How US CEOs are being cut down to size by investors

Allister Heath
HERE is a finding you won’t have read elsewhere. The total pay of top CEOs in listed US firms has gone down – yes, gone down – by about 50 per cent in real terms since peaking in 2000-01. This is what Steve Kaplan, professor at the University of Chicago Booth School of Business, reveals in brilliant research. This is the opposite of what has happened in the UK, where total FTSE 100 CEO pay has gone up substantially (to close to US levels, which used to be much higher, when adjusting for firm size). Those interested in the debate on pay currently raging in the UK need to familiarise themselves with what is actually happening in the US, rather than with the caricatures of deranged excess and greed.

The total dollar pay of S&P 500 CEOs is down by over half. The share of these top bosses’ pay is also down: it peaked in 2001 at 0.55 per cent of the top one per cent of incomes; it is now down to around 0.28 per cent, a share last seen in 1994. Others have increased their share of the top one per cent, including investors, investment bankers (until recently), lawyers, athletes, entertainers and so on. The average profit per partner at top US law firms has more than doubled during the time that the average S&P 500 CEO’s pay has halved, closing the gap.

The data marshaled by Kaplan is striking. In 2009, the latest year for which data is available, the top 25 hedge fund investors earned over $25bn; all 500 S&P CEOs combined earned $4.4bn (including salary, bonus, restricted stock and the value of options exercised).

Kaplan also took a look at the Forbes 400 list of richest Americans: he found at least 89 investors (of which 27 hedgies, 33 private equity and 29 property); 136 entrepreneurs, of which 77 founded their firm after 1970 and 59 before 1970; and just nine non-founder CEOs or employees, most of whom made their money from options at flotation and with just four who joined their firms after flotation.

What about pay and performance? This has improved noticeably on a three-year measure. There is a decent correlation between total CEO pay and the S&P 500. Dirk Jenter and Katharina Lewellen have found that in the first five years in the job, the bottom fifth of performers are 42 percentage points more likely to depart than CEOs in the top quintile. This increases to over 70 percentage points for firms with the best boards.

More surprises include findings by Jon Bakija, Adam Cole and Bradley T Heim that there have been larger pay increases for executives of private, closely-held businesses than executives of publicly-held businesses with a dispersed shareholder base. In other words, the US story is not about out-of-control CEOs in listed firms running rings around their lily-livered investors; it is about profound economic forces, not failures of corporate governance. Kaplan says “boards are doing a much better job than press, activists, shareholders and politicians let on. Pay is largely market driven.”

Yet America is hardly immune to rewards for failure, with CEOs walking away with vast amounts having bankrupted firms, or being given crazy payoffs. As I have written in the past, such practices are wrong and must be stamped out. But in the US at least, the situation is improving. British politicians and shareholders ought to study these academic papers – and learn from them.
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