Get the first tool we used that helped us pay off $51,000 of debt in less than 3 years.

The Real Reason for Income Inequality in America: You Do Not Matter to the People Who Matter

  March 10, 2014  |    #Make Money

Income Inequality: Why Some Employees Are More Equal Than Others

In 2012, the Center for Economic Policy Research issued findings from a study as shocking as any movie created by M. Night Shyamalan.

The study showed that if the minimum wage had kept up with the pace of productivity from 1968 through 2012, the same as it did from 1945 through 1968; the minimum wage would have been $22 an hour. If the minimum wage had kept up with the pace of corporate executive income increases from 1968 through 2012, the minimum wage would have been $33 an hour. Many would call this income inequality.

If even $22 an hour was the baseline for wages, it would increase the power of Americans to buy more of the products their employers sell, infuse more real money back into the economy, and improve the average American’s quality of life – your life.

All employees, though, are not treated equally. The same “free-market” that justifies an average household annual wage increase of 0.84 percent from 1982 through 2012 for most of us apparently justifies an average annual wage increase of 10.20 percent over the same thirty year period for corporate executives.

Both business and government claim to care about income inequality, but are they willing to do something about it? As I argue in this article, much of this is due to increased corporate executive compensation via stock options, as opposed to cash compensation, and is partly the fault of your government.

Now is when you say, “Whatcha talkin’ bout, Willis?”

The Sweetest Boss on Earth

When I was in grade school, I was assigned a paper to write on a leading American figure, either past or present. Partly because I lived near Hershey, PA and partly because I loved chocolate even before knowing the amazingness of pairing chocolate with red wine, I wrote my paper about Milton Hershey, the founder of The Hershey Chocolate Company.

Hershey believed that his employees were his greatest asset and treated them equitably because he felt his employees would reciprocate and do their best work for his company. He created the town of Hershey with schools; a shopping center, theme park and more to ensure his employees had the best work-life balance possible.

Also Read: 10 Simple Steps to Investing

Several years after I wrote my paper on Milton Hershey, I went to graduate school for business where it was reinforced in me that a company’s greatest asset is its employees. This is mutually beneficial. Not only does this strategy create a desirable workplace that attracts and retains the best employees, but equitably treated employees create a larger, more satisfied and loyal customer base.

Competing for top talent is one of two ways companies compete in the marketplace. The other way is competing for customers. Viewing employees as a company’s most important asset and treating them equitably is the most efficient way to satisfy and grow the company’s customer base.

Putting People First Becomes Anti-Capitalism

A 2010 study found that “Companies with [committed employees] outperformed the total stock market index and posted shareholder returns 19 percent higher than average. Companies with [uncommitted] employees had a total shareholder return that was 44 percent lower than average.” Therefore, employee commitment can drive the performance of a company’s stock price. Employees stay committed, in part, when they feel they are being treated equitably.

Not only does it drain the company purse through shareholder value to not keep employees committed, it also affects the company’s bottom line. Studies show that replacing a “key person” can cost a company anywhere from 70 to 200 percent of that key person’s total compensation. This cost includes scouting, hiring and training for that key person’s replacement.

Throughout history, as with Milton Hershey, some corporate executives have known that the heart and soul of their company is its employees. Indeed, this now abstract philosophy was familiar as recently as 1971 when Thomas J. Watson, Jr., then President of IBM, spoke about the need to balance a company’s interest with the country’s interests. (If you listen quietly, you can hear the accusations of anti-capitalism.)

During the past 20 to 30 years, a circuitous shift in thinking occurred putting shareholder value above all else. This shift began when profits became the top priority in September 1970, when the economist and University of Chicago professor Milton Friedman published “The Social Responsibility of Business is to Increase Profits” in New York Times Magazine.

Friedman argued, and Ronald Reagan embraced, the philosophy that “a corporate executive is the employee of the owners of the business.” Therefore, the corporate executive will inherently put their employees and shareholders at the top of the list of competing assets. While that is logical in the free-market system of which Friedman wrote, the rules changed in 1993.

The Game Becomes Rigged

One of numerous attempts to rein in corporate executive pay took place in 1993 when the 103rd Congress, controlled by Democrats, passed and President Bill Clinton signed into law U.S. tax Code 162 to require companies to link corporate executive pay to performance (i.e. shareholder value).

For sentient humans that live outside of Washington D.C., the code basically says that any person in the top five highest paid positions of a publicly traded company is limited to a $1 million annual cash salary, but stock compensation is unlimited. Because stock performance is tied to company performance, the theory is that this rule ties corporate executive performance to company performance. This is supposed to be mutually beneficial, making corporate executives accountable to both company shareholders and employees.

The passing of U.S. tax Code 162 got the Securities & Exchange Commission (SEC) as excited as a kid on a venti Caramel Macchiato as, since 1993, it has adopted more rules to make corporate executives even more accountable to company shareholders. No longer is business an entity in a “free-market” system. The Government, as is too often the case, meddled where it should not have and opened a Pandora’s Box of problems for those popularly defined as the Ninety Nine-Percent.

Because of these changes, corporate executives no longer view employees as an asset, let alone their most important asset. Employees are now a liability. Labor is a commodity. Employees are an expense that suppresses shareholder value. “There’s never been less pressure on employers to give raises at the same time there’s so much pressure to control costs,” says Dave Van De Vort, a principal with Buck Consultants. “Employers have learned they can squeeze more and more out of their workforce.”

Some Free Markets Are More Free Than Others

Employers are hiring fewer employees. Employee-wages are stagnant and the unemployment rate is so high that employees have no leverage to demand more equitable compensation relative to corporate executive compensation. This trifecta is perfect for increasing shareholder value in the short-term and handicapping real growth in the long-term.

Steven Pearlstein eloquently stated the problem in his September 2013 Washington Post article, “How the Cult of Shareholder Value Wrecked American Business“:

Indeed, you could argue that much of what Americans perceive to be wrong with the economy these days — the slow growth and rising inequality; the recurring scandals; the wild swings from boom to bust; the inadequate investment in R&D [research and development], worker training and public goods — has its roots in this ideology.

The revolving door between the public and private sector, the movement of high-level private sector employees to powerful lobbyists to high-level public sector employees has created a “you scratch my back, I’ll scratch your back” relationship between Washington and Wall Street.

Take, for example, taxes. While the federal corporate tax rate is 35 percent, most companies pay less than that. In 2010, the most recent year for which data is available, large, U.S. corporations paid a federal corporate tax rate between 12.6 percent and 22.7 percent according to the Government Accountability Office.

Companies are reducing R&D spending and letting the government cover the tab with your money through tax funding. Companies are reducing the workforce and keeping wages stagnant, while the government increasingly spends more on government assistance programs such as SNAP, WIC, Medicaid, and others.

Reduced corporate taxes and expenses mean larger profits for companies. Larger profits increase shareholder value and are used to increase share buyback and dividend distributions. Over the previous decade, about 94 percent of Fortune 500 company’s profits were spent on share buybacks and dividends. That is anywhere between $300 billion to $600 billion annually that did not go to employees or investments for future corporate growth. Nor did this money go to the government to cover the cost of doing business.

The main capital generation for U.S. companies these days is from retained earnings, and credit and debt financing. The leading cause of capital generation is not from the creation of newer and better products and services. It is not from new inventions and scientific and technological breakthroughs. It is from creative accounting methods. PIMCO’s Bill Gross calls this “balance sheet alchemy and financial wizardry”. It is not business management.

What many of the laws leading up to and following the passage of U.S. tax Code 162 have done is create a fraternity of corporate executives who manage balance sheets and not companies that directly and indirectly consist of their customers and who collectively make up America. This myopic focus on shareholder value steals from employees and conflicts with Thomas J. Watson, Jr.’s advice to not put a company’s interest ahead of the country.

This is how the rules changed in 1993. A corporate executive is no longer just the employee of the owners of a company serving multiple stakeholders that include shareholders, customers and employees. A corporate executive is now the employee and owner of the business with incentive to overweight their focus on shareholder value.

Short-Termism is Profitable

Linking corporate executive compensation to such incentives is dubious at best. Studies suggest that “changes in [company] performance account for only 4 percent of the variance in corporate executive [compensation].” That means that history shows there is minimal causation between how well a company performs and how much corporate executives get paid. They are like 50 Cent. “I get paid [no matter what].”

Adding insult to injury, Roger Martin and Lynn Stout’s research on the benefits of linking corporate executive performance to shareholder value has not controlled corporate executive compensation as the 103rd Congress hoped it would. It has not proved particularly fruitful for shareholders, either.

In 1970, only 1 percent of Fortune 500 chief executive’s compensation was in stock options and the average salary was $700,000. Today stock and stock options account for 80% of the vastly inflated compensation, which has increased more than 1,800 percent to $12.9 million.

Martin and Stout go on to say that with average corporate executive tenure being four and a half years and stock ownership tenure being four months, corporate executives have no incentive to maximize a company’s long-term growth.

Maximizing shareholder value should be a byproduct, not a goal of a company. The long-term success of any company depends more on innovation, quality products and services, a good business strategy and not simply meeting quarterly earnings. As Keld Jensen says, “Maximizing returns is an outcome, not a strategy.”

A Change Is Needed

America’s political and business leaders must stop rigging the game and create equitable rules applicable to all citizens. Every American should balance their needs and the needs of their company with the needs of the country. If we are to remain the world leader in business, we must create an environment that fosters innovation, advancements in technology, science and engineering and allows all citizens to reap the financial rewards of their blood, sweat and tears.

This will increase the buying power of average Americans, infuse more real money into the economy, and improve their quality of life while, as the 2010 study above suggests, it increases shareholder value because of engaged employees.

I know that liberals will claim we are advocating unmitigated capitalism and conservatives will argue that we are advocating spread-the-wealth socialism. We are advocating that all employees participate in the rewards of a prosperous company just as all employees participate with the results of a non-prosperous company through wage cuts and layoffs.

Beware of those who argue firmly for either side. They often know we are more easily conquered when we are divided.

And . . . this is the reason it is so hard for the average American to stay debt free.

Leave a Reply

Your email address will not be published. Required fields are marked *