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THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISoutrage, they will also cripple one of the world’s most important, and historically mostproductive, industries.It is important to recognize that the outrage over banking bonuses is emanating notfrom shareholders but from politicians, labor unions and the general public. While suchoutrage is understandable – especially for banks paying bonuses after being bailed out bytaxpayers – it is often driven by jealously and envy and not by concerns about maximizingvalue or even protecting taxpayer interests in the future. Moreover, even for those whobelieve that CEOs can effectively set their own salaries (e.g., the Bebchuk-Fried “ManagerialPower” view discussed in Section 2.5), there is no credible evidence that the compensationarrangements for lower-level bankers, traders, underwriters, or brokers are set in anythingother than a highly competitive market for talent. For better or worse, there is an extremelyscarce supply of individuals with the highly specialized skills required to understand andtrade in increasingly complex derivative instruments, and the market for such individuals isglobal with little respect for international boundaries. Restricting banking bonuses for TARPrecipients in the USA led to a drain of talent from those banks to private equity andunrestricted banks (including those that quickly paid the money bank). Similarly, punitivebonus taxes in France and the UK will lead to a drain of talent from those countries to othercountries.Ultimately, we conclude that improvements in executive compensation will bestemanate through stronger corporate governance, and not through direct governmentintervention.5. Summary and Policy Implications5.1. Putting the Pay Controversies in ContextThe recent financial crisis has created a public uproar over top-executive pay packagesand has led to calls for reform of executive pay in Europe and the USA. Anger over bonusespaid to executives at bailed-out banks have led to supplemental taxes on banker bonuses inthe UK and France, and outright prohibitions on bonuses or other incentive payments forUSA executives in firms receiving government bailouts. In addition, the crisis has sparkeddemand for increased government regulation of executive pay more broadly on both sides ofthe Atlantic.-117-
THE EXECUTIVE COMPENSATION CONTROVERSY: 24 MAY 2010A TRANSATLANTIC ANALYSISA primary purpose of this report is to add “context” to the ongoing debate over CEOpay. The current controversy is not the first – nor will it be the last – time that executivecompensation has sparked outrage and calls for regulation in the USA and Europe. For thisreason, we devoted considerable attention on the evolution of executive pay on bothcontinents. We showed, for example, that many features of executive pay in the USA –including the explosion in stock options that led to the dramatic increase in pay levels in the1990s – can be traced directly to government accounting, tax, disclosure, and social policies.Similarly, the rise and fall of options in the UK, France, and Italy can also be tied togovernment policy. In many cases – beginning in the 1950s in the USA and continuingthrough the 1990s in Europe – government intervention has taken the form of conferring, andthen removing and maybe conferring again, tax advantages for options by having the gainstaxed as capital gains rather than as ordinary income.Based on a comprehensive comparison of pay spanning six years and coveringapproximately 1,500 USA firms and 1,100 firms from ten European countries, we showedthat USA CEOs are paid significantly more than their European counterparts even aftercontrolling for company size, industry, and a variety of other firm and managerialcharacteristics. Moreover, while more than half of the average CEO’s pay in the USA comesin the form of stock options or restricted stock, we find that European CEOs receive onlyabout a tenth of their pay in stock or options. Indeed, we conclude that most of the differencein cross-continental pay levels is attributable to the higher use of stock and options in theUSA.Our finding that the “USA Pay Premium” is largely “explained” by the fact that USACEOs have different pay structures merely shifts the question: Why do American executivesUSA receive more equity-based compensation than do European executives? We consider(and mostly dismiss) a variety of agency-theoretic explanations that would require Europeanexecutives to be less productive and more averse to risk and effort than their Americancounterparts. Ultimately, we conclude that the early 1990s created a “perfect storm” for anexplosion of option grants in the USA for not only executives but also for lower-levelmanagers and employees. First, options were considered a “safe-harbor” from thegovernment’s just-introduced $1 million cap on deductible compensation. Second, sinceoptions were not recorded as an expense on accounting statements, they were treated as“free” or cheap to grant (when, in fact, they are especially expensive ways to conveycompensation). Third, government policies and stock-exchange listing rules encouragedfirms to grant options to all employees, which in turn increased executive grants. Ultimately,too many options were granted to too many people. The explosion in option grants continued-118-
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