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News from EPI Curbing CEO pay will require a broad policy toolkit, including measures to empower shareholders

In a new paper, Dean Baker, Senior Economist at the Center for Economic Policy Research, Josh Bivens, Research Director at the Economic Policy Institute, and Jessica Schieder, Federal Tax Policy Fellow at the Institute on Taxation and Economic Policy, argue that recent proposals to rein in excessive CEO pay are welcome, but need to be accompanied by measures to reform corporate governance and give shareholders and other stakeholders leverage to restrain exorbitant pay packages.

The explosive growth of CEO pay in large firms has been well documented, with CEOs at the top 350 firms earning 312 times more than a typical worker in 2017. Excessive CEO pay has a sizeable effect on inequality, not only because a large amount of money goes to a very small group of individuals, but also because it affects pay structures throughout the corporation and the economy as a whole. Shareholders should have the clearest interest in keeping CEO pay down, as these salaries come directly out of a firm’s profits..

“Shareholders could be a powerful ally in the fight against high CEO pay and growing inequality,” said Bivens. “They have as much reason as anybody to want to rein in CEO pay. We just need to give them the policy tools to do it.”

Importantly, weak corporate governance that blunts shareholders’ incentives and ability to police managers’ salaries has been a primary enabler of high CEO pay. Once elected, board directors are too-often more concerned with maintaining their board positions—which pay well for very little work—than with advocating for the best interests of shareholders. The larger group of shareholders that these directors are supposed to be representing is not well positioned to hold corporate boards accountable. Policymakers, the authors argue, should look for ways to empower shareholders to push back against lavish executive pay packages.

“Conventional wisdom says that corporations have to do what’s in the best interest of their shareholders but when it comes to pay, corporate executives and board directors are just looking out for themselves” said Baker. “Boards will keep offering over-the-top compensation packages to stay in CEOs’ good graces until shareholders are given a say in the matter.”

For example, while the law requires that every three years companies hold a “say-on-pay” vote in which shareholders can vote on the pay package provided to the company’s top executives, the vote is nonbinding, so it can be difficult to rally shareholders in a say-on-pay vote. The authors suggest strengthening these rules so that board directors lose their stipend for the year in the event that shareholders vote down a proposed pay package. Directors would stand to lose hundreds of thousands of dollars, and the risk might cause them to be more careful about rubber-stamping exorbitant pay packages. Smaller executive pay packages could also be incentivized by giving board directors the opportunity to share half of the savings from cutting the pay of CEOs and other executives.

“The evidence shows that tax penalties enacted so far have not effectively reined in CEO pay, as boards just add the penalties to the cost of doing business,” said Schieder. “But if tax penalties get really large and shareholders are shown how they are harmed and are given the power to do something about it, then we might make some real headway.”

Current proposals to restrain CEO pay lean heavily on changing tax policy to increase the incentive for shareholders to discipline this pay. Greater incentives are a useful part of the policy toolkit to address CEO pay, but they need to be matched by reforms that increase shareholders’ ability to restrain pay as well.