When CEO pay exploded (update)

Episode Summary

Executive Summary: Planet Money traces the mid-1990s surge in CEO pay to a 1993 tax change that encouraged performance-based compensation, especially stock options, combined with accounting rules that made options appear cost-free. Options spread and became more valuable during a rising stock market, pushing pay sharply upward. After the dot-com crash and accounting changes, pay fell, but has risen again: since 2014 CEO earnings have grown about 10% annually, versus 3% for average employees, and the CEO-to-median-worker pay ratio has widened.

Main Topics: The tax-code change and performance-based pay: A 1993 provision capped the tax deductibility of non-performance-linked CEO compensation at $1 million, while exempting pay tied to performance. Companies responded by increasing stock-option compensation rather than cutting salaries. Why stock options accelerated CEO pay: Stock options gave executives gains when share prices rose. During the 1990s bull market, companies often granted similar numbers of options each year, so rising stock prices automatically increased the value of compensation. The mistaken belief that options were free: Accounting rules did not require options to be expensed like salaries, leading many companies to treat them as costless. In reality, issuing shares diluted existing shareholders, transferring value from them to employees and executives. The boom, reversal, and accounting response: CEO pay at large U.S. companies nearly quintupled by 2000. The dot-com crash brought greater scrutiny from shareholders and boards, while accounting rules eventually changed to require companies to recognize the cost of options. CEO compensation since 2014: The update reports renewed growth, with CEO earnings rising about 10% per year on average since 2014, despite pandemic-era fluctuations in performance-based payouts. The widening CEO-worker pay gap: Required public-company disclosures show the median CEO-to-median-employee pay ratio rose from about 160-to-1 in 2017 to about 190-to-1 in the latest figures cited.

Key Arguments: Linking CEO pay to company performance was intended to reward results and discourage executives from collecting high pay regardless of how their companies performed. The tax exemption for performance-based compensation unintentionally encouraged companies to substitute stock options for other pay, without necessarily reducing base salaries. Stock options were not economically free: issuing shares diluted existing shareholders, even though the accounting treatment at the time obscured that cost. Rising stock markets magnified the value of repeated option grants, helping CEO pay at 500 major U.S. companies roughly double between 1992 and 1996 and reach $19 million on average by 2000. Pay later declined as markets fell, shareholders scrutinized compensation, and accounting rules changed, but CEO compensation has increased again and is outpacing typical employee pay.

Data Points: Selected CEO compensation cited in the episode introduction: David Zaslav: $52 million; David Gitlin: $66 million; Patrick Smith: $165 million - Examples of reported compensation for the prior year, used to frame the question of whether CEOs are paid too much. Tax deductibility limit for non-performance-based CEO compensation: $1 million - The 1993 tax-code provision limited the amount companies could deduct above this level, while exempting qualifying performance-based pay. Average CEO pay at 500 large U.S. corporations: About $4 million in 1992 to about $8 million in 1996 - Pay roughly doubled during the period when stock-option compensation surged. Increase in stock-option compensation in a mid-1990s survey: 40% - A compensation consultant initially suspected this reported increase was a data error. Average CEO pay at large U.S. corporations: $19 million in 2000 - The figure was nearly five times the 1992 average; the original episode later cited a decline to $12 million in 2014. Average annual growth in CEO earnings since 2014: About 10% - Update based on compensation data described by consultant Don Delves. Average annual growth in employee pay: About 3% - Compared with CEO earnings growth since 2014. Median CEO-to-median-employee pay ratio: About 160-to-1 in 2017 and about 190-to-1 in the latest figures cited - Publicly traded companies began required reporting of this ratio following a delayed effect of the Dodd-Frank Act, with disclosures starting around 2018.

Pivotal Quotes: "We thought they were free." — Barbara Franklin: She describes the widespread belief that stock options cost companies nothing, a belief reinforced by the accounting rules of the time. "I started being worried about watching in real time the largest transfer of wealth from shareholders to workers that we'd ever seen in corporate America." — Kevin Murphy: The economist who had advocated performance-based pay explains his concern about the scale of option grants and their cost to shareholders. "It's neither spiraling nor is it out of control, but it is high." — Don Delves: His assessment of CEO compensation in the update, following renewed growth since 2014.

Implications: Pay policies can produce unintended incentives: tying compensation to performance may encourage options without lowering salaries, while accounting rules can obscure who bears the cost. CEO pay has risen faster than employee pay, making transparency, shareholder scrutiny, and compensation design ongoing industry concerns.