crisis. How noble of them, exclaimed corporate PR departments!

Actually, not particularly noble at all. Salaries, remember, make up just a small piece of total executive compensation. Execs can cut their salaries and still end the year with higher total compensation. Disney executive chairman Bob Iger, for instance, has been refusing his salary paychecks since the end of March. For Iger, no big deal. His 2020 salary, the research firm CGLytics reports, equals just 3.3 percent of his total 2019 compensation.

Lawmakers could be doing plenty to end the confusion around executive compensation and discourage executive pay excess, and the new EPI corporate pay report helpfully lists a variety of promising approaches to getting executive pay under control, including tax hikes on companies where the ratio between CEO and worker pay has become clearly excessive.

How many major corporations have clearly excessive chief executive pay levels? Just about all of them. In 2019, the new EPI numbers show, big-time CEOs averaged 320 times more pay their average American workers. The ratio in 1978: 31.4 times.