Tag Archives: labor

Was Clinton’s Executive Compensation Policy a Mistake? (Revised)

Thesis: The current tax code has created an incentive for management to focus corporate profits on short-term stock-boosting strategies rather than long-term investment, and thus is a contributing factor to the stagnation of wages in the US.

One of the most troubling issues facing economists studying the United States has been the stagnation in wage growth over the past few decades.  Common wisdom would dictate that as marginal productivity of labor rises, so would wages.  As evidenced by the graph below, courtesy of the Economic Policy Institute, this was the case for some 25 years during the US postwar boom era, but beginning in the 1970’s, wages began to flatten out as productivity continued to rise.

wage growth

Economists have attributed this trend to a handful of factors: rapid globalization creating a massive increase in competition in the labor force, technological improvements reducing the supply of jobs, erosion of large-scale union power, and more recently, rising health care costs to employers.  In a recent opinion piece in the Washington Post, Harold Meyerson has added a new factor to the discussion: the recent tendency of corporations to use capital to increase shareholder value, rather than investment in the company.  As Meyerson writes, investment has slowed down significantly while earnings have been funneled at an increasing rate towards shareholders through stock repurchases (which increase stock price with artificial demand) and dividend payments.  The prioritization of shareholder payouts over investment puts a damper on job creation and wage increases, and makes it harder for traditional monetary policy to stimulate the economy.  So why the dramatic shift in corporate cash flow allocations?  I would argue that the single biggest driving force is the rise in stock-based compensation packages for executives.

A little background on the concept of stock-based compensation: in 1993, facing pressure from institutional investors and in an effort to limit the rise of executive compensation, Bill Clinton created section 162(m) of the IRS tax code (wiki), which stated that companies could only deduct the first $1 million of executive pay.  However, the code included a provision that excluded performance-based pay, which is why we see the executive compensation packages we have today: a seemingly meager base salary, under $1 million, with substantial stock options that make up the bulk of pay.  In theory, there are certainly some benefits to stock-based compensation: they help ensure that management’s actions are in line with shareholder goals, as executives have a vested interest in the company’s performance.  But there are two sides to this coin.  Since executives receive such an overwhelming portion of their pay via equity, they have an incentive to boost the company’s stock prices even when it might not be in the best long-term interest for shareholders.  The disparity in time horizons between executives and corporations exacerbates this problem: according to the Wall Street Journal, the average CEO’s tenure is just 9.7 years, meaning that executives rarely stick around long enough to see the company benefit from gradual growth and investment.  Instead of re-investing earnings, an executive is better off allocating capital to stock repurchases and dividends to increase stock prices in the short run.

The trend has troubling implications for the economy.  Undoubtedly, declining corporate investment means slower growth in output and employment.  But more importantly, if companies aren’t allocating capital to investment, then monetary policy is somewhat crippled.  A paper published by The Roosevelt Institute found that in the 60’s and 70’s, an additional dollar of corporate borrowing or earnings led to a 40-cent increase in investment.  Today, that same dollar leads to less than 10 cents of new investment.  That means that stimulating borrowing with low rates has had an increasingly diluted effect on actually stimulating investment.  So it may be time for regulators to re-think whether performance-based compensation is really in the best interest of shareholders – the shift in corporate capital seems to suggest otherwise.

The Unintended Consequences of an Attempt to Reign in Executive Pay

Thesis: The current tax code has created an incentive for management to focus corporate profits on short-term stock-boosting strategies rather than long-term investment, and thus is a contributing factor to the stagnation of wages in the US.

One of the most troubling issues facing economists studying the United States has been the stagnation in wage growth over the past few decades.  Common wisdom would dictate that as marginal productivity of labor rises, so would wages.  As evidenced by the graph below, courtesy of the Economic Policy Institute, this was the case for some 25 years during the US postwar boom era, but beginning in the 1970’s, wages began to flatten out as productivity continued to rise.

wage growth

 

Economists have attributed this trend to a handful of factors: rapid globalization creating a massive increase in competition in the labor force, technological improvements reducing the supply of jobs, erosion of large-scale union power, and more recently, rising health care costs to employers.  In a recent opinion piece in the Washington Post, Harold Meyerson has added a new factor to the discussion: the recent trend by corporations of using profits to increase shareholder value, rather than re-investing them into the company.  As Meyerson writes, investment has slowed down significantly while earnings have been funneled towards shareholders through stock repurchases (which increase stock price with artificial demand) and dividend payments.  The resulting lack of new value creation and growth has put a damper on job creation and wage increases.  So why the dramatic shift in corporate profit allocations?  I would argue that the single biggest driving force is the rise in stock-based compensation packages for executives.

A little background on the concept of stock-based compensation: in 1993, facing pressure from institutional investors and in an effort to limit the rise of executive compensation, Bill Clinton created section 162(m) of the IRS tax code (wiki), which stated that companies could only deduct the first $1 million of executive pay.  However, the code included a provision that excluded performance-based pay, which is why we see the executive compensation packages we have today: a seemingly meager base salary, under $1 million, with substantial stock options that make up the bulk of pay.  In theory, there are certainly some benefits to stock-based compensation: they help ensure that management’s actions are in line with shareholder goals, as executives have a vested interest in the company’s performance.  But there are two sides to this coin.  Since executives receive such an overwhelming portion of their pay via equity, they have an incentive to boost the company’s stock prices even when it might not be in the best long-term interest for shareholders.  The disparity in time horizons between executives and corporations exacerbates this problem: according to the Wall Street Journal, the average CEO’s tenure is just 9.7 years, meaning that executives rarely stick around long enough to see the company benefit from gradual growth and investment.  Instead of re-investing earnings, an executive is better off allocating profits to stock repurchases and dividends to increase stock prices in the short run.  And the resulting benefits to shareholders contributes less to the economy than continual re-investment would – since the wealthiest 10% of households own 84.5% of US financial assets (source: Fed data on inequality.org), the impact of these shareholder-focused actions have a disproportionate effect on public welfare.  So it may be time for regulators to re-think whether performance-based compensation is really in the best interest of shareholders – the lack of corporate profits being re-invested seems to suggest otherwise.

The Annual Debate of March Madness

Thesis: The NCAA’s compensation rules are fine just as they are.  

March is well underway, and with it comes the annual flurry of excitement over the NCAA’s Division 1 basketball tournament, more commonly known as March Madness.  Along with all the media hype and debates over which teams deserve to be picked comes a far more important annual debate: that about NCAA athlete compensation.

The tournament generates a massive bubble of economic activity.  As Forbes writes, the yearly event triggers a revenue stream of nearly $1 billion for the NCAA at large (mostly through the sale of broadcasting and advertising rights), with around half a billion going to the schools involved.  But as the article notes, the benefits aren’t always direct – schools who make it far in the tournament often see a massive increase in donations as a result of the exposure, donations that can be quantified in the range of millions of dollars.  And the betting on the tournament, most of which is illegal, generates a whopping $9 billion in additional activity, according to Vox.  So where does all this money (the legal money, that is) end up going?

While that may be a tough question to answer, we know one thing: essentially none of it ends up in the hands of players.  Despite the millions of dollars that flow to a school as a result of a tournament, despite the millions of dollars that schools spend on coaches’ salaries (per CBS), the main labor involved in providing this source of entertainment receives absolutely no compensation.  And so every year, the public re-asks itself the same question: is this at all fair?

I would say no, it is not fair.  It’s not fair that those who are directly responsible with providing for a multi-billion dollar business don’t get to see any of the profits.  However, instead of seeing injustice, I see the unfortunate result of a system that doesn’t have any easy solution.  Allowing schools to offer compensation to players outside of scholarship opportunities would put smaller schools at a huge disadvantage, and threaten the sanctity of the tournament.  Instead of having the exciting possibility of smaller underdogs uprooting nationally recognized programs, the tournament would become a bland affair where everybody watching knew ahead of time what team would win (at least for the first few rounds), as the biggest programs would instantly become constant powerhouses who could not only attract the best talent, but pay them the most.  It would also de-incentive athletes from deciding to attend schools based on factors that could impact them as members of society, such as the quality of the education they receive.

For the vast majority of students who will never reach the pros (just 1.2% of basketball players go pro, according to the NCAA website), playing a collegiate sport is not a career, but a means to obtaining a degree at a school where they otherwise might not have been able to obtain one.  The most valuable thing that most players will receive while in school is their education, and it should remain that way.

The US Should Have Banned Tipping Long Ago

The very concept of tipping is somewhat ambiguous.  Is it some sort of courtesy fee?  Is it meant to incentivize better service?  Is it a form of charity?  Whatever an individual’s motivation is for tipping, it is a practice that has become so ingrained in American society that it is considered a repugnant act to not leave a tip, even though a person is still entirely free to do so.  The history of tipping is rather dark – the practice was born out of malevolent intentions.  As Steve Dublanica writes in his book “Keep the Change” (the first chapter of which is available in this article by Today), The Pullman Company, a railroad company that was the first large business to force its workers to rely on gratuity-supplemented wages, exploited a largely ex-slave workforce by paying them far below living wages, citing tipping as the reason.  The company even went so far as to play to the compassion of its customers so that they, the customers, would be responsible for ensuring the employees were adequately compensated, instead of the employer.  The St. Louis Republic wrote at the time, “Other corporations before now have underpaid their employees … but it remained for the Pullman Company to discover how to work the sympathies of the public in such a manner as to induce the public to make up, by gratuities, for its failure to pay its employees a living wage.”  This exploitation of workers by retail and restaurant businesses was pushed to the extreme in some cases, like a restaurant in 1920s New York that paid no wages, and actually required employees to pay the restaurant $10 a week for the opportunity to earn tips.  There were some movements to ban tipping, and per Wikipedia, six states successfully outlawed tipping in the early 1900s, only for the bans to be repealed.

Some might argue that the current tipping system is more well established, that it’s a concept that makes sense in a modern, polite society.  I wholeheartedly disagree.  The burden should be on the employer to decide on the precise compensation for their employees, not the customer, even if it means adding fixed service fees to every bill.  It’s a custom that adds unnecessary friction to the server-customer relationship, and there’s evidence that it’s discriminatory.  Research presented by Michael Lynn in a Freakonomics podcast (link to study available on page) suggests that factors such as race, gender, hair color, and physical appearance play a large role in determining the average tip that a server will receive.  While most would have probably predicted this, it is hard evidence of discrimination at play.  As the study points out, both black and white customers will, on average, tip a white server more.  Another worthwhile tidbit from the study is the fact that the correlation between service quality and tip size is incredibly weak, with about 4% of the variation in tip size explained by service.  Here is evidence that perhaps the best argument for tips – to incentivize and reward better service – is practically moot.  As tips rise over time, there will be less pressure to increase the sub-minimum or tipped minimum wage, forcing workers to rely more and more on the tips that they earn, and allowing businesses to survive that cannot afford to pay their employees minimum wage.  The New York wage board will vote Friday on a measure to increase the tipped minimum wage to $7 (or 80% of the state’s minimum wage), as reported by the Wall Street Journal, a measure that will hopefully prompt other states to re-evaluate their tipped wage as well.