The Contemporary American SSA in the Light of Ceos Remuneration Evolution

61

December 2006

the contemporary American SSA in the light of CEOs remuneration evolution

Robert Boyer

PSE - PARIS-JOURDAN SCIENCES ECONOMIQUES

(Joint research unit CNRS-EHESS-ENPC-ENS)

48, Boulevard Jourdan 75014 PARIS, France

Phone: (33-1) 43136256 — Fax: (33-1) 43136259

e-mail:

web site: http://www.jourdan.ens.fr/~boyer

Paper prepared for the conference “Growth and Crises: Social Structure of Accumulation Theory and Analysis”, November 2nd - 4th 2006 at The National University of Ireland in Galway.

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the contemporary American SSA in the light of
CEOs remuneration evolution
Robert BOYER

Abstract

The explosion of CEOs remuneration during the 90s and the persistence of unprecedented levels in the 2000s are used as an evidence of the emergence of a finance led SSA or accumulation regime in the terms of régulation theory. It is argued that the diffusion of stock-options and financial market related incentives, that were supposed to discipline managers, have entitled them to convert their intrinsic power into remuneration and wealth, both at the micro and macro levels. This is the outcome of a de facto alliance of executives with financiers, who have thus exploited the long run erosion of wage earners’ bargaining power. This de facto institutional compromise has been structuring a new accumulation regime, quite specific to the US. It is not clear that this regime should or could diffuse all over the world, since it is highly specific to the US economy, even if the diffusion of stock options and financialisation has been quite general, but no so strong, in other OECD countries.

Contents

1. Introduction: An indirect approach to emerging SSA 1

2. The emergence of the corporation: two centuries of theorising by social scientists 2

Division of labour and size of the market: from Adam Smith to Alfred Chandler 3

From a pure legal entity to an organic conception of the firm: Berle and Means 4

State interventions and legal conceptions shape the internal organisation of the corporation: from Kenneth Galbraith to Neil Fligstein 4

The employees recognition as stakeholders: Alfred Sloan 5

The embeddedness of the firm into civil society: Mark Granovetter 5

3. Managers and corporation: from the end of XIXth century to early XXIst century 6

The crisis of the previously successful managerial corporation 6

Value creation and shareholder value as disciplinary devices 8

Financial bubble and infectious greed: executive compensation under scrutiny 9

4. Corporate governance and shareholder value: the divorce between economic performance and managers remuneration 10

The joint stock corporation in the 90s: good financial performance but moderate improvement of economic efficiency 11

The surprising coming back of patrimonial capitalism even in the US… 12

… Family controlled firms outperform managerial corporations in France 13

The surge of private equity: a challenger to dispersed ownership? 15

Top executives have divorced from labour 16

5. Managers at the centre of shifting alliances: A political economy analysis 17

A brief history of economic and social alliance since the golden age 17

The power and informational asymmetry in favour of executives 20

When the financial crises and scandals burst out: two new actors, the lawyer and the activist 21

6. The power of managers at the firm level: numerous converging empirical evidences 23

Insider trading: a manifest use of strategic information 23

The diffusion of stock options plans: a response to shareholder value 25

The larger the corporation, lesser CEO pay-performance sensitivity 27

The surge of mergers and acquisitions: a benefit for the managers, more rarely for shareholders 28

Clear windfall profits for managers benefiting from stock options 29

CEOs have an asymmetric power on the remuneration committee 31

After 1997, a favourite corporate strategy: distorting the profit statements 32

A last resort weapon of CEOs: shift from the transparent to the hidden 34

The financialisation of CEOs compensation: the consequence of the internal restructuring of the divisions of the quoted corporation 34

7. The power of managers in the political arena 36

Financial liberalisation has been a prerequisite for CEOs compensation explosion 36

When economic power is converted into political power 36

The general context of rising inequality 37

The surge of entrepreneurial incomes contributes to the growing number of super rich 39

The concentration of wealth goes along with stock market bubbles 40

The tax system is redesigned in favour of the richest 41

8. From the micro inefficiency of stock options to the surprising resilience of the financialised SSA 42

After the Internet bubble: a critical reappraisal of the virtues of stock-options 42

The recent literature: a rediscovery of the power of managers 43

Corporate America versus Silicon Valley: two different uses of stock-options 44

The emergence of a corporate governance market? 45

The explosion of CEOs remuneration: the symptom of a specific form of corporation 46

9. An evidence for the financialisatyion of secure regime in the US Erreur! Signet non défini.

10. Conclusion: managers, financiers, politicians and SSA 53

The expression of the transformation of corporate governance after the crisis of Fordism 53

No efficiency gain at the micro, macro level 54

The intrinsic power of manager at the firm level and its extension at the society wide level 54

11. References 56

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1.  Introduction: An indirect approach to emerging SSA

SSA theory has been quite useful in order to point out the basic social relations and economic mechanisms that were at the origin of the post WWII golden age. A second wave of these researches has investigated the impact of conservative strategies and the absence of a clear alternative to the previous SSA regime. The last decade has brought forward another hypothesis about the restructuring of capital accumulation under the aegis of finance. This has been also investigated by régulation theory and the related research has finally delivered a quite balanced assessment of the viability and generality of a finance led accumulation regime. Previous papers have investigated various aspect of this complex regime at the society wide level. The novelty of the present paper is to start of a much more micro analysis of the role of managers, the transformation of their remunerations and their shifting alliances from a fraction of wage earners to financiers.

Since the mid-80s the remuneration of CEOs has exploded in an era of speculation triggered by quite optimistic appraisals about the rate of return of the new information and communication technologies. When the Internet bubble out, it became clear that many managers had mismanaged their corporation, that the average shareholder incurred major losses…but nevertheless the remuneration of CEOs declined, but only moderately. With the post internet bubble recovery, their remuneration is again growing.

Their stylized facts are challenging most conventional economic theories, specially the consequences derived from the seminal paper by Michael Jensen and William Meckling. The first stage consists in a brief historical retrospective analysis of the factors that have been shaping the internal an external organisation of the modern corporation (section 2). A second question has then to be addressed at: why such an acute concern for managers’ remuneration took place at the end of the 90s and not before? Both corporate related factors and the macroeconomic context seem to play a major role in the emergence of the paradox of managers’ compensation (section 3). The complexity of the forces that shape the performance of corporations and the incentives that govern managers behaviour, addresses challenging questions to economic as well as managerial theories of the firms. In a sense, the search for an optimal principal/agent contract is bound to fail precisely because the objectives of the managers and shareholders can never be totally reconciled.

This theoretical analysis help to explain the recurring conclusions of many empirical studies: the public corporation run by managers facing dispersed shareholders may be less efficient than patrimonial corporations run by family related managers. Actually, less agency conflicts seem to exist in family run corporation than in typical public corporations. Similarly, private equity is again an effective option for reducing agency costs (section 4). These converging findings call for a political economy approach. During the last half-century, the relationships between executives, employees, consumers, finance and State have been transforming themselves. Taking into account the shifting alliance between these stakeholders casts some light upon the issue under scrutiny: how to explain an unprecedented boom of executive remuneration far ahead of corporate performance in terms of value creation and shareholders wealth? The answer is simple, if not trivial: managers have used the pressures of institutional investors and diverted them at their own benefit. This gives ex post the impression of a de facto alliance of managers with institutional investors. This shift has contributed to the process that had already curbed down the bargaining power of employees; furthermore the financialisation of the wage-labour nexus has imposed/induced labour to accept a larger share of risk (section 5).

The bulk of the paper provides a survey of the empirical evidences from the abundant literature about managers’ compensation. Numerous converging statistical analyses confirm the rather large autonomy and significant power of managers at the firm level (section 6). Similarly, it is argued that the highly specific social and macroeconomic context of the 90s has given a renewed power of managers in political arena. Even economic policy and the tax system have been redesigned according to this new distribution of power between corporations, institutional investors and wage earners (section 7).

This significant change in institutionalized compromises is therefore the origin of the transformation of the accumulation regime towards a typically finance led configuration. Consequently, the explosion of CEOs remuneration is the revealing factor of this structural change. Surprisingly, the bursting out of the Internet bubble only transitorily affected the rise of CEOs remuneration. In spite of a more drastic regulation implemented by Sarbanes Oxley law, the managerial power over their own remuneration has been translated towards new methods such as the backdating of stock options (section 8). This is a confirmation of the large embeddedness of finance led SSA. Quite all institutional forms are drastically affected by comparison with the Fordist era, since financialisation simultaneously labour market institutions, the welfare especially concerning retirement, but also the role of credit for household consumption. Finally the objectives and tools of the central bank have to take into account the leading role of private and globalised financial market (section 9).

A short conclusion summarises the core arguments and findings. The role of stock-market options in aligning the objective of managers with the interest of shareholders is not at all fulfilled both at the theoretical level and the analysis of actually existing schemes. Basically, top managers exert a de facto power at the micro level of the genesis of profit by the complementarity of firm specific assets. Accounting scandals are the most vibrant expression of these asymmetries between the insiders (the managers) and the outsiders (the shareholders). Thus, the liquidity of financial markets has entitled CEOs to expand drastically their remuneration, on top of high wages and various bonuses indexed to profits. Paradoxically, a de facto alliance prevails between CEOs and financiers, whereas typical workers are no more part of the core compromise of large quoted corporations. This micro power has been extended at the political level and affected taxation, financial regulations and even the evolution of labour market institutions. Consequently, CEOs remuneration explosion is the expression of a new finance-led SSA, but contrary to the Fordist era, this regime cannot be extended easily to the rest of the world.

2.  The emergence of the corporation: two centuries of theorising by social scientists

The complex issues related to the control and rewarding of managers cannot be captured without an assessment of the origins and rationales of the modern joint stock corporation. This entity has to overcome a series of coordination problems among the various actors, and simultaneously to prevent the related mechanisms from eroding the competitive advantage associated to the large corporation. Just to paraphrase a well known contributor (Fligstein, 2001:126): “The joint corporation comes into existence in situations where technology requires a large among of capital, a demand exists for specialised agents to utilise economies of scale and a large pool of capital is needed to bond contracts and organisation –specific assets”. As Fama and Jensen (1983: 346) put it, “the benefits of unrestricted common stock residual claims in activities where optimal organisations are large and complex offset the agency costs resulting from separation of decision functions and residual risk-bearing”. This is an opportunity to explicit the core mechanisms that explain the emergence and the persistence of the organisation form associated to the joint stock corporation (figure 2, infra).

Figure 2 – The factors that shape the internal organisation of the corporation

Finance / Goods Market
/ Corporation

Jensen, Meckling / Smith
Relation with
finance / Top / 1 / Competition on the goods market
Berle, Means 2 / Managers / Chandler
Employees
/ 3 /
Relation with the State / 5 Granovetter
Fligstein / Galbraith
Shonfield / Embeddedness
Sloan / 4 / Industrial
relations
State
Labour market / Civil Society

Division of labour and size of the market: from Adam Smith to Alfred Chandler

The pin factory of Adam Smith is the starting point of this story. Given the large increasing returns associated to the specialisation of workers to a specific and repetitive task, this process of industrial manufacturing calls for a large size of the product market. The entrepreneur is then coordinating the labour process, observing the market and he pays the workers at the ongoing wage, set according to competitive mechanisms. By definition, his remuneration is the residual income when receipts exceed the costs of labour and raw materials. In such a configuration, there is no distortion between property and management that are jointly remunerated by the profits. Such a configuration has been the implicit reference and has inspired the neo-classical theory of the firm, as a profit maximising entity.