The Opinion Pages |
Editorial
How Excessive
Executive Pay Hurts Shareholders
By
THE EDITORIAL BOARD
JULY
14, 2016
|
Simon Dawson/Bloomberg |
In theory, “pay for performance” —
linking
executive pay to a company’s
stock price — aligns the interests of executives and shareholders.
It’s supposed to ensure that executives are not tempted to enrich
themselves at the expense of shareholders, who are too numerous and
far-flung to influence a company’s behavior.
In
practice, it hasn’t quite worked that way. Instead, beginning around the 1970s
and becoming increasingly common in the leverage-buyout era of the ’80s, the
defining characteristic of pay for performance has been an explosion in chief
executive pay that exceeds the value that any human being who isn’t Midas could
reasonably be credited with producing. In 2015, the median pay package for chief
executives at 200 large United States companies was almost $20 million per year,
nearly 400 times the pay of a typical worker.
Because executive pay is an expense, excessive pay means that shareholders are
losing money. A
new study, analyzed in a
recent report in The Times, explores that
loss and provides fresh evidence that should reinforce the mounting calls for
reform of executive pay practices.
The
study, by Wintergreen Advisers, a money management firm, looked at two hits that
shareholders absorb from executive stock awards. The first hit is well known.
When a company issues shares under an executive-pay agreement, the increase in
the number of shares outstanding dilutes the value of existing shareholders’
stakes.
The
second blow, involving share buybacks, is less obvious. Buybacks, in which
management reduces the number of publicly held shares by repurchasing the
company’s stock, are often pitched as a way to boost a company’s earnings per
share. But the study points out that buybacks are aimed not necessarily at
benefiting shareholders, but rather at offsetting the dilution that results from
awarding stock to executives.
That
observation is reinforced by the fact that corporate buyback activity increases
when stock prices are high — exactly the opposite of what prudent investing
would dictate. In all, the study estimates that the shareholder costs of the
dilutions, and the buybacks to reduce that dilution, at companies in the S.&P.
500 index amounted to 4.1 percent of each company’s shares outstanding and 10.2
percent at companies with the highest combination of awards and buybacks. That
implies a hefty sum of shareholder money spent to funnel money to executives.
Research into the motives and consequences of share buybacks is continuing, so
other approaches could yield different figures, but even the lower estimates
would represent a significant cost to shareholders.
Excessive executive pay is deservedly blamed for rising income inequality,
because worker pay has stagnated as executive pay has soared. But it has not
been as widely faulted as a drag on shareholders because the durable
pay-for-performance narrative still persuades many investors that they benefit
when executives are lavishly rewarded. The Wintergreen study suggests otherwise,
that oversized awards can mean diminished shareholder wealth.
A version of this editorial appears in print on July 14, 2016, on page
A26 of the New York edition with the headline: How High Executive Pay
Hurts Shareholders.
© 2016 The
New York Times Company