The proposed financial bailout could become an opportunity — our biggest since the Great Depression — to start confronting the top-heavy distribution of American income and wealth that has fueled this Wall Street meltdown in the first place. The prime point where this confrontation should begin: CEO pay.

Executive Pay Proposals

To qualify for bailout assistance, firms should be required to:

• Adopt a policy that no executive will be compensated at a level that exceeds a set multiple of the lowest-paid employee. We recommend that that multiple be 25-to-1, based on the guidance of Peter Drucker, the founder of modern management science. Thus, for example, if a firm’s lowest-paid employee earns $30,000, the ceiling for the top-paid executive’s total compensation would be $750,000, still far more than the annual salary of the President of the United States (See below for further analysis).
• Eliminate severance packages (“golden parachutes”) for executives.
• Eliminate stock options and other bonuses that encourage short-termism. It is not acceptable to allow the Treasury Secretary to have the authority to determine what is inappropriate or excessive in terms of executive compensation.

Background

This month’s meltdown on Wall Street has created the urgent necessity for what the New York Times is now calling “the biggest bailout in U.S. history.”

This bailout, in turn, could become an opportunity — our biggest since the Great Depression — to start confronting the top-heavy distribution of American income and wealth that has fueled this Wall Street meltdown in the first place.

The prime point where this confrontation should begin: CEO pay.

Excessive executive rewards have played a fundamental role in the current financial crisis. To hit the pay jackpot, executives have engaged in reckless behaviors that have now endangered millions of American families — and our entire financial system.
If the bailout that emerges leaves these jackpot incentives in place, this recklessness will remain a fixture on the American economic landscape. The lure of fabulous short-term rewards will continue to blind top executives to incredibly damaging long-term risks.
The American people now overwhelmingly support action to rein in executive compensation excess. To translate this support into meaningful restrictions, Congress needs to build upon the pay restrictions already on the books — and plug the loopholes that have made these restrictions largely ineffective.

Key legislative precedents

Office of Federal Procurement Policy (OFPP) Act (41 U.S.C. 435)

The Office of Management and Budget’s Office of Federal Procurement Policy has been annually calculating a benchmark ceiling on executive pay for government contractors since 1997.

The actual ceiling varies from year to year, based on the median compensation for all senior executives of U.S. corporations with $50 million or more in annual sales. The ceiling applies to wages, salary, bonuses, and deferred compensation, as recorded in financial statements.

The current ceiling sets the maximum contractor compensation at $612,196 for FY 2008. But this benchmark only limits the executive pay a company can directly bill the government for reimbursement. The benchmark in no way curbs windfalls that contracts generate for companies and their top executives.

Defense contractor Lockheed Martin, for instance, took in $32.1 billion from the federal government in 2006. This taxpayer support made up more than 80 percent of the aerospace giant’s total revenue. In 2007, Lockheed Martin CEO Robert Stevens took home more than $24 million, 787 times the annual pay of a typical U.S. worker (pay data for Lockheed Martin employees is not publicly available).

One bill now before Congress, the Patriot Corporations Act, would discourage these windfalls. This legislation offers a preference in the evaluation of bids or proposals for federal contracts to companies that meet a series of benchmarks for good corporate citizenship. Among the benchmarks: paying executives no more than 100 times the pay of their lowest-paid employee.

Air Transportation Safety and System Stabilization Act of 2001 (H.R.2926, SEC. 104)

In the aftermath of 9/11, Congress authorized a $15 billion bailout for the nation’s airlines. This bailout prohibited airlines from handing any raise, over the following two years, to any executive who made over $300,000 in the year 2000. The legislation also limited severance to double an executive’s final annual compensation.

This legislation did set an important precedent for restraining the capacity of corporate executive to gain personally from the country’s troubles. But the overly generous restrictions have contributed little to the necessary narrowing of the huge pay — and sacrifice — gaps within the airline industry.

Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (S.256, SEC. 331)

In 2005, Congress banned companies in bankruptcy proceedings from giving executives retention and severance bonuses that run over 10 times the bonus that workers receive. But the law doesn’t limit “performance-based” bonuses, and corporations in bankruptcy situations have been sailing through this loophole.

Calpine, a California energy company, exited bankruptcy this past winter with a workforce cut by nearly a third. The company’s CEO exited with a $10.9 million bonus.

American Housing Rescue and Foreclosure Prevention Act of 2008
(H.R.3221, SEC. 318)

The rescue package for Fannie Mae and Freddie Mac gives the director of the Federal Housing Finance Agency the authority to ensure the “reasonableness and comparability of compensation” for executives of these institutions.

This language has already proved useful in moves against “golden parachutes” for the ousted CEOs. But the package does not define “reasonableness and comparability of compensation,” and that leaves overly wide latitude for future determinations.

Defining CEO Pay ‘Reasonableness’

Americans do not want their tax dollars subsidizing excessive earnings for top executives. But at what level does pay become excessive?

A just-published commentary in Business Week — by the director of the Drucker Institute at the Claremont Graduate University, Rick Wartzman — reminds us that experts on the factors that make for business enterprise effectiveness have long debated the question of how much is too much in executive compensation.

Peter Drucker, the founder of modern management science, considered the ratio between executive and worker pay to be the key metric in executive compensation. Top executives, Drucker believed, should make no more than 20 or 25 times what their workers receive.

A corporate pay gap wider than 25-to-1, Drucker noted repeatedly before his 1995 death, “makes it difficult to foster the kind of teamwork that most businesses require to succeed.”

Drucker began emphasizing the danger of excessively wide pay gaps in the late 1970s, at the early stages of America’s executive pay explosion. At that time, most major company CEOs were taking home 30 to 40 times the pay of their average workers. Last year, CEOs of major U.S. companies collected 344 times the pay of the average American worker.

Congress, with its consideration of a bailout plan for the U.S. financial sector, can begin to reverse this unjustifiable and dangerous trend-line — and, in the process, help restore a more reasonable and healthy pay equilibrium throughout the American economy.

Revenue Proposals

In addition to provisions related to executive pay, Congress should consider measures that would fairly pay for a broad-based economic recovery and reduce the extreme inequalities that fueled speculation at the outset, such as:

• Institute a Financial Transactions Tax. Congress should levy a tax on financial transactions such as sale and purchase of stock and more exotic transactions such as credit default swaps, options, and futures. The UK has a modest financial transaction tax of 0.25 percent, a penny on every $4 invested. This is negligible for a long-term investor, but imposes a cost on the fast-buck flippers. Estimated annual revenue: $100 billion.
• Impose an Income Tax Surcharge Rate on Incomes Over $5 Million. The 50,000 households with annual incomes over $5 million are the bigger winners from twenty-five years of Wall Street deregulation. They’ve also seen their effective tax rates decline under President George W. Bush. Instituting a 50 percent tax rate surcharge on incomes over $5 million and a 70 percent rate on incomes over $10 million would generate $105 billion a year.

(For more ideas on how to pay for economic recovery see Tax the Speculators, by Chuck Collins.)