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How Jumbo Executive Salaries Lead To Income Inequality

The impact is even worse when the bonus arises through lay-offs.

19/09/2017 9:46 AM AEST | Updated 19/09/2017 11:07 AM AEST
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Qantas CEO Alan Joyce's pay packet has taken off.

The salary package of Alan Joyce, the Qantas boss, has almost doubled to $24.6 million, according to The Sydney Morning Herald. This is more than four times Ahmed Fahour's annual salary of $5.6 million at the Australia Post, which caused so much fury a few months ago.

If Ahmed Fahour's salary package was seen as 'too high' and 'unjustified', shouldn't one be outraged at this obnoxious pay package of Mr Joyce?

Of course, a large part of Alan Joyce's salary package is share options. Significant increases in Qantas' share price over the past three years pushed his pay packet to this level from a substantially high base remuneration of $2.1 million.

Thus, one may defend Mr Joyce's pay packet on the grounds of performance. But it is well known how Mr Joyce produced profit for the first time in 2015. Qantas shares gained five cents, or 3.6 percent, when Mr Joyce announced 4,000-5,000 job cuts in October 2014. In addition, there has been a wage freeze for 18 months, and the airline's share price surged by more than 180 percent during 2014-2015.

In fact, there is a well-established relationship between job cuts and share price increases, as CNN's Paul La Monica documented under the title, 'You're fired. Stock rises. Wall Street loves layoffs'. Therefore, profits shown in this manner cannot be regarded as real -- they arise through the robbing of workers, not through new investment or better management.

Thus, one should not be surprised that ballooning executive pay contributes to rising income inequality. The impact on inequality is even worse when the executive salary arises through lay-offs.

The growing pay gaps between executives and average workers are not only contributing to rising income inequality but also are inimical to economic growth.

According to the ABS weekly wage data (May 2016), while the salary for all of the listed CEOs is already more than 10 times the annual wage of the average Australian, CEO take home pay is highly affected by bonuses and equity allocation.

For example, the annual pay packet for Commonwealth Bank CEO, Ian Narev, increases from 32 times to 106 times the average annual wage when his bonus and equity are added. Pay of David Murray, Mr. Narev's predecessor, went up when he implemented job cuts of 3,700 during 2004-2006 and 1,600 in 2012.

Growing pay gaps between executives and average workers is not a phenomenon peculiar to Australia -- it has been happening globally, especially since the 1980s. For example, CEOs in the U.S. are paid around 300 times the median employee wage, while in 1965 the ratio was 20-to-one. In the UK the ratio is roughly 183-to-one.

Research has shown that changes in tax structure, especially reductions in marginal tax rates are largely responsible for this perverse situation. For example, in the early 1960s, when a typical chief executive at a large American company made only 20 times as much as the average worker, the top marginal tax rate was 91 percent. If a CEO had accepted the bonuses, he/she could keep only a tiny fraction of them. Thus, there was not much incentive for bonuses and share options that push the CEO salary package to the stratosphere. But now there is no restraint when the current U.S. top marginal tax rate is 39.6 percent.

Australia's top marginal tax rate was 75 percent in the 1950s and it was cut since then to the current rate of 45 percent. The tax cuts have created perverse incentives driving gaps between executive pay package and average workers' pay to astronomical heights.

The growing pay gaps between executives and average workers are not only contributing to rising income inequality, but also are inimical to economic growth. Peter Drucker, considered the most influential management thinker ever, suggested in 1977 that a lopsided pay balance erodes the teamwork and trust on which businesses depend. He believes that a 20-to-one ratio is the limit for managers who "don't want resentment and falling morale to hit their companies".

Historical evidence suggests that higher marginal tax rates create restraints on executive salary packages and thus should promote industrial peace and higher productivity.

Ironically, however, tax cuts are often justified on the grounds that they would unleash entrepreneurial spirit and hence higher investment and growth. But recent research has found that past studies showing positive growth impacts of tax cuts were either methodologically flawed or deliberately misleading. Research at the U.S. Congressional Research Service has found that "slower growth periods have generally been associated with lower, not higher, tax rates".

In a recent article, The Economist, which generally has a pro-business stance, found that the relationship between tax rates and growth or investment is not very strong. It concludes, "the decision to invest in a country depends on a lot more than tax". Research has shown that these may include good infrastructure, high-quality education and social cohesion.

Taxes are not only the main source of revenues for the government to provide high-quality infrastructure and education, but they also perform an important redistributive role and hence positively contribute to social cohesion. High marginal tax rates can limit executive salary packages and promote industrial harmony.

More than a hundred years ago, U.S. Supreme Court justice Oliver Wendell Holmes wrote that "taxes are the price we pay for a civilized society". A good democratic society requires that we make sacrifices for others and to think not only of our own needs but also those of others.

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