2017-04-06

The Fairy Tale of Capitalism: Supercompensation, Income and The Exchange

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A mythology, such as FTC the Fairy Tale of Capitalism, provides explanations and justifications for the norms of society, inspiration and justification for our actions, a narrative of transformation, and no small portion of entertainment.



Sculpture: Brenda Putnam, "Solon" (1950)
Once upon a time, a small, small number of people in the Society received a large, large amount of pay for their work. So large an amount did this small number of people receive that it accounted for a significant part of the National Income.

In those days, there was a young man who received a good education and became an employee receiving $55,000/yr of pay. His colleagues liked him and regarded him highly. He reliably exceeded short-term goals while remaining consistent with the long-term plan. He worked with versatility and insight. He was diligent, clever, persistent, adaptable, creative and quite productive. He worked with devotion to customers, colleagues, Society and the Shareholders. He never wasted the Firm’s resources, though he didn’t shirk from taking a calculated business risk. His work advanced long-term strategic growth and drove strong results. He embraced change, improved product quality, focused on the customer and led his colleagues in grasping new challenges. His Managers observed his consistently superior performance. Each year, he received an increase of 10% in his rate of pay, a reward for good work and an implied incentive to perform well in the future. After 30 years of superior performance, no longer young, with promotions to new responsibilities and the 10% increase each year, he received nearly $1m/yr of pay.

The CEO Chief Executive Officer of the same Firm received Supercompensation of about $8m/yr of pay.

We'll return to the excellent worker and the CEO in a minute, but first, what is this thing called National Income? And for that matter, what is Income?

The Economists calculated National Income as GDP Gross Domestic Product minus depreciation of capital plus or minus some relatively minor adjustments, mostly for transactions with foreign parties.

United States 2016
$ trillions
GDP Gross Domestic Product
19
Less: Depreciation
-3
Equals: National Income
16
The Aristocracy got about 20%, or $3t, of National Income. Of that, about 2/3 was Capital Income, and the remaining 1/3, or about $1t, was Labor Income for the Aristocracy. The Aristocracy were One Percent of the households in the Society. Those of them who got Labor Income were the small, small number who received a large, large amount of pay.

Customarily, in those days, nearly everyone received money, called “pay” in exchange for the Labor of some members of their household. The people could exchange the money for the necessities of life and a degree of personal indulgence. Some of the people saved a part of their pay for future use.

A different arrangement called “slavery” prevailed in earlier times, but most of the people had forgotten it. Slavery enabled some people to force Labor from Workers. If these Workers got pay, they rarely got much of it, but that is a different story.

Another arrangement sometimes called “debt slavery” wasn’t uncommon in earlier times, but most of the people had forgotten it. Even though Solon of Athens had prohibited some forms of debt slavery, the arrangement persisted elsewhere even 2,500 years later, the time of the great wars. In one form, an employer paid Workers cash insufficient for bare subsistence, and lent money to the Workers for house rent in housing the employer owned and for food from a store the employer owned. With loan payments deducted from their pay, Workers borrowed even more, and so remained under perpetual obligation to the employer. But that too is a different story.
However, the Workers, in this (longish) story of Supercompensation, Income and The Exchange, didn’t live in the time of slavery. For the most part, and like nearly all of the 99 Percent, the Workers were employees of Firms. Around 9/10ths of their Income came from exchanging their Labor for money. If you didn't have Capital Income, then you had to give up Labor to get Income.

The Society (with some exceptions in this immense population, of course) believed that without the principle of Labor for Income, civilization would be lost. Maybe it didn't have to be that way, but that's how it was.


The Income of the median household was about $55,000/yr. Many Workers got pay of about that much, which was nearly all of their income. A Worker with 5 times that pay was quite well paid and characteristic of the upper reaches of the 99 Percent and the less wealthy Aristocrats. Aristocratic Income came mostly from ownership of Firms and the lending of money, which the Economists called Capital Income, and about ⅓ from Labor Income, as we mentioned earlier. Supercompensation, a form of Labor Income, became a more important component of Aristocratic Income following the great wars then tapered off.

As we said earlier, in those days, there was a man whose excellent work brought him, after 30 years of superior performance, nearly $1m/yr of pay. And you remember the CEO of the same Firm who received Supercompensation of about $8m/yr of pay.

comic: Scott Adams http://amzn.to/2nC642w  © 1993 United Features Syndicate

The Firm’s shares were traded at the Exchange, a big granite building where representatives of people who wanted to own part of the Firm would buy shares from representatives of Shareholders of the Firm who wanted to sell some of their shares. The Exchange was also an association of members, like a club, that met every day at the big granite building. They never ran on the floor of the Exchange. The members were the representatives who bought and sold shares of various Firms. They would buy or sell shares for you, if you paid them their fee. Their revenues came from their fees, and from buying shares for a few pennies less than the price for which they immediately sold them. They bore the costs of trading paperwork and of the Exchange membership, which they had bought from someone else. Like all other businesses, the Incomes of the members were their revenues less their costs.

The Exchange’s members had rules limiting the character of the shares they traded. They had created many of these rules at the insistence of Government, which usually allowed the members to pretend the rules were voluntary. The historical reason for this custom of pretending the voluntary was lost even to the Old Ones, most of whom had been dead a long time. The Society kept the custom for the same reason they placed the forks on the left sides of their plates.

One set of Exchange rules required Firms, with shares traded on the Exchange, to make public the amounts paid to the most highly paid employees every year with explanation for why they paid $8m/yr.

Chart: Daniel Brockman
To explain why they paid $8m/yr, the Board of the Firm appointed a Committee of Compensation of three of their members, who were 2 CEOs and 1 Executive from other Firms. First, they hired a consultancy, a kind of organization that provides Staff on demand. The Staff so hired researched the matter carefully. After several months, they provided two or three dozen pages of intensely boring prose for inclusion, with approval of the Committee of Compensation, in the Notice to Shareholders of Annual Meeting and Proxy Statement.

With this text, the Proxy Statement explained how the CEO upheld the Firm’s devotion to customers, employees, Society and the Shareholders. It explained how the CEO exceeded short-term goals while remaining consistent with the long-term plan (except for a pesky little legal problem), advanced long-term strategic growth drivers, drove strong results in all parts of the Firm, and got general concurrence from the Shareholders on pay in the previous year. The Proxy Statement also gives great detail on the competition with other Firms to pay up for CEO talent, the extensive industry experience of the CEO, levels of pay (without giving specific numbers) at other Firms of similar size and complexity, various Staff-concocted methods of pay and executive benefits, and an abundance of other detail.

The Shareholders who paid any attention ignored most of the detail, looked quickly at the total in the Summary Compensation Table part of the Proxy Statement, then voted yes. And that’s why the CEO got $8m/yr.

The Economist Thomas Piketty (2014, p.510) said the CEOs exercised “bargaining power” to extract the higher rates of pay. The Economists Piketty, Emmanuel Saez and Stefanie Stantcheva (2014, p.231) attributed an aggressive bargaining response to reduced top marginal income taxation as a possible cause of Supercompensation. They said on the other hand that the CEOs might have been paid for luck. On yet another hand, they said that CEOs might indeed merit their Supercompensation.

The Economist Dean Baker said that the CEOs collected rents (2016, p.18), unless the value the Firm received was about equal to the money paid to the CEO. CEOs receiving Supercompensation, he wrote, got money that could only have been taken from funds that the Firm otherwise would have paid to other employees or to Shareholders or as reductions in prices for customers.

“Rents” was a word Economists liked to use to describe money a person could get simply because she or he was in a circumstance to demand it. They picked it up from the writings of David Ricardo, one of the Old Ones. Ricardo described how the value of older agricultural land increased when farmers cultivated new lands nearby. But that is another story.

Two verses of the Professors’ song “Market Value” described how the CEOs’ Supercompensation fully reflected the CEOs’ value, because it was tempered by the competition of many buyers and sellers. Customarily, when a CEO recognized the wisdom of the Professors, as often happened, the CEO would endow a chair in Economics at a University.    

Some Workers wondered why the excellent employee of 30 years topped out at $1m/yr when the CEO got $8m/yr. But most Workers knew the song “Market Value” had the right idea, more or less. They taught their children that good children, with hard work, would deserve Supercompensation when they grew up.



I’m grateful to my friends who reviewed a prepublication draft and offered helpful corrections and advice.


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Sources

Alphabet, “Notice of 2016 Annual Meeting of Stockholders and Proxy Statement” (Apr 2016) https://abc.xyz/investor/pdf/2016_alphabet_proxy_statement.pdf

Dean Baker, “Rigged” (Center for Economic and Policy Research, 2016) http://deanbaker.net/images/stories/documents/Rigged.pdf

Daniel Brockman, “Critique of GOP Tax Plan” (Mar 2, 2017) https://daniel-brockman.blogspot.com/2017/03/critique-of-gop-tax-plan.html

Daniel Brockman, “The Fairy Tale of Capitalism: The Buyer of Labor and the Nine Percent” (Mar 11, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-buyer-of.html

Daniel Brockman, “The Fairy Tale of Capitalism: Workers, GDP and Economists” (Mar 17, 2017) https://daniel-brockman.blogspot.com/2017/03/the-fairy-tale-of-capitalism-workers.html

Bureau of Economic Analysis, “Selected NIPA Tables: Table 1.7.5. Relation of Gross Domestic Product, Gross National Product, Net National Product, National Income, and Personal Income” (Mar 30, 2017) https://www.bea.gov/national/pdf/SNTables.pdf

Johnson & Johnson, “Notice of Annual Meeting and Proxy Statement” (Mar 2017) http://www.investor.jnj.com/secfiling.cfm?filingID=200406-17-15&CIK=200406

Thomas Piketty, “Capital in the Twenty-First Century” (2014, English translation) http://amzn.to/2fJg7Oi

Thomas Piketty, Emmanuel Saez, Stefanie Stantcheva, “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities” (2014) https://eml.berkeley.edu/~saez/piketty-saez-stantchevaAEJ14.pdf

Thomas Piketty, Emmanuel Saez, Gabriel Zucman “Distributional National Accounts: Methods and Estimates for the United States” (Dec 2016, NBER Working Paper No. 22945) https://eml.berkeley.edu/~saez/PSZ2016Slides.pdf https://eml.berkeley.edu/~saez/Piketty-Saez-ZucmanNBER16.pdf

United States Census Bureau, “Median Household Income in the United States: 2015” (Sep 2016) https://www.census.gov/library/visualizations/2016/comm/cb16-158_median_hh_income_map.html