By EDUARDO PORTER
May 25, 2007
Like most companies, Office Depot has long made sure that its chief executive was the highest-paid employee. Ten years ago, the $2.2 million pay package of its chief was more than double that of his No. 2. The fifth-ranked executive received less than one-third.
But the incentive for reaching the very top of the company is now far greater. Steve Odland, who runs Office Depot today, made almost $12 million last year, more than four times the compensation of the second-highest-paid executive and over six times that of the fifth-ranking executive in the current hierarchy.
As executive pay has surged in most American companies, attention has focused on the growing gap between the earnings of top executives and the average wage of workers in cubicles or on the shop floor. Little noticed, though, is how much the gap has also widened between the summit and the next few echelons down.
“It’s executive pay chasing executive pay,” said Mark Van Clieaf, managing director of MVC Associates International, a consulting firm that develops compensation plans. “But nobody looked at the issue of internal pay equity, so the disparity just kept getting bigger.”
Few are deprived in corporate suites, of course. But the widening disparities in business, which show up in a variety of other ways, reflect a dynamic that is taking hold across the economy: the growing concentration of wealth and income among a select group at the pinnacle of success, leaving many others with similar talents and experience well behind.
In the 1960s and ’70s, chief executives running the nation’s biggest companies earned 80 percent more, on average, than the third-highest-paid executives, according to a recent study by Carola Frydman of the Massachusetts Institute of Technology and Raven E. Saks at the Federal Reserve. By the early part of this decade, the gap in the executive suite between No. 1 and No. 3 had swollen to 260 percent.
Many experts argue that chief executives have a particular ability to drive their own pay upward, in part by manipulating directors they work closely with and encouraging the use of consulting firms that have a built-in incentive to increase pay packages for those who hire them.
“There’s a sense that the C.E.O.’s pay is not determined by supply and demand,” said Robert J. Gordon, a professor of economics at Northwestern University.
There is some truth to that, but economists who have recently studied the issue contend that basic economic forces still play a big role in determining pay at the very top of the corporate ladder. It just happens to be working to the advantage of an increasingly narrow slice of business leaders.
The pay of chief executives, analysts say, is being driven by superstar dynamics similar to those that determine the inordinate rewards for pop stars and athletes — a phenomenon first explained by Sherwin Rosen of the University of Chicago in 1981 and underlined more than a decade ago by the economists Robert H. Frank and Philip J. Cook in their book “The Winner-Take-All Society” (Free Press, 1995).
As American companies, American hedge funds — and even American lawsuits — have grown in size, it has become ever more valuable to get the “best” chief executive or fund manager or litigator. This has fueled a fierce competition for talent at the top, which has pushed economic rewards farther up the ladder of success, concentrating the richest pay levels even more.
“There is an interaction between technology and scale which is true in all these businesses,” said Steven N. Kaplan, a finance professor at the Graduate School of Business of the University of Chicago. “One person can oversee more assets, and this translates into more money.”
The gap in executive pay is widening even at companies that once had more even-handed practices. At Wal-Mart, for instance, the top executive 10 years ago made some 40 percent more than his second in command. Last year, H. Lee Scott, the chief executive, received more than twice as much as his chief administrative officer, John B. Menzer.
“Wal-Mart was under the influence of its founder for so long, and he had a different set of values than the current managers,” said Graef S. Crystal, a leading expert on executive pay. “He was much more egalitarian. These are professional managers.”
The changing rewards for corporate executives are not unlike the acute concentration of wealth among entertainment industry superstars, with television, the globalization of movie audiences and the spread of digital technologies having allowed those at the very top to generate enormous incomes at the expense of those that might be slightly less popular.
Alan B. Krueger, a Princeton economist, found that the share of concert ticket revenue taken by the top 1 percent of pop stars — measured by sales per concert — rose to 56 percent in 2003 from 26 percent in 1982.
Similarly, the best-paid baseball player 20 years ago, Gary Carter, earned $2.4 million from the New York Mets, 41 percent more than the 25th-ranked, Tim Raines of the Montreal Expos. This season, the $28 million, pro rated, that the Yankees will pay Roger Clemens is more than double the paycheck of David Ortiz of the Boston Red Sox, who is 24 rungs down.
This even more skewed pattern at and near the top of the income ladder has become a sort of national standard. From 1985 to 2005, the incomes of taxpayers in the top 10th of earnings rose about 54 percent after inflation, to an average of $207,200, according to Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California, Berkeley.
But among the top 1 percent of taxpayers it increased 128 percent, to $812,500. And among the top 0.01 percent it nearly quadrupled, to $14 million on average.
Corporate executives, for all the attention they have drawn, are far from a majority of the superwealthy. Mr. Gordon and Ian Dew-Becker at the National Bureau of Economic Research estimated that executives accounted for 20 percent of the income in the top 0.01 percent of the scale. Others put their share lower — around 8.5 percent.
As for the gap between C.E.O. pay and that of executives working under them, one reason may be that the larger share of stock options in top executives’ compensation packages these days makes the gap widen when the market is rising, as it was in the late 1990s and generally these days. By contrast, it narrowed somewhat in the first years of the decade, when equity prices fell.
Still, that does not fully explain the current situation, fueling the debate over runaway executive pay. Standard views tend to splinter between corporate apologists, who say that top executives have tougher jobs and are more deserving than in the past, and critics who accuse many of them, in essence, of doing little more than larding their pay at the expense of stockholders.
At Office Depot, a spokesman, Brian Levine, said, “We usually don’t comment on our executive compensation other than to say all our programs are linked directly to performance.”
Mr. Scott of Wal-Mart, at a recent lunch with reporters, argued that his pay had shot up in relation to the rest of the executive pack in part because today’s chief has a much more demanding job than a decade ago.
“As we enter a world that is more complex, the company places value on things that go beyond the running of the business,” Mr. Scott said. “There are aspects of interfacing with the external world that are more like running a presidential campaign than running a business.”
But a number of economists argue that the steep growth of executive pay has less to do with the complexities of the job and more with the competition for talent among American companies.
Kevin J. Murphy, a professor of finance at the University of Southern California, said that in the 1970s, fewer than 10 percent of chief executives were hired from outside and most of those were brought in to save a company in distress.
Since then, he argued, generalist executive skills have become more valuable to companies than expertise in whatever the company does, leading to fewer businesses’ promoting executives from within. By 2000, more than a third of all new chiefs were brought in from outside.
As a result, more C.E.O.’s find themselves in the enviable position of being pursued by competing suitors. And this type of market does not exist to the same extent for executives one or two notches down.
“A really successful C.E.O. can have a significant impact on the stock price,” said Joseph E. Bachelder, a tax lawyer who advises firms on executive pay, “and I’m not sure I can say the same is true generally about the C.F.O. or a general counsel.”
As companies grow and expand globally, the value of the top executive can grow exponentially. In a study last year, two economists, Xavier Gabaix of the Massachusetts Institute of Technology and Augustin Landier of New York University, argued that the fast rise in pay of corporate C.E.O.’s mostly reflected the growing size of American corporations.
Processing reams of data, the economists estimated that hiring the most effective chief executive in the country would, statistically, increase the stock value of a company by only 0.016 percent, compared with hiring the 250th chief executive. But at a company like General Electric, which is worth about $380 billion, that tiny difference would amount to $60 million.
This, the economists argued, helps explain why that top chief executive earned five times as much as the 250th. “Substantial firm size leads to the economics of superstars, translating small differences in ability to very large deviations in pay,” the economists wrote.
But all the attention on chief executives as business superstars raises new questions. In a report published last year, Moody’s Investors Service said it would start taking into account the difference in pay within an executive team in its bond ratings.
“It raises issues of key-person risk and of whether the C.E.O. has too much authority,” said Mark Watson, managing director of the corporate governance group at Moody’s. “We are rating the company, not the person. A bus might come by and knock the person over.”
Copyright 2007 The New York Times Company