Executive Pay and Labor’s Shares: Unions and Corporate Governance from Enron to Dodd-Frank

Abstract

This article is an historical analysis of the U.S. labor movement’s shareholder activism during the 2000s, which was based on their pension-plan assets. During the previous decade, corporate governance had tilted to give shareholders greater voice in corporate decisions. The protagonists were public pension plans such as CalPERS. Come the 2000s, they were replaced by unions and union-influenced pension plans. Their agendas overlapped but union investors were distinctive in their use of shareholder activism to make companies more public-minded, raise labor’s organizing power, and challenge executive power by reliance not only on shareholder activism but also political activities. Labor’s signature issue was executive pay, which was a topic that that shareholder activists during the 1990s had avoided other than to push for stock-based pay. But three waves of corporate scandals during the following decade caused other shareholders to become skeptical of executive pay-setting methods. Union investors zeroed in on expensing and backdating of stock options, and fought for say on pay, the issue where they had the greatest impact. An interaction between private orderings and regulation now developed, whereby shareholder pay reforms found their way into law. With inequality a major social concern, unions repeatedly contrasted lofty executive pay to stagnant wages. Yet little was said about lofty payouts to shareholders, which may have been a more important driver of inequality than executive pay. The article ties corporate governance to larger social and political developments in the U.S., and to the labor movement, embedding corporate governance in historical context.

Full text

Sanford M. Jacoby*
Executive Pay and Labor’s Shares: Unions
and Corporate Governance from Enron
to Dodd-Frank
https://doi.org/10.1515/ael-2019-0073
Abstract: This article is an historical analysis of the U.S. labor movement’s
shareholder activism during the 2000s, which was based on their pension-
plan assets. During the previous decade, corporate governance had tilted to
give shareholders greater voice in corporate decisions. The protagonists were
public pension plans such as CalPERS. Come the 2000s, they were replaced
by unions and union-influenced pension plans. Their agendas overlapped but
union investors were distinctive in their use of shareholder activism to make
companies more public-minded, raise labor’s organizing power, and chal-
lengeexecutivepowerbyreliancenotonlyonshareholderactivismbut
also political activities. Labor’s signature issue was executive pay, which
was a topic that that shareholder activists during the 1990s had avoided
other than to push for stock-based pay. But three waves of corporate scandals
during the following decade caused other shareholders to become skeptical
of executive pay-setting methods. Union investors zeroed in on expensing
and backdating of stock options, and fought for say on pay, the issue where
they had the greatest impact. An interaction between private orderings and
regulation now developed, whereby shareholder pay reforms found their way
into law. With inequality a major social concern, unions repeatedly con-
trasted lofty executive pay to stagnant wages. Yet little was said about lofty
payouts to shareholders, which may have been a more important driver of
inequality than executive pay. The article ties corporate governance to larger
social and political developments in the U.S., and to the labor movement,
embedding corporate governance in historical context.
Keywords: corporate governance, executive compensation, labor unions, say on
pay, Dodd-Frank
*Corresponding author: Sanford M. Jacoby, Management History and Public Affairs, UCLA, Los
Angeles, USA, E-mail: sanford@ad.ucla.edu
Account Econ Law 2020; aop
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Table of contents
1 Introduction
2 Economics of executive compensation
3 Pay proposals
4 Stock-based pay
5 Expensing options
6 Backdating
7 Say on pay and private orderings
8 Take it to Congress
9 Say on pay and Dodd-Frank
10 Pay ratios
11 Conclusions
Bibliography
1 Introduction
In the United States, the worlds of finance and organized labor spun in separate
orbits for most of the twentieth century. They drew nearer at century’s end, due
in part to the magnetic force of swelling assets in union-influenced pension
plans–multiemployer and public-employee plans–whose value reached over $3
trillion by the late 1990s. It was a stark contrast to the plunge in union member-
ship in America’s private sector, once the heart of organized labor. Shaken by
the decline, union leaders now prioritized growth in numbers to replenish the
movement’s fading power. Their strategies included the leveraging of stock held
in pension plans and other finance-based tactics to pressure employers to
remain neutral during union organizing campaigns. The labor movement and
its pension plans often are ignored in discussions of corporate governance,
executive pay, and regulatory responses to the financial crisis.
Often criticized for its hide-bound traditionalism, the U.S. labor movement
responded energetically to financialization, riding the wave of stock market
capitalism. After the beginning of the twenty-first century, union shareholders
eclipsed public pension plans as shareholder activists. Placing limits on sky-
rocketing executive pay was labor’s signature issue, one that public pension
plans had shied away from. Union investors filed proposals seeking options
expensing and say on pay, and occasionally they demanded that corporations
report on the ratio of CEO pay to that of an ordinary worker. Union investors
challenged the authority of CEOs and the directors who enriched them. Doing so
drove a wedge between management and employees, reinforcing the claim that
executive excess was shortchanging workers. If a union wanted to represent
workers at the company, or already had a bargaining relationship, targeting
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executive pay could raise support for the union and/or embarrass management
sufficiently that it would agree to tone down any anti-union behavior. We return
to these issues below.
The focus on executive pay permitted tie-ins to broader social issues, espe-
cially income inequality. America’s concern about inequality mounted during
the 1990s and more rapidly after that. Among its causes was the plummeting of
union density. Between 1973 and 2007, one-fourth to one-third of the growth in
wage inequality was the result of union shrinkage. There also were hopes that
shareholder activism would improve the performance of underfunded union
pension plans.
There is a cottage industry of people who study inequality’s causes. At the
firm level, the widening pay gap between executives and the rank and file is a
well-studied subject. Executives figure prominently in the top 1 percent of the
income distribution. Less often considered is the effect of shareholders on
inequality. For the past thirty years, shareholders have received a growing
share of valued-added paid as dividends and stock repurchases. The dubious
claims of shareholder primacy –that shareholders own corporations and that
their interests must be paramount–contributed to a reallocation of corporate
profits among workers, owners, and managers. But the labor movement was
slow to criticize mounting shareholder payouts, in part because this would have
conflicted with the needs of its pension plans, and also because management
was labor’s traditional nemesis.
Shareholder activism was a slow slog, company by company, vote by vote. It
required time-consuming meetings and costly proxy solicitations, usually to no
avail since, in the end, directors and executives were free to disregard share-
holder sentiment. On the other hand, government regulation was market-wide
and possessed enforcement teeth. Getting government to take action depended
on the ever-shifting balance of political forces, but shareholder activism was a
prod. Writing about social movements of the 1970s such as Campaign GM (an
effort to make General Motors more socially responsible) and anti-Apartheid
protests demanding that institutions divest their holdings of companies doing
business in South Africa, political scientist David Vogel observed, “The extent to
which demands addressed to the corporation anticipate the substance of sub-
sequent government regulation of business is quite striking.”
1
1Cited figures are from Lawrence Mishel, “Unions, Inequality, and Faltering Middle-Class
Wages,”Economic Policy Institute, Issue Brief no. 342, August 29, 2012; quote from David
Vogel, Lobbying the Corporation (New York: Basic Books, 1978), 14. On unions and inequality,
see Bruce Western and Jake Rosenfeld. “Unions, Norms, and the Rise in US Wage Inequality,”
American Sociological Review 76 (2011): 513–537; Christopher Kollmeyer and John Peters,
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When attempts to change private orderings proved insufficient, labor and its
friends in Washington sought to embed governance reforms in law. On several
occasions during the 2000s, voluntarism anticipated and interacted with pay
regulations formulated by the SEC and Congress, including those contained in
the Dodd-Frank Act (2010), the main legislative response to the financial crisis.
Governance reforms were adopted most widely when private activism was
alloyed with legislation, politics being one place where labor still had sway.
As labor went on the offensive over executive pay, the Wall Street Journal
opined that the issue was “perfect for galvanizing workers.”The AFL-CIO
released a study alleging that high levels of CEO pay were the result of “perva-
sive cronyism”between executives and board members. Compensation consul-
tants were quick to challenge the report, with one of them implausibly stating
that, inside the board room, “You don’t see much cronyism.”Bill Patterson of
the AFL-CIO disagreed: “Companies are giving out stock options no matter what
the CEO does or what the company does.”Patterson had a remarkable exchange
with General Electric’s CEO Jack Welch at GE’s 1997 shareholder meeting. That
year Welch’s pay package was $21.4 million, and he received 20,000 options on
top of 2.2 million unexercised options. Patterson asked Welch, “My question to
you is, do these options motivate you to bring more ideas, commit more value
and more time to the growth of the company? …Why stop at 320,000 shares?
Why not double that? …. Do the stock options motivate you?”“Absolutely,”said
Welch to laughter and applause from the audience.
2
“Financialization and the Decline of Organized Labor: A Study of 189 Advanced Capitalist
Countries, 1970–2012”Social Forces 98 (2019): 1–30. For critiques of shareholder primacy, see
Lynn A. Stout, “New Thinking on Shareholder Primacy,”Accounting, Economics, and Law: A
Convivium 2 (June 2012) at https://www.degruyter.com/downloadpdf/j/ael.2012.2.issue-2/2152-
2820.1037/2152-2820.1037.pdf; Lynn Stout, The Shareholder Value Myth: How Putting
Shareholders First Harms Investors, Corporations, and the Public (San Francisco: Berrett-
Koehler Publishers, 2012); and Simon Deakin, “The Coming Transformation of Shareholder
Value,”Corporate Governance 13 (2005): 11–18.
2“Call to Action: Labor Has Discovered the Perfect Issue for Galvanizing Workers,”Wall Street
Journal, April 9, 1998. Patterson’s questions were a throwback to the AFL-CIO’s 1991 “Model
Guidelines,”which supported stock-based incentive pay for managers but cautioned against
providing additional stock compensation that might diminish the incentive effect. AFL-CIO
Executive Council, “Model Guidelines for Delegated Proxy Voting Responsibility,”February
1991; “Executive Pay: Do CEOs Get Paid Too Much,”Congressional Quarterly Researcher 7,
July 11, 1999, 603–4; “Unions Take Fight over CEO’s Pay to Shareholders,”Knight-Ridder
Business News, April 11, 1999; “AFL-CIO Links Some Executives’Big Paychecks to Cronyism,”
Washington Post, April 10, 1998; Lucian Bebchuk and Yaniv Grinstein, “The Growth of Executive
Pay,”Oxford Review of Economic Policy 21 (2005): 283–303.
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During the early 1900s and again during the 2000s, a new populism took
hold in the United States, driven by the widening separation in pay and
working conditions of ordinary workers from wealthy elites, including corpo-
rate executives. Many Americans felt that the system was rigged, and there
was plenty of evidence to support them: the corporate pay scandals of the
2000s, beginning with options backdating, followed by Enron-era scandals,
and ending with the financial crisis during which bankers’pay became a
salient issue. This article is based on scrutiny of the historical record to
establish the context in which actors tussled around executive pay. We
identify actors and institutions, and embed them in politics and society. It’s
through historical accounts that we can study process, and separate conjunc-
tural and structural change.
We begin in Part 2 with an examination of the economics of executive pay.
This is followed by an overview of shareholder proposals to remedy defects in
stock-based pay (Parts 3 and 4), including failures to expense options (Part 5)
and unlawful backdating (Part 6) which had allowed executives to enrich
themselves without shareholder knowledge or approval, sometimes unlawfully.
Unions, as investors and political actors, were key players here. Their main
focus, however, was say on pay: giving shareholders the right to vote on the
board’s recommended executive pay package (Part 7). It had been relatively
uncontroversial in the United Kingdom but kicked off a storm of management
opposition in the United States, even though the votes would be advisory. Say
on pay found its way to Congress in the years preceding the 2008 financial crisis
(Part 8) and then was enshrined in the Dodd-Frank Act (Part 9). When pay voting
became prevalent, however, there were few of the predicted negative conse-
quences. This is followed by a brief discussion of pay-ratio reporting (Part 10) an
issue that the labor movement did not initially embrace. Conclusions round out
the paper.
2 Economics of executive compensation
For decades, CEO pay was remarkably stable, standing at about the same
inflation-adjusted level from the end of the Second World War through the
1970s. The stability mirrored that of the total income share flowing to the top
brackets. A change occurred during the 1980s, when real total compensation of
CEOs increased by 55 percent as did the size of top-income shares. After that,
things accelerated dramatically: pay rose by 126 percent during the 1990s and by
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125 percent from 2000 to 2005. Stock-based compensation is only part of the
story because CEO compensation grew twice as fast as share prices.
3
Economists offer several explanations for the rise in executive pay. The first-
optimal contracting- asserts that CEOs are paid what they’re worth. Economists
like this idea: what is, is efficient. According to their account, changes in
technology that began in the 1980s permitted the creation of a robust labor
market for CEOs in which competition for scarce talent pushed up pay. Before
the 1980s, allegedly, CEOs had skills that were specific to a single firm, which
meant there was no incentive for other firms to hire them. Then their skills
became fungible with the rise of MBA-CEOs whose accounting and finance skills
could be used at any kind of company. Another strand relates rising CEO pay to
firm size, as measured by capitalization. As size increased, CEO compensation
went up because it was difficult to find people capable of managing large,
complex organizations. A third is that the executive labor market originated in
the changing power dynamics between shareholders and executives. Outsiders
were preferable because they had no loyalty to the status quo. Competition for
outsiders-”the search for saviors”-led to higher pay.
4
In the past, workers relied on collective bargaining to stabilize their share of
value added. The portion of labor’s share going to CEOs declined as part of the
compression effect that unions have on within-firm pay. CEOs of unionized
companies are paid less than comparable CEOs at nonunion companies, but
3Carola Frydman and Raven E. Saks, “Executive Compensation: A New View from a Long-Term
Perspective, 1936–2005,”Review of Financial Studies 23 (2010): 2099–2138; Lawrence Mishel and
Alyssa Davis, “Top CEOs Make 300 Times More than Typical Workers: Pay Growth Surpasses
Stock Gains and Wage Growth of Top 0.1 Percent,”Economic Policy Institute, June 21, 2015;
Bebchuk and Grinstein, “The Growth of Executive Pay.”
4Rakesh Khurana, Searching for a Corporate Savior: The Irrational Quest for Charismatic CEOs
(Princeton, NJ: Princeton University Press, 2002); Carola Frydman and Dirk Jenter, “CEO
Compensation,”working paper no. 16585, National Bureau of Economic Research, 2010; Alex
Edmans and Xavier Gabaix, “Is CEO Pay Really Inefficient? A Survey of New Optimal
Contracting Theories,”European Financial Management 15, no. 3 (2009): 486–96; Xavier
Gabaix, Augustin Landier, and Julien Sauvagnat, “CEO Pay and Firm Size: An Update after
the Crisis,”Economic Journal 124 (2014): F-60-F89; Steven N. Kaplan, “Are U.S. CEOs Overpaid?”
Academy of Management Perspectives 23(2008): 5–20; Michael C. Jensen and Kevin J. Murphy,
“Performance Pay and Top-Management Incentives,”Journal of Political Economy 98 (1990):
225–264; Kevin J. Murphy, “The Politics of Pay: A Legislative History of Executive
Compensation,”Marshall School of Business working paper no. FBE 1 (2011); Steven N.
Kaplan and Joshua Rauh, “Wall Street and Main Street: What Contributes to the Rise in the
Highest Incomes?”NBER working paper 13270 (2007); Xavier Gabaix and Augustin Landier,
“Why Has CEO Pay Increased So Much?”The Quarterly Journal of Economics123, no. 1 (2008):
49–100.
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as unions shrank, so did the size of the slice paid to nonmanagerial workers.
Bargaining power-and pay- were further eroded by overseas outsourcing, an
increase in part-time jobs, and use of outside labor contractors. Today, wages no
longer track productivity. To whom do those productivity gains go? They go to
shareholders and to CEOs. CEOs have made out quite nicely in recent years.
They receive greater than the percentage increase in share prices on the upside;
on the downside, their pay is rigid. There’s nothing efficient here.
5
Over time it became easier for CEOs to manipulate the pay-setting process to
benefit themselves. Stock- based compensation offered myriad opportunities to
game the system, and the scandals of 2000, 2002, and 2008 provided plenty of
evidence of self-serving behavior. Other factors drove CEO rewards beyond what
was competitively necessary: pay for “luck”rather than performance, an inten-
tional lack of pay transparency, and compensation consultants who recommend
to their clients that they pay their executives above average, producing a leap-
frog effect. Spillovers from “bad”(overpaid relative to performance) to “good”
firms occurred as “good”firms had to offer more to executives to meet the
market. But what should CEOs receive? With so much of their compensation
riding on luck and bargaining power, nobody really knows what they are
worth.
6
5“Neither Rigged Nor Fair”The Economist, June 25, 2016; Lawrence Mishel and Natalie
Sabadish, “CEO Pay in 2012 Was Extraordinarily High Relative to Typical Workers and Other
High Earners,”Economic Policy Institute, June 26, 2013; K. J. Martijn Cremers and Yaniv
Grinstein, “Does the Market for CEO Talent Explain Controversial CEO Pay Practices?”Review
of Finance 18 (2013): 921–60; Mishel and Davis, “Top CEOs Make 300 Times More”; Qianqian
Huang, Feng Jiang, Erik Lie, and Tingting Que, “The Effect of Labor Unions on CEO
Compensation,”Journal of Financial and Quantitative Analysis 52, no. 2 (2017): 553–82 ; John
DiNardo, Kevin Hallock, and Jorn-Steffen Pischke, “Unions and Managerial Pay,”working paper
no. 6318, National Bureau of Economic Research, 1997; Rafael Gomez and Konstantinos
Tzioumis, “What Do Unions Do to CEO Compensation?”discussion paper 720, Centre for
Economic Performance, London School of Economics, May 2006; Ian Dew-Becker and Robert
J. Gordon, “Where Did the Productivity Growth Go? Inflation Dynamics and the Distribution of
Income,”National Bureau of Economic Research working paper no. w11842, 2005; Martin J.
Conyon and Kevin J. Murphy, “The Prince and the Pauper? CEO Pay in the United States and
United Kingdom,”The Economic Journal 110, no. 467 (2000): 640–61; Lucian A. Taylor, “CEO
Wage Dynamics: Estimates from a Learning Model,”Journal of Financial Economics 108, no. 1
(2013): 79–98.
6“Pay Check,”Economist, August 6, 2016; Lucian Bebchuk and Jesse Fried, Pay without
Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, MA: Harvard
University Press, 2004); Gretchen Gavett, “CEOs Get Paid Too Much, according to Nearly
Everyone in the World,”Harvard Business Review, September 23, 2013; “Behind Big Dollars,
Worrisome Boards,”New York Times, April 9, 2006; Cremers and Grinstein, “Does the Market for
CEO Talent?”;“Tax Savvy Execs Work for $1, Get Paid Millions as Capital Gains,”Forbes, May 2,
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3 Pay proposals
Labor unions in the United States are not permitted to bargain over executive
compensation. That leaves politics and shareholder activism as their options
for weighing in on the issue. Union pension plans became shareholder activists
in the 1990s and more so during the following decade, when they submitted
an-ever growing number of shareholder proposals, which are voted on by
shareholders but are merely advisory to the board of directors. Pay-related
proposals mushroomed after the Enron-era scandals and jumped again in
2007. Union investors were responsible for the change; on average, they
were more successful than other groups in obtaining majority support for
their proposals. Nearly one out of four of them garnered a majority of “yes”
votes between 2003 and 2007, whereas previously they had received a mere 2
percent. Labor chose its targets carefully: companies with governance defects
and poor performance. Even when union investors had collateral interests
related to obtaining new members, other institutional investors gave consid-
erable support to union proposals. They cared more about immediate returns
than any theoretical possibility that, if some of a company’s employees joined
a union, it would cut into funds that could have been used for shareholder
payouts.
7
Who were the targets of labor’s pay proposals? They were companies where
CEOs collected high levels of pay and/or served as board chairs. A study of
labor’s pay activism found “no evidence of union-related motives,”and compa-
nies were equally likely to implement compensation proposals from union
investors as from public plans. Both were signs that labor was swimming in
the shareholder mainstream. Occasionally, union investors selected firms with
2016; Taekjin Shin, “Fair Pay or Power Play? Pay Equity, Managerial Power, and Compensation
Adjustments for CEOs,”Journal of Management 42 (2016): 419–48; “House Committee Probes
Executive-Pay Consultants,”CFO.com, December 5, 2007; “How Big a Payday for the Pay
Consultants?”New York Times, June 22, 2008; Carola Frydman and Dirk Jenter, “CEO
Compensation,”Annual Review Financial. Economics 2 (2010): 75–102. A comprehensive dis-
cussion of defects in executive pay setting is Bebchuk and Fried, Pay Without Performance.
7Majority votes matter because, on average, a company’s full implementation of all submitted
pay proposals is only 5 percent, but, when a proposal receives a majority vote, full implemen-
tation rises to 32 percent. Yonca Ertimur, Fabrizio Ferri, and Volkan Muslu, “Shareholder
Activism and CEO Pay,”Review of Financial Studies 24 (2011): 535–92.On labor’s targets, see
Andrew K. Prevost, Ramesh P. Rao, and Melissa A. Williams, “Labor Unions as Shareholder
Activists: Champions or Detractors?,”Financial Review 47 (2012): 327–349; Ertimur, Ferri, and
Muslu, “Shareholder Activism.”The data on pay proposals and their sponsors is taken from
Georgeson’sAnnual Corporate Governance Review (ACGR).
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labor disputes, but the same study showed that this had no effect on the like-
lihood that other shareholders and proxy advisors would lend support. The only
situation in which union investors incurred a voting penalty happened when the
target firms’employees were affiliated with the union sponsoring the submis-
sion, not a common occurrence.
8
The bull market of the 1990s left investors disinterested in executive pay.
During those years, said Beth Young, “compensation had been considered a
governance stepchild.”CII’s Ann Yerger said that her members might care more
about executive compensation if the market were down but added, “Everybody’s
kind of fat and happy now.”The situation changed shortly thereafter.
Institutional Shareholder Services (ISS) now regularly backed pay proposals,
whereas in the 1990s it had been less consistent in offering support. As always,
public plans were chary of sponsoring pay proposals lest it appears that govern-
ment was dictating what the private sector should do. Confidential meetings
were a better way to go.
9
Of the different compensation proposals offered during the 2000s, those
demanding “say on pay,”an advisory issue, were the single most popular type.
Say on pay gave shareholders the right to vote on the board’s pay recommen-
dations, that is, greater voice in corporate governance rather than specific pay
practices, although the latter was part of the mix. If we group all kinds of
compensation-related proposals into categories, the largest by far involved
stock-based pay. To eliminate various gimmicks, the proposals recommended
options indexing, longer time periods for cashing options, and eliminating
options entirely and replacing them with other types of stock-based pay such
as performance-based units and restricted stock.
Disclosure of executive compensation drew relatively few proposals and few
votes. The picture changes if one classifies options expensing as a type of
disclosure. Then there were “social”pay proposals, a potpourri of ideas for
tying executive pay to nonstock criteria such as employee satisfaction, environ-
mental performance, and downsizing (cutting CEO pay after mass layoffs), but
8Ertimur, Ferri, and Muslu, “Shareholder Activism and CEO Pay,”566; Renneboog, Luc and
Peter Szilagyi, “The Success and Relevance of Shareholder Activism through Proxy Proposals,”
European Corporate Governance Institute –Finance Working Paper, 275/2010, March 2010; Luc
Renneboog and Peter Szilagyi, “The Role of Shareholder Proposals in Corporate Governance,”
Journal of Corporate Finance 17 (2011): 167–88; “Union Funds Champs of the Proxy Season,”
Pensions & Investments (hereafter P&I), February 5, 2007; Executive Excess: Annual CEO
Compensation Survey, 2003–2007 (Washington, DC: Institute for Policy Studies).
9Interview with Beth Young, July 2008, New York City; “Heads I Win, Tails I Win: More
Companies Offer Bonus Payments That Aren’t Tied to Performance,”Wall Street Journal, April
6, 2000.
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these were much more likely to come from socially responsible investors than
union funds. There were two other items of note: so-called commonsense pay
plans and pay for superior performance plans, both developed by the Carpenters
Union.
10
4 Stock-based pay
Stock options were not a new practice, but they were uncommon until after the
Second World War. The Revenue Act of 1950 sweetened the tax treatment of
qualified stock plans and caused an uptick in their usage. One of the earliest
critics was the AFL-CIO’s Industrial Union Department, which in 1959 issued a
report called “The Stock Option Scandal.”Stock options, said the report, “pro-
vide tax-privileged, risk-free profit opportunities unrelated in any meaningful
way to executive performance and unchecked by effective stockholder control.”
These were prescient words, all the more so given that stock options counted for
less than 5 percent of CEO compensation during the 1950s.
The idea of compensating executives with stock-based pay instead of sal-
aries received strong support during the 1980s, when American industrial com-
panies were struggling to compete in global markets. Financial economists such
as Eugene Fama and Michael Jensen alleged that America’s industrial problems
were the result of executives failing to act in the interests of the corporation’s
principals, its shareholders. Either they were pursuing their own interests, which
included risk-aversion (the quiet life), or they were giving undue attention to
stakeholders whose interests were unrelated to share-price maximization, such
as employees and communities. Payment in cash, they said, would not wake
executives from their quiet life because the money was risk-free. Economists
Michael Jensen and Kevin J. Murphy said in 1990 that tying executive pay to
stock prices and firing CEOs if they failed to raise them were “the most effective
tools for aligning executive and shareholder interests.”Institutional investors
seconded the idea. Jon Lukomnik, the deputy comptroller for New York City’s
pension plans, said in 1995 that “shareholders just don’t own a piece of paper
but actually own the company. The whole thing is you don’t want management
to have a different set of initiatives financially than the shareholders have. You
10 Yaniv Grinstein, David Weinbaum, and Nir Yehuda, “Perks and Excess: Evidence from the
New Executive Compensation Disclosure Rules,”working paper no. 04–09, Cornell University,
Johnson School Research Paper Series, 2008. The easiest way to track pay proposals over time is
through AGCR, which breaks out non-withdrawn pay proposals by type, sponsor, and voting
outcome.
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want to align the business of managers with shareholders so they both prosper
together.”
11
Stock options, as intended, caused CEOs to take bolder steps but there were
unintended consequences. Options delivered erratic corporate performance–big
gains and big losses–with the losses exceeding the gains. It may explain why
companies whose CEOs received options worth more than those of comparable
firms experienced unexpectedly low stock returns. Related to risk is the finding
stock options were associated with product safety problems because they “pro-
mote a lack of caution in CEOs.”Although options repeatedly were touted as a
mechanism for aligning managers and shareholders, they were like other incen-
tive-pay schemes in that recipients eventually figured out how to game them.
Law professors Lucian Bebchuk, Jesse Fried, and David Walker found that
misuse of options was rife, and that they were associated with earnings manip-
ulation and corruption.
That executives used options to extract rents is evident in their design: a
host of clever features such as failing to index a company’s stock gains to
performance of its peers, offering in-the-money options (guaranteed payoff),
reloading (breaking the pay-performance link by protecting options losses),
hedging the company’s own stock, spring loading (timing an options grant to
precede positive news), repricing (replacing underwater options with new,
above-water ones), and other tricks that were difficult to discern. The lack of
transparency was intended, not accidental, something that the AFL-CIO first had
flagged in its 1959 report: “The average person is caught in a maze if he attempts
to obtain some idea of the value of stock options granted to specific individu-
als.”But even if options reduced the relative size of rents going to shareholders,
they helped erode vestiges of managerialism. Said Damon Silvers of the AFL-
CIO, “The managerial class gave up resisting the financial players and realized
that it was better to play along with them. You got very rich by playing along
with them …and stock options were a big part of that change.”
12
11 Industrial Union Department, AFL-CIO, The Stock Option Scandal (Washington, DC: 1959), 23;
Michael C. Jensen and Kevin J. Murphy, “CEO Incentives –It’s Not How Much You Pay, But
How,”Harvard Business Review 68, no. 3 (1990): 138–53; Eugene F. Fama and Michael C. Jensen.
“Agency Problems and Residual Claims,”Journal of Law and Economics 26 (1983): 327–349. For
a cogent criticism of agency theory as applied to corporate governance, see
Iman Anabtawi and Lynn Stout, “Fiduciary Duties for Activist Shareholders,”Stanford Law
Review 60 (2007): 1255–1308. Lukomnik in “Holders Put the Screws to Wooden Performers,”
Footwear News, November 27, 1995.
12 William Sanders and Donald C. Hambrick. “Swinging for the Fences: The Effects of CEO
Stock Options on Company Risk Taking and Performance, “Academy of Management Journal 50
Executive Pay and Labor’s Shares 11
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5 Expensing options
One reason stock options flowed like water during the 1990s and early 2000s
was that they were not reported on a company’s books, thus overstating earn-
ings. At WorldCom, earnings would have been 30 percent less in 2000 had
options been expensed. Options also reduced taxes, at least for NASDAQ and
S&P 100 companies. Companies were permitted to take a tax deduction for
employees gains when they exercised their options. Heavy users-high-tech
firms like Microsoft and Cisco Systems-erased all or most of their federal taxes
by failing to expense. Stock options almost certainly would have been less
widespread had expensing been required.
13
Beginning in the mid-1980s, when options were starting to catch on, the
Financial Accounting Standards Board (FASB), the US accounting-standards
setter, considered requiring companies to expense stock options to show the
(2007): 1055–1078; Michael J. Cooper, Gulen, Huseyin and Raghavendra Rau, “Performance for
Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance,”
SSRN working paper 1572085, November 1, 2016; Adam J. Wowak, Michael J. Mannor, and
Kaitlin D. Wowak, “Throwing Caution to the Wind: The Effect of CEO Stock Option Pay on the
Incidence of Product Safety Problems,”Strategic Management Journal 36 (2014): 1082–92;
Lucian Bebchuk, Jesse Fried, and David Walker, “Managerial Power and Rent Extraction in
the Design of Executive Compensation,”University of Chicago Law Review 69 (2002): 751–55;
Bebchuk and Fried, Pay without Performance; Jared Harris and Philip Bromiley, “Incentives to
Cheat: The Influence of Executive Compensation and Firm Performance on Financial
Misrepresentation,”Organization Science 18, no. 3 (2007): 350–67; Lin Peng and Ailsa Roell,
“Executive Pay and Shareholder Litigation,”Review of Finance 12, no. 1 (2008): 141–84; “Bush
Failed to Stress Need to Rein in Stock Options,”Wall Street Journal, July 11, 2002; Edmans,
Gabaix, and Jenter, “Executive Compensation”; interview with Damon Silvers, March 2007,
Washington, DC.
13 “Bush Failed”; Sanford M. Jacoby, “For More Honesty with Stock Options,”Christian Science
Monitor, July 29, 2002. Graham and his colleagues explain that, “Unlike other forms of com-
pensation, stock options are not typically reflected in pretax income or in deferred taxes. In
terms of pretax income, options are generally not considered an income statement expense, and
firms that opt not to expense stock options also do not reduce tax expense on the income
statement to reflect the effect of option deductions. Further, unlike many book/tax differences,
the effect of options is not captured in deferred taxes because the difference between tax and
book income never reverses. As a result, a firm can consistently report high tax expense (on
financial statements) and never pay any taxes (on tax returns). Prior research has typically used
income statement data to infer taxable income and thus ignored option compensation deduc-
tions for the majority of firms (because most firms do not expense options).”John R. Graham,
Mark H. Lang, and Douglas A. Shackelford. “Employee Stock Options, Corporate Taxes, and
Debt Policy,”Journal of Finance 59 (2004): 1589.
John R. Graham, Mark H. Lang, and Douglas A. Shackelford. “Employee Stock Options,
Corporate Taxes, and Debt Policy,”Journal of Finance 59 (2004): 1589.
12 S. M. Jacoby
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liabilities they were carrying on their books. The issue came to head in 1993,
when FASB released the draft of an expensing plan. Democratic Senator Carl
Levin of Michigan offered a bill making expensing mandatory if companies took
a tax deduction when options were cashed. The business community, with high
tech in the lead, formed a united front against expensing.
The 1990s was an era of boundless enthusiasm for high tech, and Congress
mostly supported that fervor. Democrats from tech-heavy states in New England
and California led the opposition to expensing. Senators Joseph Lieberman (D-
CT) and Ed Markey (D-MA) savaged the FASB proposal. By a lopsided vote of
eighty- eight to nine, the Senate passed a nonbinding resolution asking FASB to
drop its expensing project, so it did. Lieberman called this “a great victory for
American business and workers,”while Levin said that “honest accounting lost
out to the pressure of the rich and powerful.”In retrospect, Levin was closer to
the truth. An accounting professor at Columbia University subsequently judged
Lieberman’s intervention as the first step on “the slippery slope that got us
mired in the Enron swamp.”
14
The California Public Employee Retirement System (CalPERS) the giant
public pension plan, was susceptible to lobbying from the state’s technology
and venture-capital companies, was firmly against expensing. It pressed the
national association of public pension plans, the Council of Institutional
Investors to remain neutral on the issue. CalPERS preferred to leave the issue
to advisory votes by shareholders. The AFL-CIO’s Karen Ignani, director of
employee benefits, asked FASB and CII to adopt a compromise according to
which companies would not have to expense their options but would have to
separately list on their financial statements their present value and the impact
on stock dilution. Under pressure from union investors, most CII members
supported the compromise. But opposition from CalPERS and from Cll’s corpo-
rate pension funds kept CII from endorsing it. Three years later, Levin, this time
together with Republican Senator John McCain (AZ), offered another bill to
expense stock options. But this effort went nowhere; by then, the economy
was in overdrive and executive compensation less of a concern.
15
14 William Greider, “Not Wanted: Enron Democrats,”The Nation, April 8, 2002; “FASB Caves in
on Stock Options,”Practical Accountant, February 1, 1995. FASB sets U.S. GAAP standards for
public companies. Although it is a private organization, it is designated by the government’s
Securities and Exchange Commission to have authority in this area. The blending of public
purpose and private administration is a potential source of conflict with accountability and
transparency, as became clear after Enron failed
15 Andrew K. Prevost and John D. Wagster, “Impact of the 1992 Changes in the SEC Proxy Rules
and Executive Compensation Requirements,”unpublished paper, September 1999; “Accounting
Board Yields on Stock Options,”New York Times, December 15, 1994; Harlan Wells, “U.S.
Executive Pay and Labor’s Shares 13
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Come Enron, and expensing again was on the agenda. Senators Levin and
McCain, joined by new players like Representative Barney Frank (D-MA), rein-
troduced their expensing bill. Republicans were dead set against it; instead, the
GOP created the Senate Republican High-Tech Taskforce, with the express
purpose of heading off expensing. Working with them was the International
Employee Stock Options Coalition, a lobbying group composed of venture-
capital and technology companies. The party line was that expensing was
technically unfeasible; there was no way to calculate the present value of option
liabilities. Opposition to expensing included a phalanx of heavy hitters:
President George W. Bush, Harvey Pitt of the SEC, and the nation’s two main
business associations-the U.S. Chamber of Commerce and the Business
Roundtable.
16
On the other side were prominent business figures like Warren Buffett and
Alan Greenspan, who noted that business people were not any greedier than in
the past but that stock options had given them “avenues to express greed.”A
study by the Boston Consulting Group found that the value of stock options
granted to companies guilty of options-related fraud was 800 percent greater
than those given to CEOs of comparable firms: “Nothing correlated so strongly
with corporate fraud as the value of stock options-not the standard of the firms’
governance, nor analysts’inflated expectations about their earnings, nor ego-
boosting stories about their CEOs in the press.”
17
Sarbanes-Oxley (SOX) contained a few provisions regulating stock options,
such as rapid disclosure. The law created a Public Corporation Accounting
Oversight Board, in response to criticisms that FASB, a private organization,
was too close to the financial industry. But fierce opposition from business kept
expensing out of the act. Labor was furious about that omission. On the day that
the law went into effect, the AFL-CIO held a rally to kick off a nationwide
Executive Compensation in Historical Perspective,”in Research Handbook on Executive
Compensation, ed. Randall S. Thomas and Jennifer G. Hill (Cheltenham, UK: Elgar, 2012), 41–
57; “Council Toughens Stance,”P&I, February 21, 1994.
16 “Business Lobby Seeks to Limit Investor Votes on Options,”New York Times, June 6, 2002.
Despite the hoopla about secretaries in high-tech companies becoming rich from their stock
options, in fact, 75 percent of stock options went to a company’s top five executives, and more
than half the remainder went to the next fifty managers. Only three million workers- about 2
percent of the U.S. labor force-were granted stock options, and they received a relative pittance.
Roger Lowenstein, Origins of the Crash: The Great Bubble and Its Undoing (New York: Penguin,
2004), 45.
17 “The Campaign to Keep Options off the Ledger,”Bloomberg News, July 14, 2002; Lucian
Bebchuk, “Insider Luck and Governance Reform,”presentation for Capital Matters, May 2007;
Boston Consulting Group in “Fat Cats Turn to Low Fat,”The Economist, March 3, 2005.
14 S. M. Jacoby
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campaign, “No More Business as Usual.”Hundreds of union members gathered
in front of the New York Stock Exchange to listen to AFL-CIO president John
Sweeney denounce Enron’s ex-executives for cashing their options as the com-
pany went under. “They are thieves and they are stealing our hopes, stealing our
dreams, and stealing our future,”he declaimed. In a press release, Sweeney
blamed stock options for driving up executive compensation “to an obscene 410
times average workers’pay.”However, compared to his rhetoric, Sweeney’s
recommendations were blandly technocratic. He told the rally that the num-
ber-one item on his agenda was expensing. The other was to prohibit executives
from selling shares in their firm while in office, which, he said, would remove
incentives for them to pump up their company’s stock.
18
Congress returned to the executive compensation issue several months after
SOX became law. The Senate Commerce Committee, chaired by John McCain,
convened hearings in May 2003. The Arizona senator, by now a longtime critic of
top-level overcompensation, was particularly incensed by the airline industry,
which had been paid close to $4 billion from the government to tide it over the
drop in airline travel following 9/11. The subsidy had been contingent on fixing
what McCain called “insulting”executive pay packages, yet the airlines had
failed to rein in compensation. The hearings delved into a variety of other topics,
including Jack Welch. Welch had been invited to testify but did not appear, nor
did other highly paid CEOs like Michael Eisner and Leo Mullin (Delta Airlines).
McCain, sounding even more spirited than Sweeney, warned that the United
States was “returning to a second Gilded Age”and that stock option misdeeds
“give capitalism a bad name.”
19
18 “How Congress Rode a Storm to Corporate Reform,”Washington Post, July 28, 2002; “AFL-
CIO Head Calls for Grass-Roots Campaign against Corporate Greed,”AP Newswire, July 30, 2002;
“Statement by AFL-CIO President John J. Sweeney on the Need for New Rules to Ensure
Corporate Accountability,”PR Newswire, July 9, 2002. During the Congressional hearings
leading up to Sarbanes-Oxley, the AFL-CIO’s Damon Silvers testified that “[a]nyone familiar
with the political pressures brought to bear on FASB around accounting for executive stock
options in the mid-1990’s, not to mention the decade long paralysis on SPE [Special Purpose
Entities, a major issue at Enron] accounting knows that FASB is too open to pressures from
issuers and those beholden to issuers.”After SOX’s passage, Silvers was appointed to the
PCAOB’s Standing Advisory Group and its Investor Advisory Group. Silvers quoted in Donna
M. Nagy, “Playing Peekaboo with Constitutional Law: The PCAOB and its Public/Private
Status.”Notre Dame Law Review, 80 (2004): 988.
19 “Despite Recession, Perks for Top Executives Grow,”Los Angeles Times, February 1, 2002;
“Corporate Reform, Back on the Front Burner,”National Journal, March 1, 2003; “Excessive
Executive Pay Eroding Investor Confidence,”Associated Press, May 20, 2003; CEO Compensation
in the Post-Enron Era: Hearing be!ore the Committee on Commerce, Science, and Transportation,
108th Cong., 1st Sess., May 20, 2003 (Washington: U.S. GPO, 2006). The association between
Executive Pay and Labor’s Shares 15
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Damon Silvers, associate counsel for the AFL-CIO, was one of those who did
appear, providing wide-ranging testimony. He was a product of labor’s financial
turn, a graduate of Harvard’s business school and its law school. Playing to
McCain, he noted that, after 9/11, American Airlines had failed to disclose an
executive pay plan that included a $41 million payment to protect executive
pensions in case of bankruptcy. He said that the timeframe for granting options
was too short and led to risky decisions that hurt the interests of long-term
investors like pension funds. FASB and the SEC had the power to do something
about executive compensation, Silvers asserted, but “they need the support of
Congress.”In light of the business community’s campaigns, he stressed that the
accounting board had to have its independence protected so it could proceed
with what it had been trying to do for twenty years. However, a greater issue was
at stake than expensing, he contended: “Our markets will be damaged if after
the events of the last two years it appears that our accounting standards are still
being held hostage to the very political dynamics that prevented effective
regulation in the 1990s.”
20
Business lobbying against a FASB rule remained intense. The International
Employee Stock Options Coalition collected signatures from more than forty
members of Congress, including California representatives from both sides of
the aisle, and sent them to FASB in January 2003. The coalition brought prom-
inent executives to Washington to make personal visits to members of Congress.
They included Oracle’s Larry Ellison, another CEO who had thumbed his nose at
McCain’s committee. Representatives David Dreier (R-CA) and Anna Eshoo (D-
CA) co-sponsored a bill to delay any FASB rule until the completion of a three-
year study of expensing. In November, Senator Michael Enzi (R-WY), a former
accountant, introduced yet another bill to stave off an FASB standard, this one
requiring that expensing be limited to a company’s top-five executives. With a
touch of hyperbole, Enzi said a FASB rule would kill entrepreneurial activity in
the United States. Not to be outdone, John Doerr, the doyen of the venture-
capital industry, said to FASB’s chairman, “I don’t think there could be a worse
time in America’s economic history to adopt such a policy.”
21
commercial airplanes and the destruction of the World Trade Center caused a sharp drop in
passenger travel. The federal government responded with loans and short-term assistance to the
commercial airline industry.
20 CEO Compensation, 15–17; “Investors Grow Restive over Lavish Boardroom Pay.”
21 “Corporate Reform, Back on the Front Burner”;“Congress, FASB in Stock Option Flap,”CFO.
com, June 6, 2003; “This Options- Expensing Bill Is No Reform,”Business Week, November 25,
2003; Doerr quoted in Michael Liedtke, “Tech Industry Challenges Reform,”Los Angeles Times,
May 20, 2003.
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In the midst of this back and forth, Microsoft broke ranks with an electrify-
ing announcement: it would abandon stock options for a mix of time- and
performance-based stock grants. The company had been preceded one year by
Coca-Cola, but Coke was not from the tech world, nor was it nearly as influential
as Microsoft. Following the announcement, Richard Trumka of the AFL-CIO sent
letters to twelve major companies, including Intel and Cisco, urging them to
follow suit. Sounding more like the attorney he was than a tough- talking union
chief, Trumka wrote, “I strongly encourage you to expense all equity compen-
sation including previously granted stock options, and to grant performance-
vesting restricted stock to senior executives instead of stock options.”Bill
Patterson labeled the Microsoft decision “a defection”and “the beginning of
the end, though not the end”for unexpensed options.
22
On a parallel track, union investors offered numerous shareholder proposals
to compel expensing. Companies successfully bid the SEC to block them-as
when National Semiconductor said that a Carpenters’proposal was an account-
ing-related and not pay-related matter and therefore covered by the ordinary
business exclusion. At the end of 2002, the SEC reversed course and deemed
expensing “an important social policy issue,”hence, free from the exclusion. Ed
Durkin immediately announced that his building-trades coalition planned to
submit over a hundred proposals and “create momentum”to prod Congress
and FASB to act. “Shareholder proposals,”he said, “provide an opportunity to
weigh in while politicians are waffling.”
Over 150 expensing proposals were filed in 2003 and 2004; of these, 107
made it to a vote. Over 90 percent of the proposals came from union investors,
most of them in Durkin’s coalition, and they received an average vote of 49
percent. Support reached 90 percent at Starwood Hotels and 79 percent at Fluor.
After the vote, Fluor responded by immediately beginning to expense options.
Like other companies at this point, it could see the handwriting on the wall.
Fabrizio Ferri and Tatiana Sandino, accounting professors at Columbia and USC,
respectively, found that the mere submission of an options-related proposal in
2003 was associated with an 11 percent increase in the likelihood of a company’s
voluntarily choosing to expense. When proposals obtained majority votes at
Fortune 500 companies, they were followed by an average decrease in CEO
compensation of $2.3 million, a significant amount.
23
22 “Coke to Report Options as an Expense,”New York Times, July 15, 2002; “Tarnished Gold:
Microsoft Ushers Out Era of Options,”Wall Street Journal, July 9, 2003; “AFL-CIO Asks Others to
Follow Microsoft on Options,”Reuters, July 9, 2003.
23 “Shareholders Have the Floor,”Boston Globe, January 2, 2003; “Joint Effort: Union Funds
Using Proxy Resolution as Lobbying Tool,”P&I, June 9, 2003; interview with Ed Durkin, April
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After FASB issued a draft expensing proposal, Cisco and Intel prodded their
employees to swamp the board with antiexpensing letters. Cisco executives
knew that, if they had to expense options, earnings would be cut by over a
third. On the other side, the AFL-CIO created a form letter stating that executives
should be “ashamed for trying to hide the cost of stock options”and put it on
the Paywatch site. The AFL-CIO was one of the founders of RestoretheTrust.com,
a forty-member association of pension funds and other institutional investors
that earlier had lobbied for Sarbanes-Oxley. The group had a form letter sent by
nearly one thousand people that excoriated unexpensed options and the “exor-
bitant pay packages”that resulted from them.
24
In the background was the steady drumbeat of corporate scandals. The SEC
sued HealthSouth in 2003 for falsifying $2.7 billion in profits. The Justice
Department indicted Richard Scrushy, the company’s CEO, for money launder-
ing, securities fraud, and other charges. This was one of the few criminal cases
ever pursued for violations of Sarbanes-Oxley. Shareholders filed lawsuits charg-
ing Scrushy with insider trading connected to sale of his stock options. That
same year a cocky Jack Welch got his comeuppance after his divorce proceed-
ings revealed a secret severance package that left General Electric on the hook
for a luxury apartment, regular flower deliveries, and food service staff, among
other eye-opening perks. Even the SEC criticized GE for failing to disclose the
details of Welch’s retirement deal. In contrast to the shareholder meeting where
Bill Patterson drew hoots of derision from other investors, the 2003 meeting saw
one shareholder stand up and say, “What we did for Jack Welch was absolutely
disgusting.”
25
2008, Washington, DC; Fabrizio Ferri and Tatiana Sandino, “The Impact of Shareholder
Activism on Financial Reporting and Compensation: The Case of Employee Stock Option
Expensing,”The Accounting Review 84 (2009): 433–66. Durkin quoted in Phyllis Plitch,
“Teamsters Enter Options War with Battle Against Tech Co,”Dow Jones News Service, October
17, 2002.
24 “Cisco and FASB: Options Showdown,”CFO.com, May 24, 2004; “Letter Campaigns Try to
Sway FASB on Option Expensing,”Dow Jones Newswires, May 18, 2004; “Group of Big Pension
Funds, Unions, Urges Option Expensing,”Dow Jones Newswire, May 19, 2004; FASB Proposals
on Stock Option Expensing: Hearing be!ore the Subcommittee on Commerce, Trade, and Consumer
Protection o! the Committee on Energy and Commerce, U.S. House of Representatives, Serial 108–
99, July 8, 2014; Fabrizio Ferri, Garen Markarian, and Tatiana Sandino, “Stock Options
Expensing: Evidence from Shareholders’Votes,”European Accounting Association Annual
Congress, Goteborg, DE, 2005.
25 “HealthSouth Founder Is Charged with Fraud,”Washington Post, November 5, 2003;
“Former HealthSouth CEO, Richard Scrushy, Gets Prison Sentence Reduced,”Forbes, January
26, 2012; “GE Executive Pay under Spotlight at Annual Meeting,”Reuters, April 22,
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In the wake of repeated scandals, investors realized that they’d been
scammed. Michael Jensen, an early and influential enthusiast, recanted his
faith: “I recommend that a company never again issue another typical standard
executive stock option. The vast increase in the use of options in managerial
compensation plans in the last decade does not suffice to identify managers’
interests with those of their stockholders and with that of society.”Paul Volcker
took a similar position, blaming fixed-price options for a “capricious element”
and recommending that they be “strongly discouraged for public companies.”
FASB finally adopted an expensing rule in December 2004.
26
There then occurred a dramatic reversal in the popularity of options, from a
weight of 49 percent in CEO compensation in 2000 to 12 percent in 2016, though
they were replaced by other lucrative types of stock-based pay. One group,
however, failed to recoup losses from the ebbing of stock options: nonexecutive
employees. During the NASDAQ boom, stock options had been liberally distrib-
uted, but because expensing raised the real cost of options, fewer employees
now received them.
27
6 Backdating
No sooner had expensing become law than another problem arose: options
backdating. Backdating occurs when an option’s grant date is reset to an earlier
2003; “Investors Grow Restive”;“GE Settles with SEC over Welch Retirement Perks,”Reuters,
September 23, 2004.
26 “Why the Get-Rich-Quick Days May Be Over,”Wall Street Journal, April 14, 2003; Michael C.
Jensen, “How Stock Options Reward Managers for Destroying Value and What to Do About It,”
Harvard Business School, working paper No. 04–27, April 2001; Volcker in Conference Board,
Commission on Public Trust and Private Enterprise (New York: The Conference Board, 2003), 13;
Miller in “Weighing the Options,”Business Mexico, November 1, 2002; David F. Larcker and
Brian Tayan, “Union Activism: Do Union Pension Funds Act Solely in the Interest of
Beneficiaries?”Rock Center for Corporate Governance Stanford University, working paper
CGRP-30 (2012).
27 L. D. Brown and Y. Lee, “The Impact of SFAS 123R on Changes in Option-Based
Compensation,”SSRN working paper 930818 (2007); Equilar, 2016 CEO Compensation Pay
Trends (Equilar, Redwood City, CA: 2016); “Citigroup Payouts of Chiefs Irk Holders,”Wall
Street Journal, August 25, 2006; Jacob S. Hacker and Paul Pierson, “Winner-Take-All Politics:
Public Policy, Political Organization, and the Precipitous Rise of Top Incomes in the United
States,”Politics and Society 38 (2010): 152–204; Douglas L. Kruse, Joseph R. Blasi, and Rhokeun
Park, “Prevalence, Characteristics, and Employee Views of Financial Participation in
Enterprises,”ed. Kruse, Blasi, and Richard B. Freeman, Shared Capitalism at Work (Chicago:
University of Chicago Press, 2010), 50.
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date. Doing this minimizes the risk associated with a falling share price and
raises the option’s value. While not unlawful per se, if it is not disclosed and
approved by shareholders, it can violate accounting and securities laws.
Backdating also overstates net income. If backdating is unreported but subse-
quently discovered, a financial restatement is required, which reduces previous
profits. A study by Erik Lie at the University of Iowa found that backdating had
led to executives receiving “billions of [illegitimate] dollars.”The Wall Street
Journal reported Lie’s findings in a March 2006 story that rocked the business
world. The Journal created a website revealing companies under scrutiny by the
Justice Department and the SEC.
28
Of nearly eight thousand companies studied by Lie, almost 30 percent-more
than two thousand from all industries, not only tech-had not reported backdated
options granted between 1996 and 2005. Most companies were forced to restate
earnings. A few had credit downgrades and were temporarily delisted. Several
CEOs were indicted by the Justice Department. Some of the companies inves-
tigated for backdating would later be implicated in the subprime mortgage
meltdown. In fact, sixteen months after a shareholder sued Lehman Brothers
for manipulating grant dates, the company declared bankruptcy.
29
In 2006, the SEC circulated a draft proposal to limit backdating and other
compensation problems through enhanced disclosure in proxy statements,
annual reports, and registration statements. The rules would require that most
of the disclosure be written in plain English. But the proposal left many people
dissatisfied. Pressure on the SEC to take a tougher stance came in various forms,
including shareholder proposals from union investors. The Electrical Workers’
(IBEW) pension plan demanded longer holding periods for stock options, the
AFL-CIO sponsored proposals asking that vesting be prohibited until perform-
ance criteria were met, and LongView sought specific grant dates and filed
backdating resolutions at nine companies.
28 Erik Lie, “On the Timing of CEO Stock Option Awards,”Management Science 51 (2005): 802–
81; Randall A. Heron and Erik Lie, “What Fraction of Stock Option Grants to Top Executives
Have Been Backdated or Manipulated?”Management Science 54 (2009): 513–25; “The Perfect
Payday,”Wall Street Journal, March 18, 2006; “Perfect Payday: Options Scorecard,”Wall Street
Journal, http://online.wsj.com/public/resources/documents/info-optionsscore06-full.html
29 “Authorities Probe Improper Backdating of Options,”Wall Street Journal, November 11,
2005; Yonca Ertimur, Fabrizio Ferri, and David A. Maber, “Reputation Penalties for Poor
Monitoring of Executive Pay: Evidence from Option Backdating,”Journal of Financial
Economics 104 (2012): 118–44; “Options Scandal in U.S. Set to Grow Further,”Bloomberg
News, August 4, 2006; “Silicon Valley Was Calming Down. Now an Options Scandal,”New
York Times, July 22, 2006; “Lehman Sued over Alleged Backdating,”Wall Street Journal, April
14, 2007; Bebchuk, “Insider Luck and Governance Reform.”
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To keep the pot boiling, the AFL-CIO posted a form letter on Paywatch
demanding that the SEC require companies to disclose the formulas used to
calculate annual bonuses and stock options. More than fifteen thousand site
visitors sent letters to the agency, this out of a total of twenty thousand public
comments, more than for any other SEC rule in history. Large public pension
plans-among them CalSTRS, CalPERS, and the New York state and city funds-as
well as Cll and LongView, criticized the SEC’s proposal because it would shift
responsibility for preparing compensation reports from the board’s compensa-
tion committee to the CEO and CFO. The SEC rolled out its final disclosure
regulations in July 2006, the biggest change in pay reporting since the 1930s.
30
Changes were on the way at the SEC. Business had long been unhappy with
William Donaldson, the SEC’s chief since 2002. A former investment banker and
corporate liberal, Donaldson took his mandate seriously, too seriously for the
business community. He came under fire from a broad group of critics: the U.S.
Chamber of Commerce, Treasury Secretary John Snow, Federal Reserve
Chairman Alan Greenspan, and others. Donaldson, said Snow, had engaged in
“regulatory overreach.”With so much opposition, the SEC director “quit”in
June 2005. Replacing him was Christopher Cox, a conservative former House
member from Southern California. Despite the SEC’s new backdating rule, under
Cox the pace of investigation was lethargic. Few executives were indicted, and
only two went to prison, both from high-tech companies in California.
31
30 “Funds Urge SEC to Rethink Pay-for-Performance Disclosures,”Dow Jones Newswires, April
12, 2006; “Executive Pay Debate Highlights Minimal Power of Shareholders,”Wall Street
Journal, February 7, 2006; “Stock Option Timing: The Scrutiny Intensifies, Mondaq Business
Briefing, July 31, 2006; testimony of Brandon J. Rees, Protecting Investors and Fostering Efficient
Capital Markets: Hearings before the Committee on Financial Services, U.S. House of
Representatives, 109th Cong., 2nd Sess. (May 25, 2006); Cornish Hitchcock (attorney for
Amalgamated Bank) to SEC, April 10, 2006, courtesy of Scott Zdrazil; “Shareholders to Target
Options Backdaters in 2007 Proxies”Dow Jones Newswire, October 26, 2006; ACGR, 2006, 2007;
“Perfect Payday: Stock Option Practices Newest in Long Line of CEO Pay Abuses,”AFL-CIO
NOW, June 30, 2006; “SEC Issues Rules on Executive Pay, Options Grants,”Wall Street Journal,
July 27, 2006; “Options Scandal in U.S. Set to Grow Further.”The SEC disclosure rules filled over
four hundred pages and can be found at https://www.sec.gov/rules/final/2006/33-8732a.pdf.
For a summary, see “SEC Votes to Adopt Changes to Disclosure Requirements Concerning
Executive Compensation and Related Matters,”SEC Press Release 2006–123, July 26, 2006.
31 “Business Leaders Welcome Tighter Rules but Now Some Claim the Reforms Are Doing More
Harm than Good,”Financial Times, June 1, 2004; “Donaldson Ends SEC Tenure,”Wall Street
Journal, June 2, 2005; “SEC Chairman Makes Exit,”Globe and Mail (Canada), June 2, 2005;
“Donaldson: The Exit Interview,”New York Times, July 23, 2005; “Labor Unions Urge Members
to Oppose Cox as SEC Chairman,”Dow Jones Newswire, July 12, 2005. A careful study finds that
the SEC over time reduced the intensity of its backdating investigations and became less likely
to scrutinize individual executives. Stephen J. Choi, Anat Wiechman, and A. C. Pritchard,
Executive Pay and Labor’s Shares 21
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Another knock on Cox was his dark-of-the-night revision of stock-option
rules, a change put in place on the Friday before Christmas 2006. It permitted
companies to spread the cost of a grant over several years instead of counting its
value during the issuance year. Shareholder activists were furious. The Laborers,
with $30 billion in its Taft-Hartley plan, said the change was all about optics; it
would “make the numbers look smaller than they really are.”CalPERS, CalSTRS,
Cll, TIAA-CREF, and the AFL-CIO loudly complained to the SEC. Barney Frank
blasted Chairman Cox for offering a “Christmas eve gift to corporate America.”
On the other hand, the U.S Chamber of Commerce praised the revision, and even
President Bush commended Cox for “making sure that the regulatory burden is
not oppressive.”
32
7 Say on pay and private orderings
The SEC’s new regulations emphasized disclosure, requiring that annual reports
contain tables showing stock returns versus an appropriate benchmark.
Backdating was addressed with a provision that companies publicize grant
dates and stock prices on those days. But sunlight doesn’t always disinfect.
Some companies subsequently reported the required data in what the
Washington Post called “gobbledygook.”The newspaper asked three compensa-
tion consultants to study Disney’s annual report and indicate what Disney’s CEO
received. The figures ranged from $21 million to $31 million to $51 million.
Disclosure, said Damon Silvers, “doesn’t change the underlying dynamics to
make boards more accountable to investors.”To get accountability, activist
investors sought the right for shareholders to vote on executive pay packages.
It would be a long, uphill struggle to obtain it.
33
“Scandal Enforcement at the SEC: The Arc of the Option Backdating Investigations,”American
Law and Economics Review 15 (2013): 542–77.
32 “Congress Is Urged to Hold Off Acting on Options and Pay,”New York Times, September 7,
2006 “Investor Outcry over Exec Pay Retreat,”Business Week, December 28, 2006; “Investors
Oppose SEC’s Exec-Pay Disclosure Change,”Dow Jones Newswire, January 31, 2007; Interview
with David Smith, April 2008, Washington, DC; “CEO Politics,”Wall Street Journal, January 9,
2007; “President Bush Delivers State of the Economy Report,”January 31, 2007, https://georgew
bush-whitehouse.archives.gov/news/releases/2007/01/20070131-1.html.
33 “New SEC Rules Make Pay More Transparent,”Washington Post, July 16, 2007; “How Much
Does Your CEO Really Make? Go Figure,”Washington Post, February 8, 2009; Silvers in
“Disclosure Rule to Ease Executive Pay Comparisons,”P&I, September 4, 2006. Most companies
pay their executives a mixture of salaries, perks, bonuses, stock options and other equity
awards that might be paid out in one year or spread out over time. The Walt Disney
22 S. M. Jacoby
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Controversy over executive compensation was not limited to the United
States. The United Kingdom in 2002 adopted a law requiring advisory share-
holder votes on directors’remuneration reports, which originated in the
U.K.’s governance cookbooks of the mid-1990s-such as the Greenbury
Report and the Hampel Report- that advocated the practice. When Tony
Blair’s New Labour government took powerin1997,itadvancedsayonpay
as a way of addressing inequality without involving government. Almost
immediately, there was a donnybrook at the pharmaceutical company
GlaxoSmithKline, when 61 percent of shareholders voted “no,”ashockfelt
throughout the business and investing worlds. Among Glaxo’s shareholders
was CalPERS. A month after the vote, Phil Angelides, California’sstate
treasurer and a CalPERS trustee, joined the chief investment officers of six
other state plans to press the SEC to adopt a UK-style law.
34
Union pension plans introduced their first say-on-pay proposals during the
2006 season. Leading the shareholder side was AFSCME’s pension fund, the
driving force behind which was the late Richard Ferlauto. He’d worked for ISS’s
Taft-Hartley division until 1997, then went to the AFL-CIO’s Office of Investment,
and was hired four years later by Gerald McEntee, AFSCME’s president. Among
AFSCME’s first targets were Countrywide Financial and Home Depot.
Countrywide was an interesting choice, the nation’s third-largest lender of
subprime mortgages. Delinquencies on those mortgages were rising in 2006, a
canary in the coal mine. Its CEO and board chairman, Angelo Mozilo, was one of
the highest paid executives in the nation. That year he racked up total compen-
sation of $41 million, realized an additional $199 million from exercised options,
Company’s report to the SEC showed CEO Robert Iger receiving $30.6 million in 2008. One of
the compensation consultants contacted by the Washington Post was Graef Crystal. To the SEC
figure he added the shares that actually vested or were exercised; option awards from the grants
of the plan-based awards table that showed what Iger got in free stock and option shares for the
year; awards granted in 2008 that would have future payouts, including future estimated
payment for restricted stock units; and options granted to Iger to enter into an extended
employment agreement that were scheduled to vest through 2013. Graef’s calculations showed
Iger’s 2008 compensation to be worth $51.1 million. Crystal said that counting awards granted
in 2008 but not to be realized until future years was like saying, “Part of the bonus is 100
pounds of coffee. Someone says we don’t count that because she didn’t drink it. But it’s still
sitting on your shelf.”
34 “The Day Investors Said Enough Is Enough,”The Guardian, May 20, 2003; “Vodafone Board
Faces TUC Opposition over Pay Awards,”Dow Jones Newswires, July 20, 2002; “Calif., Other
States Urge More Corporate Reforms,”Reuters, June 30, 2003; interview with Janet Williamson,
TUC, November 2008, London; “Executive Pay Is at Issue,”Wall Street Journal: Europe, July 11,
2002; Randall S. Thomas and Christoph Van der Elst, “Say on Pay around the World,”
Washington University Law Review 92 (2015): 653–731.
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and held other exercisable options worth $204 million. These mind-numbing
figures were sure to hit the outrage constraint. Said a compensation consultant,
“If you are going to pick on anybody, he would be a good guy to focus on.”In
response to a say-on-pay proposal, Countrywide’s board said that having share-
holders vote on pay would hamper efforts to recruit and retain excellent senior
executives. Ferlauto asked whether the board had to give Mozilo that much
equity “to keep him happy and attached to the company? As a company
founder, is he going anyplace?”The following year, Countrywide reported losses
totaling $3.9 billion.
At Home Depot, shareholders were unhappy that the company’s stock price
had fallen 9 percent since 2000, when CEO Robert Nardelli had been hired, as
against a 185 percent increase at rival Lowe’s Companies. Yet Nardelli took home
nearly $125 million in pay, more than his Lowe’s counterpart. AFSCME, joined by
CalPERS and the CtW Investment Group, urged shareholders in 2006 to withhold
votes from ten of the company’s eleven directors. (The eleventh director was new
to the board, and his name was Angelo Mozilo.) Demonstrators stood outside the
meeting, one of them wearing a chicken costume and an orange Home Depot
apron. The demonstrators chanted, “Hey Nardelli! Your stock price turned to
jelly!”Inside the meeting, Nardelli refused to respond to questions about his
compensation and enforced strict time limits on comments from the floor.
AFSCME’s proposal received 38 percent of votes cast. The vote surely would
have been higher had Home Depot disclosed that, on five occasions, its board
had approved backdated stock options, news the company sat on until a month
after the meeting. After Home Depot’s backdating revelation, Richard Trumka
sent an open letter to Bonnie Hill, a Home Depot director, demanding he board
fire lead director Ken Langone and recoup all gains from backdated options. Hill
agreed to meet with Trumka, promising “a hard look”at Nardelli’s pay package.
Trumka’s letter came several weeks after Bill Patterson had sent a letter of his
own to Hill.
35
The business community said that investors didn’t deserve a say on pay
because they were not as well informed as directors, a clear argument for
35 “With Links to Board, Chief Saw His Pay Soar,”New York Times, May 24, 2006; “Home Depot
CEO Nailed over Pay,”Associated Press, May 26, 2006; consultant quoted in Todd Davenport,
“Countrywide Shareholders to Vote on Exec-Pay Proposal,”American Banker, June 14, 2006;
“Behind Nardelli’s Abrupt Exit,”Wall Street Journal, January 4, 2007; “Groups Blast Home
Depot over Stock Option Mistake,”Associated Press, June 29, 2006; “Home Depot Annual
Meeting Ground Zero in Pay Debate,”Wall Street Journal, May 24, 2006; “AFL-CIO: Meeting
with Home Depot Dir. Hill Productive,”Dow Jones News Service, September 7, 2006; “Home
Depot Defends CEO Pay but Reviewing Policies,”Dow Jones News Service, September 18, 2006;
interview with Dan Pedrotty, March 2007, Washington, DC.
24 S. M. Jacoby
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placing directorial discretion above shareholder views. The claim is a thin reed;
boards can easily supply investors with information about the rationale for their
pay recommendations, as was happening in the United Kingdom. In ordinary
times, institutional investors tend to support management in voting on executive
pay proposals. But the 2000s were not ordinary times; repeated scandals had
shaken investor confidence in the executive pay-setting process. What manage-
ment feared is what happened in 2011, after Dodd-Frank mandated say-on-pay
voting: Glass, Lewis, a prominent proxy advisor, recommended against manage-
ment in 22 percent of say on pay votes; ISS recommended against in 11 percent of
the votes. No executive wanted to be part of the one in five or one in ten whose
pay package would be opposed by shareholders. In fact these fears were over-
blown, as we will see.
36
36 Fabrizio Ferri and James Weber, “AFSCME vs. Mozilo …and “Say on Pay”for All! (A),”
Harvard Business School, case study 9-109-009, March 18, 2009; statement of Thomas J. Lehner,
“Written Testimony and Comments for the Record,”House Financial Services Committee, May
25, 2006; Damon A. Silvers and Michael I. Garland, “The Origins and Goals of the Fight for
Proxy Access”(2004) at https://www.sec.gov/spotlight/dir-nominations/silversgarland022004.
pdf; Yonca, Ertimur, Fabrizio Ferri, and David Oesch, “Shareholder Votes and Proxy Advisors:
Evidence from Say on Pay,”Journal of Accounting Research 51 (2013): 951–96. ISS is the largest
proxy advisors in the United States, with Glass, Lewis a distant second. Precisely how many
proxy votes are swayed by ISS is a matter of dispute. But there’s no doubt that the figure is
substantial –somewhere between 6 to 13 percent at the low end and 40 percent at the high end.
In some major battles, such as Hewlett Packard’s acquisition of Compaq and the vote against
CEO Michael Eisner at Disney, ISS is credited with tipping the balance. More striking is the
finding that no proxy proposal was ever successful unless ISS had given its imprimatur.
Although ISS has plenty of pension plans as clients, the people who pay its bills are the mutual
funds. As much as ISS wants to be a thought leader on corporate governance, it has to be
responsive to the inclinations of its customers. U.S. General Accounting Office (GAO), Corporate
Shareholder Meetings: Issues Relating to Firms That Advise Institutional Investors on Proxy Voting
(Washington, DC, June 2007), 13; Stephen Choi and Jill Fisch, “On Beyond CalPERS: Survey
Evidence on the Developing Role of Public Pension Funds in Corporate Governance,”Vanderbilt
Law Review 61 (2008): 315–54; Paul Rose, “The Corporate Governance Industry,”Journal of
Corporation Law 32 (2007): 887, 889; Stephen Choi, Jill Fisch and Marcel Kahan, “The Power of
Proxy Advisors: Myth or Reality?”Emory Law Journal 59 (2010): 869; Jacqueline Garner, and
Ralph A. Wakling, “Electing Directors,”Journal of Finance 64 ( 2009): 2389–2421; Peter Iliev and
Michelle Lowry, “Are Mutual Funds Active Voters?”The Review of Financial Studies 28, no. 2
(2014): 446–85.
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8 Take it to Congress
Barney Frank was a liberal Congressional representative with close ties to the
labor movement. Despite declining membership in the private sector, labor
unions in the United States retained political influence within the Democratic
Party as a result of their ability to mobilize voters and make financial contribu-
tions during elections.
In November 2005, Barney Frank introduced “The Protection against
Executive Compensation Abuse Act,”intended to address “runaway pay”and
“pay disparities”between executives and ordinary workers. Its centerpiece was
say on pay. Other provisions included mandatory clawbacks at companies
forced to restate their earnings, a more stringent version than Sarbanes-
Oxley’s. No doubt with Jack Welch in mind, the bill required companies to
disclose the details of executive compensation packages, including perks such
as free apartments, low-cost loans, and company-paid income taxes.
37
Frank held hearings in 2006 in front of the House Financial Services
Committee. The AFL-CIO’s Brandon Rees testified in favor of the bill, but there
was powerful opposition. The Business Roundtable drubbed say on pay as
“unwise and ultimately unworkable”and warned that it would lead to class-
action lawsuits against executives. Hedge funds were very much on the
Roundtable’s mind as a source of those lawsuits and union investors too.
Regarding say on pay, the Roundtable warned, “If we adopted a system where
small groups of activist shareholders used the process to politicize corporate
decision-making, the consequences could very well be destabilizing.”Frank’s
bill died, but it burnished his reputation as an expert in financial regulation,
even taking him to Davos.
38
37 “Frank’s Bill Seeks Greater Disclosure of Executive Pay,”Boston Globe, November 11, 2005;
“Frank Introduces Legislation to Protect Shareholders from Abuse of Executive Compensation,”
US Federal News Service, November 10, 2005; “Even with Disclosure, Investors Have Little Say
on Pay,”Dow Jones Newswires, January 31, 2006; letter from William Samuel, director, AFL- CIO
Department of Legislation to Senators Chris Dodd and Richard Shelby, April 24, 2007, courtesy
of Dan Pedrotty.
38 “Frank’s Bill Seeks Greater Disclosure”; Siobhan Hughes and John Godfrey, “House
Democrat Targets Executive Pay,”Wall Street Journal, November 10, 2005; “New SEC Rules to
Lift the Veil on CEO Pay,”Kiplinger, December 9, 2005; “AFSCME Urges US Companies to Curb
Executive Pay,”Reuters, December 7, 2005; “Labor of Love,”Institutional Investor, March 14
2005; “Union Funds Champs of Proxy Season,”P&I, February 5, 2007; Ferri and Weber,
“AFSCME vs. Mozilo”;“U.S. House Lawmakers Clash on Issue of CEO Pay,”Dow Jones
Newswires, May 26, 2006; statement of Thomas J. Lehner, “Written Testimony and Comments
for the Record.”
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After he became chair of the House Financial Services Committee in January
2007, Frank met with the media at the National Press Club, where he announced
that, over the next two years, his committee would hold hearings about the
causes and consequences of inequality and weak wage growth. Hammering
home that a “small segment”of executives had benefited from economic growth
while the majority of Americans had not, he kept his say-on-pay bill alive.
According to David Smith, Frank’s advisor, the focus on say on pay was a
reflection of “a new Chairman searching around for attention and getting stuff
that was on the shelf and ready to go.”Say on pay was easy to explain to
constituents concerned about inequality. Smith said that Frank thought say on
pay would appeal to some of the working-class voters who’d put Bush in office
in 2004.
39
Democratic leaders believed in 2007 that they could not overhaul immigra-
tion law or expand free trade unless they responded to what Robin Toner
dubbed “the new populism.”To keep the votes of the middle class, anxious
about flat wages and downward mobility, in the upcoming elections, the
Democrats would have to tilt left. Say on pay was one of their responses. But
as Toner reported, “Many on the left worry that the Democratic establishment is
merely paying lip service.”Say on pay was a good political issue: Who wouldn’t
like the idea of “voting”on the boss’s pay? As a remedy for inequality, however,
it was wanting.
Republicans recognized that they too were vulnerable to the new populism.
President George W. Bush gave a speech addressing inequality at Wall Street’s
Federal Hall after making a surprise visit to the New York Stock Exchange in
January 2007. He acknowledged that “a few extravagant pay packages”had
“disgusted”millions of Americans. Said Bush, “The fact is that income inequal-
ity is real. It has been rising for more than twenty-five years,”this contrary to
what some conservatives had claimed. The audience of bankers and brokers
reacted with silence but cheered when Bush said he would cut taxes.
40
Companies also were having a difficult time persuading the public that
executives deserved their pay. Damaging to their cause were two astronomical
39 Damian Paletta, “US Rep Frank Calls on Businesses for Wages, Trade Deal,”Dow Jones
Newswires, January 3, 2007; “Behind Nardelli’s Exit”; Smith interview. On Countrywide and its
role in the financial crisis, see Charles Ferguson, Inside Job: The Financiers Who Pulled Off the
Heist of the Century (London: Oneworld, 2014) and Neil Fligstein and Alexander F. Roehrkasse.
“The Causes of Fraud in the Financial Crisis of 2007 to 2009: Evidence from the Mortgage-
backed Securities Industry,”American Sociological Review 81, no. 4 (2016): 617–643.
40 Robin Toner, “A New Populism Spurs Democrats on the Economy,”New York Times, July 16,
2007; “President Bush Delivers State of the Economy Report”;“Bush Takes Aim at Companies’
Lavish Executive Pay,”Associated Press, January 31, 2007.
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severance payments-at Pfizer and at Home Depot-that came to light early in
2007. At Pfizer, the board awarded CEO Hank McKinnell severance pay worth
nearly $200 million, even though the company’s share price had fallen 43
percent during his five-year tenure. McKinnell retired from Pfizer more than a
year earlier than intended. Ironically, Pfizer was a member of CII and ostensibly
a company with exemplary corporate governance.
41
Home Depot was back in the news in 2007 over its gift to CEO Robert
Nardelli: an exit package worth a head-turning $210 million. Shareholders surely
were happy when Home Depot’s shares rose on news of Nardelli’s departure. But
it was hubris on the board’s part to give Nardelli so much money following the
shareholder protests back in May. Barney Frank released a scorching statement
about Nardelli’s exit package: “Some defenders of CEO pay argue that CEOs are
rewarded for increasing the stock or the overall value of the company, but
judging by today’s market reaction, Mr Nardelli’s contribution to raising Home
Depot’s stock value consists of quitting and receiving hundreds of millions of
dollars to do so.”Breaking ranks with the business community, Charles T.
Munger, business partner of Warren Buffett, predicted that say on pay “might
dampen some of the excess.”Chartered financial analysts (CFA) also were
heretical. A survey of CFAs by the Center for Financial Market Integrity found
that three-fourths were in favor of say on pay. On the other hand, William
Donaldson, in a report published by the Committee on Economic
Development, an organization of corporate liberals, publicly opposed say on
pay along with two other former SEC commissioners.
42
Frank reconvened say-on-pay hearings in March 2007. Although Bush said
that he would not sign a bill containing say on pay and most Republicans were
opposed, with Democrats in control of Congress and inequality still a very hot
issue, the bill stood a decent chance of passage. Frank met with representa-
tives from 130 pension funds at an event organized by CII and warned that, if
say on pay passed and directors were to “simply shrug off the votes, then there
could be more drastic reform,”an allusion, perhaps, to proxy access. Even
with three former SEC chairs, but not reformer Arthur Levitt, coming out
publicly against Frank’s bill, the congressman had the power to push the
41 “Give It Back, Hank,”Washington Post, December 21, 2006. Regarding conservative views on
inequality, see Paul Krugman, Peddling Prosperity: Economic Sense and Nonsense in the Age of
Diminished Expectations (New York: W.W. Norton, 1994), chap. 5.
42 “Everyone from Pres. Bush to Union Activists Asks: How Can CEO Pay Be Brought Down to
Earth?”Associated Press Newswires
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issue through the House. Democrats had the votes, and Frank’s bill passed by
269–134 in April.
43
By that time, candidates were on the hustings for the upcoming presiden-
tial campaign. One of those prospective presidents was Illinois Senator Barack
Obama, who said say on pay would give shareholders “the power to debate
and fight back against exorbitant executive compensation.”Certainly, say on
pay was a way of saying to voters, “We hear your pain.”Several hours after the
House passed Frank’s bill, Barack Obama introduced a companion bill in the
Senate. President Bush once again warned that he would not sign a say-on-
pay bill.
44
Activists pushed for say on pay in parallel with Congress. AFSCME and
Walden Asset Management, a social investor, created a coalition around the
issue including several large public funds-from California, Connecticut,
Boston and New York City-as well as the AFL-CIO, Hermes Investment,
Calvert Investments, Amalgamated Bank, and several religious pension
funds belonging to the Interfaith Center on Corporate Responsibility. The
group submitted forty-four say-on-pay proposals in 2007, more than half
the season’stotal.
45
With the SEC, Congress, hedge funds, and institutional shareholders all
nipping at their heels, companies were more willing to compromise than in
previous years, not only on executive compensation but on other issues.
Because of this, investors in 2007 withdrew 45 percent of their proposals related
to corporate governance. The intensity of consultation between companies and
investors was unprecedented. The head of CII, Patrick McGurn, said “We’ve
never had a season that had so much activity going on in the wings and much
less taking place center stage.”
46
43 “U.S. Rep. Frank: Say-on-Pay Would Test Directors,”Reuters, March 19, 2007; “AFL-CIO’s
PayWatch Website Exposes Rigged CEO Pay System,”PR Newswire, April 5, 2007.
44 “House Votes to Have Shareholders Weigh in on Exec Pay,”Los Angeles Times, April 21,
2007; Jie Cai and Ralph A. Walkling, “Shareholders’Say on Pay: Does It Create Value?”Journal
of Financial and Quantitative Analysis 46, no. 2 (2011): 299–339.
45 Ertimur, Ferri, and Muslu, “Shareholder Activism and CEO Pay”; Riskmetrics, 2007
Postseason Report;“CEO Compensation Survey,”Wall Street Journal, April 9, 2007.
46 Rob Bauer, Frank Moers, and Michael Viehs, “The Determinants of Withdrawn Shareholder
Proposals,”SSRN working paper, 2012; “Shareholders Push for Vote on Executive Pay,”Wall
Street Journal, February 26, 2007; Edward Iwata, “Backdated Options May Snare Some Directors
as Critics Blast Rubber-Stamping,”USA Today, March 29, 2007; Riskmetrics, 2007 Postseason
Report; Jie Cai, Jacqueline L. Garner, and Ralph A. Walkling, “Electing Directors,”Journal of
Finance 64, no. 5 (2009): 2389–2421; “New Breed of Directors Reaches Out to Shareholders,”
Wall Street Journal, July 21, 2008.
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Several companies reached out to the AFSCME-Walden group in search of a
compromise. Led by the besmirched Pfizer, they called themselves the “Working
Group on the Advisory Vote on Executive Compensation Disclosure.”Included in
the invitation-only group that met at Pfizer’s headquarters in New York were
twelve companies, weighted toward pharmaceuticals (Bristol-Myers, Colgate-
Palmolive, and Schering- Plough) and finance (AIG, JP Morgan Chase,
Prudential). The group had detractors in the business world, people who were
wary of anything that might encourage say on pay. Martin Lipton distributed a
letter calling the Working Group’s ideas “corporate governance run amuck”and
proffered the usual criticism that directors should not be replaced by share-
holders when it came to setting executive pay.
47
A third group was dead set against say on pay. Co-led by the Carpenters and
the U.S. Chamber of Commerce, its other members included Citigroup and
DuPont. Ed Durkin, often the renegade, had developed two alternatives to say
on pay. His commonsense pay plan included a cap of $1 million on a CEO’s
salary and payment in restricted shares instead of stock options, but this plan
rarely received more than 10 percent of votes cast, its Clinton-like cap being the
kiss of death. Durkin later formulated the pay-for-superior-performance plan,
which called for benchmarking a company’s financial performance-and CEO
compensation-to the performance of its peers. This second plan fared better
than the commonsense approach, averaging 30 percent of votes cast during the
2006 and 2007 seasons, but never came close to the popularity of proposals for
say on pay.
48
Durkin believed that activism should be based on “thoughtful investigative
work on compensation plans”that would require a company to take specific
actions, such as benchmarking, whereas say on pay simply communicated
dissatisfaction and did so in a disengaged way. The building trades always
had been more cooperative with employers than most other private-sector
unions. Part of the reason was that construction workers obtained support for
their apprenticeship programs from the industry’s unionized contractors. More
than a few construction workers left the trades and obtained a contractor’s
license. They then became employers, and others aspired to be like them. The
47 “Institutional Investors to Press Companies,”Global Proxy Watch, February 9, 2007; ISS,
“Director Elections.”
48 AFL-CIO Executive Council, “Model Guidelines for Delegated Proxy Voting Responsibility,”
February 1991; Richard Marens, “Going to War with the Army You Have: Labor’s Shareholder
Activism in an Era of Financial Hegemony,”Business and Society 47 (2008): 312–42; Ertimur,
Ferri, and Muslu, “Shareholder Activism and CEO Pay,”543, 581; Kara Scannell, “Policy Makers
Work to Give Shareholders More Boardroom Clout,”Wall Street Journal, March 26, 2009.
30 S. M. Jacoby
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unions had a voluntarist legacy that not infrequently favored private orderings
over political solutions.
49
Sixty-one proposals made it to a vote during the 2008 season; the AFSCME-
Walden coalition filed more than half of them. Companies fought back by
sending letters and making phone calls to their largest investors. Although the
proposals received an average vote of 42 percent, about the same as in 2007,
now there were eleven majority votes in favor.
50
That spring, Senator Barack Obama again urged passage of his say on pay
bill. His opponent, Senator Hillary Clinton (D-NY), sought support for her bill.
On the Republican side, candidate and Senator John McCain said he backed say
on pay as a concept, although he never endorsed any legislation. Obama’s bill
died in the Senate, but it wasn’t Republicans who killed it. Rather, it was Senator
Christopher Dodd (D-NH), now chairman of the Senate Banking Committee, who
refused to hold a hearing on the bill. Dodd too had thrown his hat into the
presidential ring in January and had no desire to help either of his opponents.
51
9 Say on pay and Dodd-Frank
The global banking system collapsed in September 2008. The initial response
from the Bush administration came a month later in the form of the Emergency
Economic Stabilization Act, most famous for its Troubled Asset Relief Program
(TARP), which authorized the Treasury to spend up to $700 billion on the
purchase of depreciated assets. The quid pro quo was that the government
asserted the right to more closely manage the financial institutions receiving
loans. Twelve million people now had underwater mortgages, Seven million lost
their homes, and employment fell by nearly 9 million. People were outraged,
and, as in 1893 and 1932, they blamed the bankers for their losses. Although the
economic details were unknown to most people, there was a feeling that bankers
49 “Firms, Investors Trying More Talk, Less Acrimony,”Wall Street Journal, July 16, 2007.
50 Randall S. Thomas, Alan R. Parmiter, and James F. Cotter, “Dodd-Frank’s Say on Pay: Will It
Lead to a Greater Role for Shareholders in Corporate Governance?”Cornell Law Review 97 (2012):
1213–66; “Investors Push 90 Companies for Say on CEO Pay,”Reuters, January 24, 2008; “Say
on Pay Movement Loses Steam,”Washington Post, May 6, 2008; “Push for Say on Pay Is Losing
Its Oomph,”Crain’s New York Business, June 23, 2008; “A Brighter Spotlight, Yet the Pay Rises,”
New York Times, April 6, 2008.
51 “Obama Pushes Say on Pay,”CFO.com, April 11, 2008; “Say on Pay Bills More Cudgel than
Reality,”Associated Press, June 15, 2008; “Presidential Rivals Differ on Senate ‘Say on Pay’
Bill,”Best’s Insurance News, June 4, 2007.
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had made out like bandits during the runup to the crisis and, in fact, they were
right. By 2005, executives in the financial sector earned 250 percent more than
comparable executives, and the size distribution of firms could explain only
one-fifth of the premium. Stoking public anger were reports that rescued banks
continued to spend lavishly. Merrill renovated its corporate offices, and Citibank
placed orders for corporate jets. The anger led to national protests and to the
Occupy Wall Street movement.
This crisis and the related scandals reignited demands for say on pay.
During the fall of 2008, investors prepared over one hundred say-on-pay pro-
posals, of which two-thirds reached a vote. Union plans divided their proposals
among companies implicated by the financial crisis (like Bank of America),
those where labor had no side interests (for example, Apple and Lexmark),
and those where it had potential collateral interests (like CenturyTel, Walmart,
and Windstream). In November, AFSCME’s Ferlauto said that the time had come
for a legislative package combining say on pay and proxy access, a one-two
punch for shareholders.
52
TARP included restrictions on bankers’compensation, some of them drawn
from the governance recipes of the previous seven years. No bonuses could be
paid at institutions receiving TARP funds unless they were in the form of
restricted stock and did not fully vest during the TARP period. Clawbacks
would occur if there were “materially inaccurate”restatements based on unlaw-
ful reporting. Recipients were told to eliminate incentive pay that encouraged
“unnecessary and excessive”risk-taking. TARP also imposed a cap of $500,000
on the tax- deductible compensation of senior executives.
On January 6, 2009, two weeks before his presidential inauguration,
President Obama proposed the American Recovery and Reinvestment Act
(ARRA). Much of the bill detailed how money would be spent on infrastructure
and aid to states. Title VII spelled out “limits on executive compensation”for
banks receiving TARP funds. While it carried over TARP’s provisions, now say
on pay was required at TARP recipients. To satisfy the citizenry, ARRA limited
luxury spending by executives of TARP companies. The president signed the bill
on February 17. After pay voting commenced, only a handful of TARP recipients
52 Baird Webel and Marc Lebonte, Troubled Asset Relief Program (TARP): Implementation and
Status, report by the Congressional Research Service, June 27, 2013; “Wall Street’s Bone-Headed
Bonuses,”Los Angeles Times, January 31, 2009; “Shareholders See Victory in Obama
Administration,”Pensions and Investments, November 10, 2008. On compensation in finance,
see Thomas Phillopon and Ariell Reshef, “Wages and Human Capital in the US Finance
Industry: 1909–2006,”Quarterly Journal of Economics 127 (2012): 1551–1609.
32 S. M. Jacoby
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received “reject”votes greater than 30 percent. At Goldman Sachs, 98 percent of
votes ratified the board’s compensation recommendations.
53
It remained uncertain whether Congress would extend say on pay to the
thousands of companies not receiving aid. In May, Senators Charles Schumer (D-
NY) and Maria Cantwell (D-WA) introduced a bill for mandatory say on pay,
which found its way into Dodd’s financial overhaul. To send a message to
companies and to Congress, shareholders flooded the system with say-on-pay
proposals during the 2009 and 2010 seasons. By the time Congress voted on
Dodd-Frank, dozens of companies voluntarily had adopted the measure. On July
21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and
Consumer Protection Act. Say on pay would go into effect at all companies in
2011, one of Dodd-Frank’s first provisions to be implemented.
54
Business’s dire warnings about say on pay never came to pass. As in the
United Kingdom, investors rarely piled on against management. At Russell 3000
companies in the United States, 91 percent of shareholders on average voted in
favor of proposed pay packages. An article in the Cornell Law Review indicated
this “showed strong support for existing pay practices.”And average support
has changed little since then. There is, however, a different way of analyzing the
data. From 2011 to 2016, there were 870 companies that had at least one pay vote
below 70 percent-considered a threshold-and 210 with at least one vote below 50
percent. Small companies-those in the Small Cap 600-were twice as likely as
large ones-the S&P 500-to receive less than majority votes.
Then there is the matter of insider and absentee votes. Insider holdings vary,
but estimates put them at around 21 percent of common shares in the average
company. Take Viacom, an illustrative example, albeit one of the most egre-
gious. In 2011, only 3.4 percent of shares were voted against the board’s com-
pensation plan, seemingly a resounding show of support for management. But
the company was closely held by its CEO, Sumner Redstone, his family, and
53 Social Investment Forum, “Socially Responsible Investors, Labor, Pension Funds Agree:
Bail-Out Recipients Facing Say on Pay Resolutions Should Adopt Policy,”February 24, 2009;
“Wall St Pay Moves in Cycles. (Guess Where We Are Now),”New York Times, February 5, 2009;
“U.S. Targets Excessive Pay for Top Executives,”Washington Post, June 11, 2009; “Investors Say
Yes on Pay at TARP Firms,”Wall Street Journal, September 2, 2009; “Shareholders Challenge
Goldman Sachs as It Prepares to Pay Record Bonuses,”Investment Weekly News, October 21,
2009.
54 Interview with Damon Silvers, January 2009, Chicago; ACGR 2009;“Shareholders to Focus
on Executive Compensation,”Wall Street Journal, January 12, 2009; “Senator Schumer and the
SEC Separately Propose Action on Corporate Governance Matters,”Mondaq, May 22, 2009; “In
Victory for Obama, House Panel Approves Restraints on Executive Pay,”New York Times, July
29, 2009.
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other company executives. If ones takes their shares out of the picture, two-
thirds of independent shareholders cast their ballots against management.
55
During the first six months of 2011, ISS had recommended voting against the
board’s compensation recommendations at one out of every ten companies.
Some of the reasons it advised “no”votes were defects with performance-
based pay and lack of transparency. The HR Policy Association, a lobbying
group comprising 325 large companies, launched a new organization, the
Center on Executive Compensation, to fight say on pay. It turned the conflict
of interest issue back on ISS by alleging that ISS’s consulting business was
influencing its proxy recommendations. The center urged all companies to
“scrutinize proxy advisory firms for bias and errors”and asked the SEC to
force ISS to disclose its client relationships.
56
Did say on pay change anything? In fact, it did. Evidence from the United
States and the United Kingdom indicates the issue led to closer engagement
between investors and companies. To avoid the embarrassment of a large
number of “against”votes, companies actively tried to win shareholders over
before the annual meeting by engaging the largest institutional shareholders.
Any unenthusiastic votes were followed up by additional meetings. More than
half of these meetings were not made public; most involved face-to-face dis-
cussions. There also were communications directed to employee-shareholders,
people with stock in the company’s 401(k) plan. “That’s one of the reasons I like
this say-on-pay idea,”said the AFL-CIO’s Dan Pedrotty. “It’s an inexpensive way
not only for investors but also employees to exhibit their displeasure. Short of
employees going on the board, I think something like say on pay is a good way
to go.”
57
Assessing the effects of say on pay is not easy. Some studies find that it
raised the sensitivity of CEO pay to share-price performance; others find no
55 Thomas, Parmiter, and Cotter, “Dodd-Frank’s Say on Pay,”1248; James F. Cotter, Alan R.
Palmiter, and Randall S. Thomas, “The First Year of Say-on-Pay under Dodd-Frank: An
Empirical Analysis and Look Forward,”The George Washington Law Review 91 (2013): 967–
1011; Semler Brossy, 2016 Say on Pay Results
56 “Companies Fight Back on Executive Pay,”Wall Street Journal, February 7, 2011; “Business
Fights Back against ISS and on Say on Pay,”Crain’s New York Business, June 27, 2011. The key
determinant of say-on-pay outcomes were the judgments of proxy advisors. A negative recom-
mendation from ISS could push support down by 28 percent. Ertimur, Ferri, and Oesch,
“Shareholder Votes and Proxy Advisors”; Semler Brossy, 2016 Say on Pay Results; Marc
Goldstein, “The State of Engagement between U.S. Corporations and Shareholders,”IRRC
Institute, February 22, 2011.
57 Goldstein, “The State of Engagement between U.S. Corporations and Shareholders”;
“Executive Pay Vote Spurs Shifts in Policies”;“Say on Pay Voting Eases Opposition to Board
Nominees”; Pedrotty interview.
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evidence that excess compensation (unrelated to performance) decreased follow-
ing a say-on-pay vote, no matter how negative. There is no evidence, however,
that negative votes led to lower levels of CEO pay. In other words, say on pay
may have tightened the pay-performance relationship. What it did not change
was the upward march of executive pay.
58
Richard Trumka had been optimistic that say on pay would give share-
holders “new tools to fight back”against out-of-control CEO pay.”But, in the
end, say on pay proved a Pyrrhic victory. After pay voting commenced in 2011,
few shareholders voted against CEOs, who continued to rack up stratospheric
earnings. The ratio between CEO pay and that of employees steadily widened,
from 227 in 2010 to 339 in 2018. The New York Times financial reporter Jesse
Eisinger judged say on pay an example of “toothless public regulations.”
59
10 Pay ratios
Several months before Dodd-Frank became law, New Jersey’s Democratic
Senator Bob Menendez inserted a provision into the bill requiring companies
to disclose in their annual report the ratio of the CEO’s compensation to that of
the median employee. Menendez quoted Louis Brandeis’s sunlight quip,
58 Ricardo Correa and Ugur Lel, “Say on Pay Laws, Executive Compensation, CEO Pay Slice,
and Firm Value around the World,”FBR International Finance Discussion Paper no. 1084 (2013);
Steven Balsamet, Jeff Boone, Harrison Liu, and Jennifer Yin, “The Impact of Say-on-Pay on
Executive Compensation,”Journal of Accounting and Public Policy 35, no. 2 (2016): 162–91; Ferri
and Maber, “Say on Pay Votes”; Vicente Cufiat, Mireia Gine, and Maria Guadalupe, “Say Pays!
Shareholder Voice and Firm Performance,”Review of Finance 20 (2016): 1799–1834; Walid
Alissa, “Boards’Response to Shareholders’Dissatisfaction: The case of Shareholders’Say on
Pay in the UK,”European Accounting Review 24 (2015): 727–52; Martin J. Conyon, “Executive
Compensation and Board Governance in US Firms,”Economic Journal 124 (2013): F60-F89. But
see Kelly Brunarski, T. Colin Campbell, and Yvette Harman, “Evidence on Outcome of Say-on-
Pay Votes: How Managers, Directors and Shareholders Respond,”Journal of Corporate Finances
30 (2015): 132–49; Peter Iliev and Svetla Vitanova, “The Effect of Say on Pay Vote in the U.S.,”
working paper, Pennsylvania State University, February 2015; Christopher S. Armstrong, Ian D.
Gow, and David F. Larcker. “The Efficacy of Shareholder Voting: Evidence from Equity
Compensation Plans,”Journal of Accounting Research 51, no. 5 (2013): 909–50.
59 “Labor Puts Executive Pay in the Spotlight,”New York Times, April 9, 2011; Mishel and
Schieder, “Stock Market Winds”; Mishel and Davis, “Top CEOs Make 300 Times More”;“For the
Wealthiest, a Private Tax System That Saves Them Billions,”New York Times, December 29,
2015; Jesse Eisinger, “In Shareholder Say-on-Pay Votes, More Whispers Than Shouts,”New York
Times, June 26, 2013; Gretchen Morgenson, “Shareholders’Votes Have Done Little to Curb
Lavish Executive Pay,”New York Times, May 16, 2015.
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asserting that disclosure would encourage fair pay. “The middle class pay has
stagnated while CEO pay has skyrocketed,”he said. Dodd-Frank had kicked the
pay-ratio provision over to the SEC for implementation. Over the next five years,
the business community fought activist shareholders, mostly union investors, to
prevent the SEC from putting the rule into practice.
60
Among the first to discuss pay ratios was management guru Peter Drucker in
his essay “Overpaid Executives: The Greed Effect,”published in the mid-1980s
when executive compensation was starting to climb above the flat line of its
postwar years. He noted that high CEO salaries bred resentments that “disrupt
the team”and made adversaries of executives and ordinary employees. Like
others at the time, Drucker pointed to the Japanese, “our toughest competitors,”
where pay gaps between top and bottom were much smaller than in the United
States. “Yet their companies aren’t doing too badly,”said Drucker. Drucker
proposed that companies voluntarily adopt a preset multiple of CEO pay over
lower-level employees in the range of 15–20:1. In 1978, the ratio stood at 30:1.
61
The person who brought the issue to Congress was Martin Olav Sabo, a
liberal Democrat from Minnesota. In 1991, Sabo proposed the Income Equity Act,
which would eliminate corporate tax deductions for executive pay in excess of
twenty-five times that of the lowest-paid full-time worker. Relentless, he re-
introduced the bill over the years, the last time in 2005 right before his retire-
ment. He harbored no illusion that the bill would pass but viewed it as a
touchstone for debate and a way to draw national attention to inequality.
Knowing the ratio, he said, “could “prompt business leaders to take a closer
look at how they may be contributing to America’s widening economic divide.”
62
Others picked up on Sabo’s idea. United for a Fair Economy (UFE), a Boston-
based advocacy organization with ties to social investors and the labor move-
ment, started a campaign in 1997 called Close the Wage Gap. UFE identified
CEOs whose compensation leapt up after layoffs and plant closures. Its leading
“job- shifter”was General Electric’s Jack Welch, whose high pay, it said, was a
60 “Executive Pay Law ‘Nightmare’on Wall Street,”Financial Times, August 30, 2010.
61 Peter F. Drucker, Frontiers of Management (1986; New York: Routledge, 2011), 138–43;
Drucker, “Reform Executive Pay or Congress Will,”Wall Street Journal, April 24, 1984;
Lawrence Mishel and Jessica Schieder, “Stock Market Headwinds Meant Less Generous Year
for Some CEOs,”Economic Policy Institute, July 12, 2016.
62 “What’s Your Boss Worth? 35 Times Your Salary? 1,000 Times? The Workforce Gets Angry,”
Washington Post, August 5, 1990; Robert Borosage, “Buchanan’s Challenge: Is Anyone
Listening? The Nation, March 18, 1996; “Sabo Fights Lonely Fight of Old-Fashioned Liberal,”
Minneapolis Star-Tribune, February 10, 1997; Sabo quote in Martin Sabo, “No One Should Be
Left Behind in Our Nation’s New Economy,”Tax Foundation’s Tax Features, October 1, 1999;
“Rep. Sabo Introduces Income Equity Act of 2005,”US Federal News, July 12, 2005.
36 S. M. Jacoby
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reward for shipping jobs to Mexico. Together with a social investor -Franklin
Research and Development (later Trillium)-UFE submitted resolutions at GE in
1998 and 1999, asking the company to set a cap on executive pay similar to what
Sabo was proposing. The resolutions each received a bit below 6 percent.
63
Social investors filed multiple pay-ratio resolutions, such as a Walmart
proposal submitted by ICCR on behalf of the Sisters of the Holy Names of
Jesus and Mary and other faith-based investors. It noted that the company’s
CEO received one thousand times the average pay of its “associates,”who
contributed to the company’s success and should be rewarded for that role.
There’s evidence that investors use pay ratios as a signal that executives are
acting against their interests. When ratios are high, they are associated with
more negative say-on-pay voting results. The AFL-CIO, however, was lukewarm
to Sabo’s approach. Like other union investors, it never filed shareholder pro-
posals on the topic and played no apparent role in the Menendez proposal.
64
Barney Frank and Chris Dodd were skeptical of the Menendez approach. But
Menendez sat on the Senate Banking Committee, and Dodd needed his vote. It’s
easy to understand how the provision found its way into the final legislation. It
made up only eighteen lines out of Dodd-Frank’s 2,300 pages, and there were
bigger fish to fry. Like other parts of Dodd-Frank, implementation was left to the
SEC, where employers kept the issue bottled up for several years. Intense
pressure on the SEC to act came from state treasurers and liberal lawmakers
such as Senator Elizabeth Warren (D-MA). Now the AFL-CIO began its own letter-
writing campaign. In a 3–2 vote along party lines, the SEC in 2015 approved
collection of pay-ratio data. The first report using the figures, released by
Representative Keith Ellison (D-MN) in 2018, emphasized that executive pay
contributed to inequality’s upward spiral, the same point that the AFL-CIO had
been making for the previous fifteen years.
65
63 “Wealth of Titans: Fat Stock Options, Payouts Fortify Execs’Compensation,”USA Today,
April 7, 1999; United for a Fair Economy, Executive Excess 1998: CEOs Gain from Massive
Downsizing, Fifth Annual Executive Compensation Survey, Boston, April 23, 1998;
“Shareholders Revolt: Is Your CEO Worth $39 Million?”Workforce Management, January 1, 1999.
64 CEO Compensation in the Post-Enron Era, U.S. Senate, Committee on Commerce, Science, and
Transportation, 108th Cong., 1st Sess. (May 20, 2003), 17; “Wal-Mart Stores, Inc., Shareholders’
Meeting,”Voxant FD, June 2, 2006; “Pay Disparity Disclosure is Focus of Unprecedented New
Shareholder Push,”PR Newswire, December 1, 2009; David Webber, The Rise of the Working-
Class Shareholder (Cambridge, MA: Harvard University Press, 2018), 146–48. Donald C.
Langevoort,. “The SEC, Retail Investors, and the Institutionalization of the Securities
Markets,”Virginia. Law Review 95 (2009): 1025–1083.
65 “U.S. Senator Offers Say on Pay, Bonus Clawback Bill,”Reuters, February 26, 2010; “Pay
Rule Still Unwritten amid Corporate Push,”Washington Post, July 7, 2013; “Firms Resist New
Pay Equity Rules,”Wall Street Journal, June 28, 2012; “Some See Benefits in Publicized
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11 Conclusions
Union investors were the leading shareholder activists of the tumultuous 2000s,
a decade of financialization and corporate scandals that ended with a colossal
banking crisis. Not often mentioned in discussions of corporate governance is
the labor movement, which played a key role in highlighting governance defects
related to executive pay, and responding to them via shareholder activism and
political engagement. Union investors allied with other shareholders, who sup-
ported labor’s proposals because they were well-designed and submitted at
companies that had governance defects and subpar performance. This was the
case even when labor had a collateral interest in persuading a company’s
employees to join a union.
As compared to other institutional investors, unions had political influence
as a result of historically close ties to the Democratic Party, this despite the fact
that union density was steadily falling. Liberal politicians and labor unions both
cast inequality as a problem related to executive pay. For political figures as for
unions, challenging executive pay-setting was one response to voter’s concerns
about inequality, and for unions it also was a “wedge issue”to support claims
that executives were becoming wealthy–sometimes unlawfully–at workers’
expense.
There was a conundrum for unions when they advanced their economic and
social objectives through shareholder activism: what to do when shareholder
and worker interests came into conflict? For all the hubbub about executive
compensation, it was small change compared to shareholder payouts. Consider
2007, when share repurchases hit a precrisis peak. That year, the total bill for
CEO compensation at the five hundred largest U.S. companies came to $8.6
billion, which was 1.4 percent of the total value of stock buybacks. Nine years
later, total compensation for the top-five executives at the S&P 500 was $18.7
billion, while shareholders at those companies took in around $1 trillion in
dividends and share repurchases. Shareholder activists always asked if execu-
tives received too much. They never asked the same of shareholders. For unions,
share repurchases were a tricky issue because they enhanced labor’s pension
assets. Not until the eve of the presidential election of 2020, when various left-
Comparisons,”International New York Times, August 7, 2015; “Rewarding or Hoarding? An
Examination of Pay Ratios Revealed by Dodd-Frank,”a report prepared by the staff of
Representative Keith Ellison, May 20, 2018.
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leaning politicians began calling for limits on repurchases, did unions begin to
criticize their shortcomings.
66
Labor made major contributions to private and public efforts to repair
defects with executive pay-setting. It’s an irony, however, that a mechanism
for advancing shareholder primacy was strengthened by the labor movement.
On the other hand, say on pay reinforced claims that corporations were a
shareholder democracy in which owners had the right to vote on corporate
governance. Say on pay was a precedent for other members of the corporate
team–such as employees–to demand a say in corporate governance, as with
collective bargaining or proxy access.
67
Corporate governance has long been the research domain of economists and
legal scholars. But in recent years economic historians and political scientists
also have explored the subject, using different methods and raising different
concerns. For economists, corporations float in markets, what D.H. Robertson
famously described as “islands of conscious power in this ocean of unconscious
cooperation.”
68
But there are other traditions that emphasize the corporation’s
status as a public entity, imbued with responsibilities and rooted in social
norms. The same is true of labor unions. Through private ordering and public
regulation, the American labor movement made modest but important contribu-
tions to corporate governance during the early twentieth-first century.
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48 S. M. Jacoby
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Article note: This paper is dedicated to the memory of Lynn Stout. Her wit, warmth, and
penetrating mind will be missed.
Executive Pay and Labor’s Shares 49
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