This is just a coincidence, but let's pick on Matt Yglesias again today. The topic is how best to calculate CEO pay.
There are two basic methods. The bulk of most CEO pay is in stock options, and you can value stock options as either granted or realized. The former is an estimate of their value at the time they were awarded. The latter is based on how much they were actually worth when the CEO cashed them in. Here's what CEO pay looks like using both methods:
This chart is reverse engineered from an EPI report on CEO compensation. EPI generally thinks that realized pay is a better reflection of reality, but Matt strenuously disagrees:
I wondered why a think tank would use a finding from a more dubious methodology....I think the answer is this: While the [granted] method of measuring CEO pay does show a huge increase since 1978, it shows no increase at all since 2000.
Or, rather, it shows a huge crash in the 2000–2009 period from which CEO pay has only partially recovered over the past decade.
I don't think this is right for several reasons. First, far from being "dubious methodology," realized pay has recently become the more common method of measuring CEO compensation and is now required by the SEC. EPI is hardly pushing a fringe theory here.
Second, CEO pay based on granted options is merely an estimate of pay in the future. Realized pay is what it turned out to be. Surely that's a better—or at least reasonable—measure of actual compensation?
Third, I wouldn't call 2000-2009 a "crash." Rather, I'd call 1997-2000 a spike. This might sound like mere semantics, but there's a difference between a true crash and a reversion to the mean from a very short boom that was never sustainable in the first place. This is why I included the trendline in the chart: ups and downs aside, realized CEO pay has been steadily increasing for decades.
So, no, I don't think EPI chose to focus on realized pay because it didn't want to admit that CEO pay has been fairly flat for the past ten years. If they wanted to do that they'd just show the numbers for realized pay and not even discuss other options. Rather, it's just the more accurate measure. CEO pay really has doubled since 2009, and the better question to ask is not "Oh really?" It's "Why?"
It is almost as if something changed circa 1990 or thereabouts to shift executive compensation towards stock …
Of course, as rickjones probably knows, something did happen.
There was a bill, which in a piece of irony which is so heavy it creates its own black hole, was meant to put some sort of break on executive compensation by denying a company a deduction for wages over $1M.
The idea was that corporate boards would be reticent to authorize non-deductible wages.
Of course, all that actually happened was the discovery of stock grants and options, which are not wage income.
Then, what happened next was that corporations and executives discovered that the dilution caused by stock grants, while real, was also mostly irrelevant for large enough companies, and frankly for small companies.
Not only that, but you can have options which provide for cashless exercise - its not even as if the executive is investing in the company. Plus, depending on how you look at it, the market is what "pays" the executive (sort of the other shareholders but see above, in my view, not really).
So much for a "limit" on executive comp.
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And not only has the pay doubled, the taxes on that pay has massively declined!
Win, win, win!
I think most of your pushback on Yglesias is fine. The theory is not fringe, and the crash from the 2000 peak was just returning to long-term trends. But this is wrong:
"Second, CEO pay based on granted options is merely an estimate of pay in the future. Realized pay is what it turned out to be. Surely that's a better measure of actual compensation?"
Options have a market value. The value of the option is what is being granted. The value of the option changes over time until it is exercised or expires, but that's due to market movements.
If I gave you stock worth $100, and then over the next three years the stock shoots up to $1,000 and then you sell it, I didn't "actually" give you $1,000. When I gave it to you, it was worth $100. The option concept is the same. How much money they actually get depends on how the stock moves after they receive the grant. But the grant has a value at the time that it is granted, and that value is the only measure of compensation that makes any sense.
No, how much CEO's get on options is not strictly dependent on how much the stock moves - they do not lose if stock goes down before the option comes due. Overall, stock options must be worth more than immediate grants.
You misinterpreted what I said. I didn't say there was a 1-to-1 correlation between the valuation of the option and the value of the underlying stock. But if the stock price goes down and the option expires "out of the money" (i.e. worthless), the option is worth $0, whereas when it was granted it was worth more than $0. The value of the option changes as the value of the underlying stock changes, but those changes in value are not the same.
I don't follow what you mean when you say "Overall, stock options must be worth more than immediate grants."
When I gave it to you, it was worth $100.
That may be the cost to the employer, but it's notionally worth zero to the CEO for the time being, because it can't be converted into actual shares until the option date arrives. Indeed, stock options can even expire if the employee in question doesn't exercise them, in which case they're worth nothing.
When that date arrives, the grant is indeed (now) worth $1,000 (actually $900 on net). To me it seem more intuitive to measure the compensation when it actually arrives in the pocket of the employee. Moreover, it actually is costing the firm nearly $1,000, because it is only receiving $100 for shares whose market value is $1,000.
The realized price is closer to reality.
In my $100 - $1,000 example, I was not trying to discuss options but a simplified example where I gave Kevin $100 worth of Apple stock or whatever, and then he sold it three years later when it had gone up 10x in value. My point was that I had given him something that ended up being worth $1,000, but that is not the same thing as me giving him $1,000.
Options work differently than just giving someone stock, but the principal is the same. At the time it is granted, the option has value. Someone could theoretically turn around and replicate that option in the market and there would be a price for that option. And this is the value of the compensation received. If the stock price goes up, the CEO wins, but the CEO could have just have easily won by buying the stock of the company, as anyone else could, as well.
This doesn't make any sense at all. These are stock options. Your example is not a stock option. Giving someone something today and giving them an option to buy something from you in the future is NOT THE SAME THING.
The original price of an option isnt important after the options are exercised because the original value is not received by the employee and it is not given by the employer
Your example fails because the company did not give the CEO $100 worth of stock in year 1. They actually gave the CEO $1,000 worth of stock in year 3 at a cost of $100.
Here is an analogy that actually makes sense.
Instead of paying you $1,000 in cash salary this year, i give you $500 in cash and an IOU that you can redeem next year and receive cash for the amount of widgets you produce that year. Next year instead of paying you $1,000 i give you $500, another IOU and i cash in your year 1 IOU to pay you an additional $750.
You have received $1,750 and hold an IOU for next year.
What is the cost to the me?
- It certainly isnt $1,000. It certainly isnt $1,500. It probably isnt even $1,750 if the I expect you to cash in the IOU next year.
- Your insistence that the I should not expense or count the cash payment of $750 for the IOU clearly doesnt make any sense. It is not sensible to assign a random value when i give you the IOU and pretend that that is the actual cost when due. Calling it an IOU doesnt lock in a value that is less than the actual realized cost.
Let's modify your example slightly so that, rather than paying off the IOU's yourself, you contract with a third party. So, the first year, you pay give me $500 in cash. In addion, you buy and IOU for $600 and give the IOU to me. The second year I am able to cash the IOU for $750. For your part, you give me another $500 in cash, and another IOU. This time you are charged $800, because the seller realizes that he set the price to low the previous time.
Under the granted method of calculating compensation, my compensation is what you paid for it: $1100 the first year and $1300 the second year. Under the realized method, my compensation is $500 the first year and $1250 the second year.
As you can see, the realized method understates my compensation. In year one, realized compensation excludes the value of the IOU, which I will only redeem the next year. In year two, the first year IOU finally shows up in my compensation, but the IOU issued that year is excluded. This becomes less of an issue if you look at my compensation over a longer time period.
In this example, the company selling you the IOU's takes a loss on the first IOU. It sells the IOU for $600 and had to pay out $750. The loss will be less than $150, because it will earn a positive return on that $600 during the year that passes between the time it receives the $600 and the time it has to pay out $750, but it will take a loss, let's assume a loss of $130.
In your original example, you don't buy IOU's from someone else, so that $130 loss comes directly out of your bottom line. The realized compensation number reflects that loss, while the granted compensation number does not. That is one argument for using the realized compensation method.
The other issue is that from my perspective as an employee, I presumably care about how much money I receive, not how much it costs the company to provide that money. I have to live on $500 my first year and can spend $1250 my second year, even though those numbers don't reflect the cost to the company. If the question is whether I'm overpaid, those numbers are definitely relevant.
My example was explicitly not trying to describe how options work. My point is that market value fluctuations impact how much cash someone eventually receives, but that those fluctuations aren’t the same as compensation.
There are liquid markets in stock options that don’t exist in “IOUs for widgets you make next year”. Options have value. That value is what is being given.
How much the person ultimately receives will depend on the value of the underlying stock when the option is exercised, but of course that is unknowable at the time it is granted.
If you don’t believe that options have value, we probably won’t be able to come to consensus on this topic.
But we are talking about options. That you are trying to misdirect with an analogy that explicitly ignores the subject of the conversation is my point.
Options do have value, which makes it hard to understand your argument that the value of options should be completely ignored when reporting compensation. The market value is never the original granted value. You are contradicting yourself.
You seem very confused or purposefully misleading. perhaps a subtle mix of both. Trying to mislead, but still confused by the subject matter.
"you are trying to misdirect with an analogy that explicitly ignores the subject of the conversation is my point."
Analogies are used extensively to clarify a point. It's extremely odd that you find the use of an analogy to be misdirection. It's a way of clarifying an argument.
"Options do have value, which makes it hard to understand your argument that the value of options should be completely ignored when reporting compensation."
I must not be making myself clear. I am not arguing that the value of the option should be ignored, I am arguing that the value of the option *when granted* is the compensation received. My point is that, once the option is granted, changes in the value of the option are market fluctuations and not representative of the compensation received.
"The market value is never the original granted value."
This is not true. The value when granted is the granted value. This is my whole point.
"You seem very confused or purposefully misleading. perhaps a subtle mix of both. Trying to mislead, but still confused by the subject matter."
I promise I am not trying to mislead. It seems I've failed in communicating clearly, so I'll try one more time:
The value of the option when granted is the value of the compensation received. After that, the value of the option will change over time, but in my view, that's not a change in the compensation received, it a change in the market value of a security that the CEO owns.
The fact that exercising the option in the future can net the CEO much more than the value of the option at the time it was granted is interesting, but it does not change the fact that the option had value at the time it was granted and that this value is the compensation that was received.
One final clarification - the value of the option is not merely the difference between the current market price of the underlying and the strike price. The value of the option takes into account the possibility that the underlying might increase in price in the future - the "optionality" as it were. So an option where the strike price is equal to the market price when granted is *not* worth $0 - it is worth more than that. Re-reading your comment, it seemed like you might have thought I was saying that such an option was worth $0 and therefore no compensation was granted, but that is definitely not what I'm saying. At-the-money calls (that would be worth $0 if exercised) still cost money to buy.
This point is good. I wonder if it is possible for anybody, you, me, anybody, to buy similar options at the "estimated value" price at the time the option is granted. If so, then the gains eventually realized by the executive are investment returns that only match what any investor could have achieved with the same starting stake.
There are active option markets in many large cap stocks.
Respectfully, CEO pay, as a percentage of public company expense is tiny, basically a rounding error. While CEO pay might be a good symbolic item to discuss, the math is clear: CEO pay does not meaningfully impact 'worker' comp or the price of the product....
You talk about math and yet you provide no figures! Just how "tiny" do you mean? Moreover, large firms are generally staffed with multiple, extremely highly compensated executives. The very fat pay extends below the CEO level. My spitball estimate is that a doubling of senior executive pay is easily costing the economy several tens of billion annually. That's not nothing, either in terms of money that could be used to compensate lower level employees, or reinvested back into productivity-enhancing cap expenditures. It's also not nothing when you consider how much of it cycles back into political spending to expand rent-seeking. Indeed, combine this increasingly glutinous executive suite pay with lower tax rates and ever more affluence-friendly, worker-unfriendly legislation, and it likely has a measurable impact on economic inequality.
You may pick whatever company you prefer. For example (a finance, manufacturing and tech example)
- Wells Fargo expenses are $74 billion and CEO total comp is $24 million
- General Motors expenses are $150 billion and CEO total comp is $29 million
- Apple total expenses are $275 billion and CEO total comp is $98 million
CEO total comp is not a meaningful percentage of total expenses AND is mostly in the form of options, a non cash expense.
If you paid the CEO nothing, and reallocated that money, the average worker would not see a noticeable pay raise: for example, a GM employee would see a $150 annual pay increase.
Cites not given of course, and you didn't answer the question.
The meaningful comparison would be total executive and manager compensation vs total worker compensation. Where the line is drawn may often be difficult, but the BLS does it for "production and non-supervisory workers".
"You may pick whatever company you prefer. ..."
Tesla.
A specific example triggered by the article behind the first link. It covers a little more than the question but I’m in my phone and editing is … painful.
If you could please, pass this along to Ms. Bauerlein. I wanted to send it as an email rather than a comment on her article at:
https://www.motherjones.com/media/2022/12/its-a-brutal-fearful-winter-for-journalism/
• Gannett, the largest newspaper company in the country, announced a second round of layoffs—the previous one eliminated 400 jobs. (Gannett’s CEO is paid nearly $8 million; the median salary at the company is $48,000.)
The Horror!
Seriously though, 400 jobs at $48,000 a pop is $19.2 million. So sure, you could argue the Gannett CEO should take less pay. Perhaps even only say 10X median. And that would then free-up enough for 156 median salary jobs. From the looks of things, that would be but a small fraction of the jobs going away.
Looking at CEO pay another way, Gannett’s 2021 annual revenue was ~$3.2 billion dollars: https://s1.q4cdn.com/307481213/files/doc_financials/2021/ar/Gannett-Co.-Inc.-2021-Annual-Report.pdf Page 41. Represents a decline of roughly $197 million from 2020, or ~4116 of those median-pay jobs. Makes dropping 400-odd or even 800 jobs look pretty small actually, but I digress…
$8 million represents ~0.25% of Gannett revenue.
Per Mother Jones’/Foundation For National Progress’ most recent "annual report” - its IRS 990: https://www.motherjones.com/wp-content/uploads/2022/02/FY2021Form_990_Public_Disclosure.pdf - the revenue was ~16.8 million dollars. The “CEO” (it always strikes me as odd that a publication with such a clear dislike of CEOs would have one itself…) was paid $216,118 (not including the other $47,984 of “other” compensation, from the organization, whatever that is…)
That would be 1.29% of revenue.
In percentage of revenue terms, the Mother Jones CEO seems to be paid 5X more than the CEO of Gannett. I don’t have figures for the median salary at Mother Jones to see how it compares vis a vis Gannett.
The “If you please” is from the email…
Middle is right mathematically but Jasper is right from a moral and policy perspective.
The obvious fact that every CEO of a fortune 500 company is compensated to the tune of 10s of millions of dollars a year is proof that such an extraordinary amount of comp has no effect on stock price and no effect on cost of goods. If it had a measureable effect on either, especially stock price, you frankly would not see it occur, as shareholders would not stand for it.
So Middle is technically correct.
But Jasper is correct in that all the technical reasons discussed here have led to a situation where top executives and CEOs are so financially separated from the actual concerns of their own employees that it would be a full time job just to maintain any sort of empathy towards the employees at all. CEO net worth is now guaranteed to be so ridiculously high that virtually all financial worries of an average person are totally theoretical. Health care, cost of education for kids, and on, and on. I remember when mass firings of employees was something companies intentionally avoided, rather than something which is now so totally acceptable that its not even worth remarking upon.
So Jasper is totally correct in that the "fat pay" is a cost to the economy, but not in my view a direct cost as to those who don't get the "fat pay." Its a very real indirect cost though, in that you have thousands of top flight economic decision makers who are totally, and I mean TOTALLY, immune from the consequences of the decisions they make.
I mean, they are always going to be somewhat immune, but the pay spread now is ghastly.
Look no further than Trump, that is what you can get when you have someone who thinks, and frankly he is correct in this, that rules don't apply to him.
I would not say all CEOs think this way, but given the stratospheric comp its almost unavoidable that their decisions are affected.
You noticed M studiously not replying to this issue as well, I see.
ScentOfViolets - my source is Google. You are free to do the necessary searches....
Still no sources, eh? Now I don't have assume good faith; I know you're not being honest and are at best -- at best -- talking about the pay of just one person. Fuck off, troll.
Middle is right mathematically
No he's not. He ignored the bulk of my argument, which is that a narrow focus on CEOs—and the ratio of their salaries to those of their employees—doesn't even begin to flesh out the real effect of excessive executive compensation in America. What do you think the top ten executives from the 1,000 largest US firms rake in? Let's call it $4 million/year on average. That's $40 billion. Are we really supposed to believe they couldn't get by on $2 million/year? Doing so would free up $20 billion for other, more socially productive purposes. And I think my spitball estimate is far too conservative. We should probably be talking not about the top ten thousand most highly paid executives but the top 30-40k.
For the record I'm not suggesting the government should tell corporations how to pay their executives. But I am saying we shouldn't have a tax code that incentives executives to loot the economy for their own behalf. It corrupts our politics, it breeds cynicism, and at the margins it increases inequaity, lowers economic growth, and renders our society less prosperous for the many (as opposed to the few).
That's exactly what he did. No, that's not quite right; he ignored your argument while trying to appear as if he had. I put this mofo into my troll rollodex a long time ago for exactly this kind of behaviour.
" ... while trying to appear as if he hadn't", sigh.
Attack that strawman! You will win the internet!
The difference between granted and realized is the difference between stock and stock options. The companies and the CEOs surely know the difference, and that's why the bulk of the pay is in stock options. The SEC has it right. It understands the game.
Yglesias does not (or pretends not to). He's pushing an argument to measure stock options as if they were stock, which of course makes the problem of extraordinary CEO compensation look not nearly as bad. Time and again, Yglesias does the bidding of the overclass and why anyone takes him seriously is beyond me.
No, I think this is wrong. For this purpose, the value of the pay should be fair value at grant date, whether paid in stock or in options. That's what Yglesias is saying.
I can't imagine why a CEO would want to pursue stock buybacks and other strategies to goose the value of their company's stock price.
/S
????
Hey, when are you going to post about the wild sea surface temperatures? Most of the northern Atlantic is 3C or higher that the 1985-1990 baseline.
Also, don't you think it's time to talk about China's pledge to reach net zero by 2060? That's far past the deadline to limit to 1.5C. And China is unlikely to reach even that target.
One big issue is China's official numbers are always goosed. Their coal usage is exploding, not flattening.
The world will blow past 1.5C.
You know, you don't have make every single comment thread about China.
This is one of those articles where ensuring words are carefully defined is useful.
Presumably, by "granted", we mean when the contract is made to give options to the CEO over some vesting schedule. We then need to distinguish between "vested" and "sold".
Since the CEO does not control the stock options when granted, the value on the grant date is mostly meaningless (although one can estimate a value based on stock volatility). The value on the vest date seems most meaningful. The CEO might nor might not choose to exercise the options or sell the underlying stock, but that is now part of their investment strategy and not part of the corporate compensation strategy.
I think the other vocabulary to drill down on is what we mean by the value at grant date. "I'm going to give you an option in three years to acquire the stock at today's price of $100". If CEOs are regularly realizing (inflation adjusted) higher value than the market value of the option, the market must be doing a poor job of estimating the value.
D_Ohrk_E1 has just alluded to what I think is the main cost to society of the compensation schemes now used for senior management. All the CEO has to do to become wealthy is to juice the stock price. There's quite a menu of actions that can be used to achieve this: massive layoffs (or just announcing lay-off plans), making bogus claims about future products or business plans, or just increasing current profits by mortgaging the future. The latter can involve ending new product development, limiting capital investment, or selling off productive assets. Big splashy business deals work for the CEO, even if disasters for the company.
Back in the old, old days with much lower CEO salaries, no stock options, and high taxes on high incomes, it would take ten or fifteen years of employment for a CEO to amass a fortune of a few million in today's dollars. Today's CEOs can sling a lot of BS and goose the bottom line while wrecking the company, then walk away in three or four years with a larger fortune than the CEOs of old.
Economists argue about why US productivity growth has cooled so much since the 1960s and 1970s. They never seem to consider that we've created a system where real productivity growth is not a factor in the compensation of corporate leaders.
The purpose of the corporation is to maximize shareholder value. That's the idea. There's a name for that idea. It's called: The Dumbest Idea in the World.
"Third, I wouldn't call 2000-2009 a "crash." Rather, I'd call 1997-2000 a spike."
Yeah, Matt's basically arguing that we should look at the trend with intentionally misleading endpoints. If you're concerned specifically about what happened in the aftermath of 2000, that might make sense, but if you're concerned about a long-term trend, that's just outright misleading.
How does using realized value even work? If I am granted options for 5 years and then retire and cash them all in does this mean I was paid nothing in options for 4 years and then the total value in year 5? That would be bonkers. So how is it figured?
It's not bonkers. If you let the options expire you would indeed end up having been paid nothing. Let's put it this way: employee stock options are technically just a contract allowing you to buy shares at some point in the future. Since the value of those shares is what underpins the value of the options, and since likewise the value of those shares is unknowable until the realization date, it makes sense to measure the compensation at such point when we know something about the value.
"... it makes sense to measure the compensation at such point when we know something about the value."
It's an option. Many option contracts are publicly traded. We know plenty about what they are worth.
And even if you insist on looking at realized value you didn't answer the question about what year the value should be assigned to, the year the option was granted or the year it was executed.
The cost can obviously be assigned and revalued every year. You create an estimated cost when granted based on your expectation of the value when realized and you update that estimate regularly. After the option is realized, you have a final cost and record any difference in the realized value and the last estimate. Pretty simple calculation.
Ultimately, the realized value is all that really matters. Imagine a standard cash pay contract that also assigned a discounted value for the present/grant value of the future payments....nobody really cares about that grant value. It might be a critical part of determining the future payments, but it isnt relevant for either party once the contract is in place.