Executive Pay and the 'Market Economy'

It's pretty hard these days to justify astronomical executive pay. In
2007, the average CEO's pay of $10.5 million was 344 times higher on
average than the average worker's wage, according to Executive Excess
2008, a joint report from the Washington, D.C.-based Institute for
Policy Studies and Boston-based United for a Fair Economy. The top 50
private investment fund managers each took home more than 19,000 times
the average worker's earnings.

But never fear, Jack and Suzy Welch -- the former high-flying CEO of
General Electric and his wife, the former editor of the Harvard
Business Review -- are willing to defend high executive pay by return
to first principles and invocation of "the market economy." In a recent
issue of Business Week, they write, "Yes, most CEOs make a ton of
money, and sometimes they make too much, but in a market economy
salaries are set by supply and demand. We also live in a market economy
where companies that field the best teams win, and, because of global
competition, the best teams tend to be expensive."

There are several decisive rebuttals to this claptrap.

First, there is no plausible market-based story why executive pay
should have been bid up so much over the past quarter century. Are
executives working harder now? Making better decisions? Has the CEO
supply and demand equation changed?

Second, executive pay is not set by the market, but by boards of
directors, who frequently are CEO cronies and excuse their behavior by
relying on conflicted compensation consultants.

Third, the most super-high compensation packages are typically based on
performance standards, with executives cashing in on stock options as
share values rise. But this is a system easily gamed, with those same
shares sold before short-term thinking leads to medium-term losses. By
way of example, consider the massive pay packages obtained by the
ousted CEOs of the now-floundering Wall Street firms.

And now comes a new analysis that further debunks the market-based
rationalization for ridiculous CEO compensation levels. Executive
Excess 2008 shows how taxpayers are helping foot the bill for these
outrageous compensation packages.

Executive Excess 2008 highlights five distinct U.S. tax subsidies for
executive pay. These are actually market distorting, in that they let
top executives and investment fund managers take home more than they
would if they played by the same tax rules as regular people.
Altogether, Executive Excess 2008 reports, the five tax loopholes heap
$20 billion in subsidies on the corporate and hedge fund honchos.

* The hedge fund manager loophole, involving what is called "carried
interest," enables investment fund managers to treat most of their
salaries as capital gains, and to pay taxes at the capital gains rate,
rather than the ordinary income tax rate. Annual cost to taxpayers:
$2.6 billion.

* The pensions for the rich loophole. While regular people can place a
maximum of $15,500 in 401(k) plans -- deferring taxes until they
withdraw the money -- CEOs can place unlimited amounts in deferred pay
plans. Annual cost to taxpayers: $80 million.

* The offshoring loophole. Although companies cannot deduct the expense
of executive compensation in deferred accounts, this is no problem for
businesses registered in offshore tax havens. Set up an offshore
subsidiary, and you can deduct the deferred income from revenue. Annual
cost to taxpayers: $2 billion.

* The greed loophole. Money spent on wages and salaries are deducted
from corporate revenues, and is not taxable. For top executives,
however, U.S. tax rules impose a limit: corporations cannot deduct
salaries and compensation that is more than "reasonable." An effort to
define reasonable as $1 million has been entirely circumvented -- and
corporations can, in effect, deduct whatever they pay CEOs. Annual cost
to taxpayers: $5.2 billion.

* The double-standard loophole. Stock options -- the right to buy stock
at a preset value, at a later date -- are now a huge component of
executive pay. For their internal accounting, corporations value stock
options using the value of the stock on the date of the option grant.
For tax purposes, however, they can deduct the generally much higher
value of the stock on the date the options are exercised. In other
words, they can deduct more than they list as their expense. Annual
cost to taxpayers: $10 billion.

Not long ago, it was possible to argue that executive pay was an
important but symbolic issue. But then it became clear that
ever-escalating executive pay is creating a culture of greed that is
fueling income and wealth inequality. And now it has become clear that
executive pay schemes are contributing to corporate practices harmful
not only to workers, consumers, communities and the environment, but to
corporations themselves, and even to the functioning of the economy.

The foolish and inexcusable housing-related investments by Wall Street
firms, Fannie Mae and Freddie Mac resulted in no small part from
executive compensation-driven efforts to drive up short-term stock
values. These decisions were so bad, and of such enormous scale, that
they have endangered the functioning of the financial system itself,
thereby necessitating government intervention and massive taxpayer
expenses -- an indirect but even more expensive taxpayer subsidy for
executive compensation.

A "market economy" indeed.