Runaway CEO Pay and the Myth of “Shareholder Democracy”

Even with better information, shareholders lack power to correct problems

By Lee Drutman 
Published December 30, 2005

CEO pay has become so unhinged from logic that even even Christopher Cox, President Bush’s Security and Exchange Commission Chairman, has vowed reform. Cox calls it “absolutely a top priority” to give shareholders “comparable executive-to-executive and company-to-company” numbers so they can “discipline” corporate boards who approve mammoth compensation. (Presently, myriad forms of compensation, —corporate jets, country club memberships and ridiculous severance packages often are obscured from shareholders.)

Cox is right to be concerned. At the 367 biggest companies last year, average CEO take-home pay was $11.8 million, while compensation far outpaced increases in profitability. Average worker pay, meanwhile, was $27,460.

No doubt, adequate disclosure of pay packages is sorely lacking at many companies, but a bigger question remains: even if they have that information, how exactly will shareholders go about disciplining corporate boards?

I ask, because at almost all U.S. companies, shareholders have about zero say into who sits on the board of directors and how executive pay is set. The directors are typically nominated by management, and shareholders are given one and only one slate of directors to choose from—a Soviet-style election that virtually guarantees managers will get their trusted friends on the board of directors. So it’s no surprise that executive pay packages continue to defy common sense. After all, what’s a few million among friends?

Unfortunately, Cox has demonstrated no interest in injecting even a modicum of accountability into the process by making it easier for minority shareholders to nominate candidates to the board of directors, something his predecessor, William Donaldson, unsuccessfully pushed for. The Chamber of Commerce and other lobbying groups for large corporations vehemently opposed any suggestion of this “proxy access reform,” effectively killing the proposal.

Without giving shareholders some means of holding directors directly accountable, it’s not clear how pay packages will ever be brought under control. Shame clearly hasn’t worked. To claim that directors would be more diligent if only they had better information doesn’t pass the straight face test.

Yet, there is some reason for hope. We may finally be reaching a critical mass of big institutional investors who are legitimately concerned about runaway CEO pay—perhaps enough to effect some change.

After all, bemoaning runaway executive pay is not just for cranky Grinches anymore. It’s also for Florida Governor Jeb Bush, who just last week announced that he was sick of “outrageous” executive compensation and “undemocratic” proxy voting and that Florida’s state pension fund was going to start using its $116 billion in assets to push for better corporate governance.

Recently, the largest U.S. manager of retirement funds, for university and college employees with $360 billion in assets, TIAA-CREF, also denounced high CEO pay. “There’s a burden on the board of directors to justify its compensation choices and explain them, so that shareholders can be confident that these are the right decisions,” said John Wilcox, the organization’s senior vice president.

Even a whopping majority—90 percent—of institutional investors think that corporate executives are overpaid, according to a recent Watson Wyatt survey. And the 85 percent who think that these excessive payments are hurting corporate America’s image (according to the same survey). And the 10 pension funds from the U.S., Canada and Europe (which represent a combined $1 trillion in assets) recently sent a confidential letter to the SEC, urging the agency to look more closely at how executive pay is being set at big companies.

But will that be enough?

After all, while CEOs continue to receive double-digit percentage raises year after year, workers barely keep pace with inflation. At 431-to-1, the U.S. ratio of CEO to worker pay is an anomaly among industrialized nations, where a more typical ratio is 25-to-1. Meanwhile, the percentage of company profits going to the top five executives more than doubled between 1993 and 2003, growing from 4.8 percent to 10.3 percent.

Yet, with each passing outrage, it seems that we are getting closer and closer to a critical mass of influential and respected investors who are completely fed up. When that moment comes, it is hard to say.

More disclosure can help bring us closer by highlighting more abuses. But when we are finally at that critical moment where enough major investors want to do something about excessive pay, they are still going to need the tools to do so—be it more say in selecting directors, the ability to vote directly on executive pay packages, or both.

If Cox is serious about disclosure, great. More information is always helpful. But without also giving the shareholders the tools to actually use this information, disclosure alone may not be such a generous gift for reform after all.

Lee Drutman is the co-author of The People’s Business: Controlling Corporations and Restoring Democracy. An earlier version of this article was written for

© 2005