Beyond Fairness: Skyrocketing CEO Pay Is Bad for Our Economy

July 16, 2015

Next week marks the 5th anniversary of the Dodd-Frank Wall Street Reform and Protection Act. While the law has made some solid strides toward regulating Wall Street (with the creation of the Consumer Financial Protection Bureau arguably the most potent and popular), there is still much work to be done, particularly in the realm of CEO pay reform.

From 1978 to 2014, executive compensation at American firms rose 997 percent, compared with a sluggish 10.9 percent growth in worker compensation over the same period.

While CEO pay continues its determined ascent up a seemingly limitless mountain of stock options and other performance pay, the SEC has yet to implement all of the Dodd-Frank rules designed to reform CEO pay practices. The Say-on-Pay provision, which allows shareholders an advisory vote on proposed executive compensation packages, has been in effect since 2011, and Section 954—the clawbacks provision—should soon be finalized. But the SEC continues to delay the disclosure rule on CEO–worker pay gaps, as well as a few other key provisions.

This raises a few obvious questions: Why is it so important to urge the SEC to implement these CEO pay reform rules? Does it really matter how much CEOs are paid? Isn’t this debate really just about people being jealous of, for example, former Oracle chief Larry Ellison and his Hawaiian island?

Hardly. We have to stop talking about the CEO pay issue in terms of fairness, which usually leads to accusations of envy. This conversation just doesn’t get us very far. The truth is that skyrocketing CEO pay is terrible for our economy for two reasons, as we explain in the infographic below.

To elaborate, the problems are as follows:

1. How CEOs Are Paid

The current trend in how CEOs are paid, particularly with stock options, creates a range of economic problems. Several studies show that equity-heavy pay, because it makes executives very wealthy very quickly, distorts CEOs’ incentives, inducing them to take on too much risk. Instead of bearing this risk themselves, they shift it onto the rest of society, as we saw during the financial crisis. This model also encourages executives to behave fraudulently, as in the backdating scandals of a decade ago, and lessens their motivation to invest in their businesses. In addition, according to economist William Lazonick, in order to issue stock options to top executives while avoiding the dilution of their stock, corporations often divert funds to stock buybacks rather than spending on research and development, capital investment, increased wages, or new hiring. To top it all off, these pay packages cost taxpayers billions of dollars due to the performance pay tax loophole instituted by President Clinton.

2. How Much CEOs Are Paid

In addition to its problematic structure, the sheer volume of CEO pay creates an array of economic problems. A handful of high-profile economists—Thomas Piketty, Joseph Stiglitz, and Robert Reich, to name a few—have begun to make the case that a high degree of economic inequality precipitates financial instability because it leads to, for example, a decline in consumer demand, which has tremendous spillover effects in terms of investment, job creation, and tax revenue, not to mention social instability.

The growth of executive pay is a core driver of America’s rising economic inequality. According to the Economic Policy Institute, “[e]xecutives, and workers in finance, accounted for 58 percent of the expansion of income for the top 1 percent and 67 percent of the increase in income for the top 0.1 percent from 1979 to 2005.” Another calculation by economists Ian Dew-Becker and Robert Gordon finds that the large increase in the share of the top .01 percent is mostly explained by the incomes of superstars and CEOs.

Dodd-Frank’s anniversary should remind us that we still have a long way to go to rein in ever-increasing CEO pay, including instituting key provisions like the CEO–worker pay gap. If we move the CEO pay debate beyond the rhetoric of fairness and envy to a conversation about its costs, we could galvanize the public around this issue. The evidence is clear: skyrocketing CEO pay is not just an ethical problem; it’s also simply bad economics.