Home > Compensation > Executive Pay moderation: what worked until 1980?

Executive Pay moderation: what worked until 1980?

Steven A. Bank, Brian R. Cheffins and Harwell Wells recently made available a draft of their analysis (1) of the levers that kept executive pay at acceptable levels in the USA since the 1940´s and until the early 1970´s.

They start presenting the facts: in that period executive pay didn`t follow the fantastic results firms were producing but remained flat and even declined versus the rank-and-file employees when adjusted for inflation. They nevertheless refer briefly to a different period, in the 1920´s. It is worth also recovering Kevin J. Murphy´s “Executive Compensation: Where We Are, And How We Got There”, where he presents the first wave of hired managers earning very large amounts in the 1920`s thanks to bonuses linked to profits; usually the amounts where similar to what we observe in the 20th century when inflation-adjusted. But as Bank, Cheffins and Wells report, in the 1930´s the story is quite different as some outrageous cases forced legislators to impose disclosure of executive pay. Although pay still increased during this decade, compensation soon started to drop, and particularly during the 1940`s. Stock options started to be common in the 1940´s, its nature of compensation (not capital gain at exercise) was recognized in 1946, but they didn´t represent abnormal amounts so that anemic growth for executive pay remained the rule in the 1950´s and the 1960´s. But executive pay started to rebound in the 1970`s and most relevantly in the 1980´s, thanks to the use of stock option and restricted stock option plans. Even more in the 1990`s. Criticism started to spread; an effort to link pay and performance also became evident, so that higher pay was needed to compensate for the riskier pay structure (as perceived by the executives). Only the crisis after 2008 was enough to stop this growth, although (according at least to part of the academic analysts) the distribution problem and compensation gap between executives and employees persists.


After that, they refer to the governmental efforts to curb and shape executive pay; as in the case of Murphy (2), they see more failures than merits, and they all even see many trends in executive pay having been engendered by pay reforms.

The authors then focus on the core of their study: what were the determinants of executive pay that kept it under control in the 1940-1970 decades?

  1. Was it Taxes?

One of the recommendations by Piketty against inequality implies raising marginal tax rates on income, to levels higher than 80% in order to force executives to let money at the table, (as their true share after a negotiation would be minor).

The authors think otherwise that taxes were not a cause for the sluggish executive pay growth, using an empirical study by Carola Frydman and Raven Saks Molloy, (3) where they studied the causal relationship and found no relevant connection between the two. The authors argue that perhaps the higher rates only kicked off at very large income levels, or tax-planning started to be effective; or perhaps tax rates were effective but high pay was a kind of efficient wage to be paid in order for second-rank executives`s salaries to rise as needed; or perhaps status was a better incentive than after-tax actual (low) increases.

      2.  What were the factors then? The authors review both internal and external possible determinants:

       A) Internal Variables. Those related with internal life at firms. Some of them follow:

  • Board of Directors. The managerial power approach states that weak boards not able to strongly negotiate with powerful executives were responsible for pay increases since the 1980´s. But boards in the 1940-1979 period were much more dominated by Ceos and executives than later. The authors introduce the fact that ex-Ceos and other ex-high executives that remained in the board had managed the companies assets carefully until recently, so they continued to do the same at the board, (thanks to (4)).
  • Shareholders. In the midst of the 20th century they could have acted collectively to curb executive pay, for instance selecting the right directors, but managers controlled the process. They could also have used their powers in order to veto certain compensation tools entailing dilution, but they didn`t usually do it, or they lacked the necessary support by other shareholders –the case of the gadflies- or by the courts, -in the case of litigators-.

       B) External Variables:

  • Direct regulation. Direct measures establishing levels or caps to total compensation or part of it were not generally applied absent exceptional situations, (after-war period, the Korean war, and the initial oil crisis), and their effect on actual compensation was meager.
  • Disclosure regulation. Disclosure needs to alter some groups`behavior (politicians, shareholders, journalists, and so on) in order to be effective in curbing pay. Avoiding disclosure with new tools or camouflaging the truth reduced these reductions and soon became the rule, (since the 1930´s first regulatory movement for disclosure), but somehow in the 1930-1970 decades disclosure seemed to be effective. But disclosure`s impact might have changed since, and the change in variables ii) and iii) may have been responsible for that.
  • Unions. Their strength together with information made available by mandatory disclosure may have reduced managerial pay increases in the period. And the plunge in unions` membership and negotiating leverage may also have pushed exec pay up since the 1980`s.
  • Market for Managerial Talent. Competition in this market was not intense and didn`t press for compensation increases in the midst of the 20th century. Recruiting for high-level ranks was generally made inside the corporation. Since 1960 and until 1980 tough, turnover doubled, forced exits increased, and companies started shopping externally for new talent. There was a change in the measure in which the top executives`job effect on the fortunes of the company was perceived, both by boards and the stock market. And there is evidence that the effect actually increased, perhaps as a result of stronger competition in product markets and tougher political and macroeconomic global conditions. (5).
  • Social rules or Norms. Apparently these norms would have changed, regarding equality matters, corporate culture, the social approach to greed and moral behavior generally, (Krugman, Bebchuk and Fried, and others point to this factor). In fact team spirit decayed in favor of individualism; takeover bids changed the environment; getting rich as an executive started to appear as acceptable; shareholder alignment helped justify pay increases…

Bank, Cheffins and Wells conclude outlining their belief in a combined effect by majoritarily changes in external variables to the way executives have been paid in the past and into the present: transparency, the previous bigger impact of unions, the market for managerial talent and different social and corporate culture. Can we get back to the past? Their answer is negative, and consequently they implicitly suggest to study new ways to affect what might be seen as necessary but sometimes excessive. The contemporary emphasis on corporate governance could well be one of the solutions, if not the only one….

  1. Bank, Steven A. and Cheffins, Brian R. and Wells, Harwell, Executive Pay: What Worked? (July 20, 2016). Journal of Corporation Law, Forthcoming; UCLA School of Law, Law-Econ Research Paper No. 16-11. Available at SSRN: http://ssrn.com/abstract=2812349
  2. Murphy, Kevin J., Executive Compensation: Where We are, and How We Got There (August 12, 2012). George Constantinides, Milton Harris, and René Stulz (eds.), Handbook of the Economics of Finance. Elsevier Science North Holland (Forthcoming); Marshall School of Business Working Paper No. FBE 07.12. Available at SSRN: http://ssrn.com/abstract=2041679 or http://dx.doi.org/10.2139/ssrn.2041679
  3. “Does Tax Policy Affect Executive Compensation? Evidence from Postwar Tax Reforms”, to be accessed at: http://web.mit.edu/frydman/www/appendix1109.pdf.
  4. Arch Patton, Those Million-Dollar-a-Year Executives, HARV. BUS. Rev., Jan.-Feb. 1985, 56, 56.
  5. Timothy J. Quigley and Donald C. Hambrick, Has the “CEO Effect” Increased in Recent decades? https://www.researchgate.net/publication/260756881_Has_the_’CEO_Effect’_Increased_in_Recent_Decades_A_New_Explanation_for_the_Great_Rise_in_America’s_Attention_to_Corporate_Leaders
  1. No comments yet.
  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: