The View

Inequality and disclosing the ratio of CEO pay versus that of the average worker

PUBLISHED : Monday, 10 August, 2015, 11:46am
UPDATED : Monday, 10 August, 2015, 11:46am

Last week US securities regulators made it official: firms listed in the United States will have to disclose the ratio of pay between the CEO and the average worker.

This requirement is being introduced at a time when wealth inequality is a top political issue, and one that will presumably be debated among candidates in the 2016 presidential race.

Yet consider three companies so far associated with that race. One is The Trump Organization LLC, run by Donald Trump, who is seeking to be the presidential candidate on the Republican ticket.

Another is Koch Industries Inc., whose owners are major contributors to Republican Party and conservative political causes. The third is Bloomberg L.P., whose founder Michael Bloomberg is a major contributor to Democratic Party and liberal causes in the US.

None of these three firms will have to produce an average CEO to worker pay ratio - they are all private.

In raising public equity, firms volunteer to publish their financials and meet higher regulatory burdens, of which the new pay-ratio disclosure in the US is but one small example.

Owners of capital don’t sign up for all this out of a love for transparency, or paperwork. They do it because public shareholding allows them to spread their risks and raise funds.

The paperwork starts with the IPO documents, which provide a fount of information on individual companies and industry history. Really – go to the Hong Kong public library and read some of the old IPOs, they offer a fascinating snapshot into the country’s business history.

After listing, of course, companies must provide regular financial updates including executive compensation details; the bigger companies are covered by an army of analysts; and the ability to short stocks has generated an industry that focused on uncovering fraud.

The system’s flaws are famous – the lazy audits that allowed scandals like Enron, the biases that can be found in investment bank research, the seeming powerlessness of institutional investors to demand accountability.

But we would know a lot less about the world’s rich and the powerful were it not for the public shareholding system.

What if more firms choose to go the route of Trump, Bloomberg and Koch - and just stay private?

The Harvard economist Michael Jensen predicted that the public equity model was dying some 25 years ago in a paper, “Eclipse of the Public Corporation.”

He argued that there is an inherent conflict between shareholders and company managers. The latter never want to return funds to shareholders, but instead grow their divisions recklessly, to bring glory and bigger bonuses.

Jensen believed private equity would save the day: privatizing firms through highly leveraged buyouts, which forces discipline on corporates since debt is a “sword,” and equity a “pillow.”

Things didn’t exactly turn out as Jensen predicted. As one ironic example, even the big private equity firms, like Blackstone, have themselves sought public listings.

Yet a recently published academic paper, titled “The US Listing Gap,” has chronicled a sizeable drop in public listings since a peak in 1996.

The US in 2014 had 14 per cent fewer listed firms than in 1975, due both to fewer new listings and more delistings.

The authors aren’t certain what is behind this trend.

They explored the possibility the rising regulatory burden, beginning with the Sarbanes–Oxley Act of 2002 and followed more recently by Dodd-Frank, is discouraging public equity. But they ruled this out as a factor.

The paper also ruled out Jensen’s theory – in part because falling public equity did not coincide with a jump in private equity acquisition of public firms.

“Another paradigm is needed to explain the eclipse of the public corporation in the US,” the authors concluded.

Surely someone out there will explore whether the “eclipse” is related to overall rise in economic inequality. Does capital not need the public’s money as much as before?

Returns to capital are rising as returns to workers are falling. Many listed companies are sitting on record cash piles, fending off heated calls by activist investors to redistribute.

A corollary to this trend is that money is cheap and easy to get.

Just ask Donald Trump, who boasted in last Thursday’s Republican presidential candidate debate that even after stiffing his bankers for unpaid loans on casino assets, he had no trouble returning to the debt markets for other business projects.