Pay: Employees Are Real Story
Once again, the season of revealing executive paychecks at major U.S. corporations has brought outcries about wretched excess. Thanks to generous stock options and the bull market, top executives won compensation increases of 54% on average in 1996 while ordinary workers averaged raises of 3%.
The compensation of chief executives was 209 times that of the front line worker, an industrial world record for pay separation between the lordly and the lowly.
The numbers have aroused calls for reform of stock option plans from managers of the pension funds that own a majority stake in most U.S. companies. Even a billionaire, Laurence Tisch, is speaking out against large stock option grants for management, charging that they dilute the ownership of other shareholders.
As it happens, Tisch is not completely right about dilution, and in the heat of debate, stock options are sometimes blamed unjustly for the human greed that abuses them.
But more important, the focus on executive privilege is obscuring the most significant development in compensation: The spread of stock options and stock ownership to the broad U.S. work force.
Five million employees are now participating in stock option plans, reports the National Center for Employee Ownership, an Oakland research organization.
And total employee ownership is far greater than that if you take into account the growth of 401(k) plans, says Joseph Blasi, professor at Rutgers University and an international authority on corporate governance. In more than 1,000 U.S. companies, employee ownership of company stock has built up to more than 10% of defined-contribution retirement plan assets, in some cases far more.
The buildup of ownership results from the shift to employee-contribution retirement plans and corporations’ eagerness to make matching grants of their own stock in such plans.
Implications are only beginning to be discussed. In Congress, legislation is being introduced to reduce employees’ risk by limiting the percentage they may own in their own company.
Sooner or later, say experts in corporate governance, employee interests will seek direct representation on boards of directors.
“I’m in favor of employee owners having voting rights,” says Nell Minow, head of LENS Inc., a Washington investment firm that presses corporations on shareholder value.
The AFL-CIO recently created an office of investment, along with a Web site called Paywatch, which compares executive pay scales with those of ordinary workers.
“We advise employees on ownership rights,” says Bill Patterson, who heads the new AFL-CIO effort. “Stock options can be a great incentive for the front line worker, because they can represent a real addition to his income.”
Several factors lie behind the buildup of ownership. One is the good example of technology companies such as Microsoft and entrepreneurial firms such as Starbucks, whose employees have benefited greatly from owning stock in their own fast-growing businesses.
Another factor is the slowdown in cash raises as U.S. companies have contained costs and conserved cash by holding down pay and benefits. Many companies have been happier to extend deferred compensation in the form of stock options. Recent history shows employees are better off. Since 1981, the average annual increase in pay and benefits has been 4% while the average return to shareholders has been 17%, reports Frederic W. Cook & Co., a nationwide compensation consulting firm. On a deeper level, stock ownership formalizes the equity employees already have. Margaret Blair, of the Brookings Institution who has written many books on corporate governance, says that the experience and skills an employee gains through years on the job are part of the company’s human capital--and the employee’s equity.
The equity is quantifiable, Blair says. If an employee loses his or her job, pay at the next job will be 25% lower on average. And part of that 25% differential represents employee’s lost equity at his or her old company.
Moreover, if somebody fires employees to cut costs and get the share price up--as Al Dunlap, the notorious “Chainsaw Al” late of Scott Paper, now of Sunbeam Corp., has done--the effect is not value creation but transfer of equity from one set of owners to another. Given his own generous stock rights, what Chainsaw Al has been engaged in--perhaps unwittingly--is a form of theft.
Such issues are at the forefront of scholarly debate on corporate governance. Shareholder advocate Ira Millstein of the New York law firm Weil, Gotshal & Manges said last year that managements and boards should “take into consideration all elements of the corporation’s wealth-creating capacity--employees, suppliers and customers.”
Many forms of compensation are emerging as debates go on, says consultant George Paulin of the Frederic Cook firm--restricted stock that managers pay for with loans from their companies; shares that employees can buy at a discount from the market price.
Also, companies are buying their own stock to fund option plans because doing so avoids dilution and gives the corporation a tax break.
In short, the practice dating to the 1920s of paying in stock options to align employee interests with those of other owners is growing. PepsiCo, for example, gives stock options equal to 10% of their annual compensation to all its employees.
To be sure, if the bull market turns to bear, employees will get hurt, just like all shareholders. But exposure to the consequences of risk will only increase calls for direct representation on boards of directors, or for other equity rights. It’s unlikely employees will trust management to look after their interests.
The unspoken but most serious consequence of excessive executive compensation is that it erodes trust. Managers re-price options when stock goes down, negotiate performance hurdles that one compensation expert describes as “below ground level,” and seek insurance against risk in the very programs that are supposed to encourage risk taking. The system lacks integrity.
And that’s ominous. Peter F. Drucker, the preeminent management scholar, wrote in his 1974 masterwork “Management: Tasks, Responsibilities, Practices” that the one quality a manager must have is integrity.
That integrity is lacking at the top of so many U.S. companies is a far greater threat to the bull market, and to the whole U.S. economy, than inflation and the lesser worries that receive so much attention.
