Who Stole the American Dream? (17 page)

While the rich were showered with tax cuts, average Americans were hit by a near doubling of the payroll tax, which funds Social Security and Medicare. The employee’s share of the payroll tax, which falls hardest on the working middle class, was increased from 3.45 percent in the 1970s to 7.65 percent today. In December 2010 and December 2011,
President Obama persuaded Congress to temporarily lower the Social Security tax by 2 percent, but in exchange, he was forced by congressional Republicans to extend the Bush tax cuts for the wealthy along with cuts for the middle class.

The other powerful force in creating the lopsided concentration of wealth in America today was the shift in the prevailing mind-set and
mores of America’s business leaders—a shift from the inclusive style of leadership from the 1940s into the 1970s that shared the nation’s gains widely with the middle class, into a more self-centered style of leadership from the 1980s onward that kept most of the economic gains for the business elite itself.

In Arnold Toynbee’s terms, such a shift may reflect the time in a civilization when the business and political leadership class changes from acting as “the creative minority” that inspires and leads the rise and flowering of a civilization, into becoming “the dominant minority” of “exploiters” focused primarily on sustaining and expanding their own wealth and power.
When this happens, Toynbee reports, it opens up perilous rifts in maturing societies. This shift in the mind-set and motivation of the elite, he contends, is a major cause of the schisms in the body politic that contribute to the disintegration of a civilization.

In America today, a CEO’s personal enrichment is taken as a hallmark of success, whereas in the late 1960s, pay restraint was a core tenet of the corporate ethic. Harvard economist John Kenneth Galbraith wrote in 1967 that a CEO’s pay was geared to the size of the company, not to its stock price, as today. Pay was good, but not outlandish. In the 1950s, Charles Wilson, as CEO of General Motors, was at the top of the pay pyramid since he ran America’s largest corporation.
His annual salary in 1950 was $626,300, roughly equal to $5 million today—a fraction of today’s top corporate pay packages. That is mainly because Wilson did not get massive grants of stock options, which were taboo in the era when management shared prosperity with middle-class employees.

“
Management does not go out ruthlessly to reward itself—a sound management is expected to exercise restraint,” Galbraith reported. Since top company executives were privy to inside company information, they could obviously cash in big-time by trading in company
stock. But the unwritten code frowned on that. “Were everyone to seek to do so …,” Galbraith wrote, “the corporation would be a chaos of competitive avarice.”

By the 1980s, competitive avarice was in. Tom Wolfe captured the winner-take-all creed in his book
Bonfire of the Vanities
, and so did Oliver Stone’s 1987 movie,
Wall Street
. “
Greed, for lack of a better word, is good,” preached Gordon Gekko, the movie’s mogul investor. “Greed is right, greed works…. Greed, in all of its forms … has marked the upward surge of mankind.” It certainly marked the upward surge in CEO pay, which rocketed from forty times the pay of an average company worker in 1980 to nearly four hundred times by 2000.

Certainly in the 1980s and ’90s, there were CEOs like David Packard of Hewlett-Packard, who practiced stakeholder capitalism, balancing the needs of various corporate stakeholders—employees, customers, and suppliers as well as shareholders and management.
James Burke, CEO of Johnson & Johnson, won accolades in 1982 for corporate integrity by recalling and repackaging the company’s entire supply of Tylenol, at a cost of $100 million to J&J’s bottom line, after someone put cyanide into Tylenol capsules on drugstore shelves and several people died.
Burke lived by the Johnson & Johnson corporate “credo” that put the company’s commitment to patients, parents, and caregivers and to employees ahead of profits and returns to stockholders.

Ken Melrose, CEO of Toro, brought the lawn mower and snow blower company back from bankruptcy to market success with an employee-centered philosophy during his tenure from 1983 to 2005. “
In our culture,” Melrose said, “the CEO in effect works for the management, management works for the employee, employees work for customers, and thus the customer is the ultimate boss.” As he took charge of his failing company, Melrose took a “substandard salary,”
giving up a cash salary for stock—but stock that would pay off only over the long term if the company actually prospered. It worked—to everyone’s advantage. But as Melrose said later, “I’m not a big fan of large stock-option grants year after year after year to already well-paid executives. I don’t buy the argument that each slug of stock options is needed to continue to motivate the CEO to get the stock value up. And it’s a hollow argument to say it’s good for the small shareholder.”

But CEOs like Ken Melrose, Jim Burke, and David Packard were not the norm in the New Economy. Wall Street was unimpressed with Melrose’s logic that CEOs did not need vast stock options to be motivated to run a company well. In fact, just the opposite happened. Wall Street saw company stock as the key to generating managerial success.

In the 1980s, stock options became the golden goose of Corporate America, the avenue to stunning fortunes among the business elite. Year after year, corporate boards would award CEOs and other top executives huge grants of company stock or stock options—either shares for free or shares at a bargain price. Unlike ordinary shareholders, the corporate brass did not face a downside risk. They would exercise their stock options only if the company’s stock went up, and as Al Dunlap showed, a fast-talking CEO can often cause a short-term run-up in the market price.

The payoffs were astronomical, enough to vault a previously affluent corporate executive into the stratosphere of the super-rich. In earlier times, inherited wealth accounted for most of America’s super-rich, but today
the top echelons of business and Wall Street constitute 60 percent of the very richest people in America—the richest 0.1 percent and stock options were the primary vehicle for the corporate super-rich.

Larry Ellison, CEO of software giant Oracle, epitomized the
nouveau super-riche
of Corporate America. Ellison, whose board richly
rewarded him every year with a grant of seven million shares of Oracle stock, topped
a
Wall Street Journal
compilation of the ten largest CEO payouts in a single year from 1995 to 2005 by garnering $706.1 million in 2001 through the combined value of his stock grants, options, cash, and bonuses. Close behind were Michael Eisner, former CEO of Disney, with $575.6 million in 1998 and another $203 million in 1993; and Sandy Weill, former Citigroup CEO, who pulled down $621.8 million in three big years between 1997 and 2000.

The economic rationale for those big stock grants by Corporate America was “pay for performance”—rewarding CEOs and senior executives by supposedly aligning management’s interests with stockholder interests. As Milton Friedman put it, that would motivate the captains of industry to “maximize shareholder value” by steadily improving the stock price of their companies. “Shareholder value”—that is, stock price—became the be-all and end-all of corporate CEOs in the New Economy.

The idea sprang from an academic paper by two of Friedman’s graduate students who became assistant professors, Michael C. Jensen of Harvard Business School and William H. Meckling of Rochester University. Writing about potential conflicts between CEO and shareholder interests, Jensen and Meckling argued that one way to match the interests of the two sides was to make the CEO an owner of the company, like stockholders—“to give him stock options.” At first the idea met with resistance, but
Jensen became its apostle, and slowly it gained traction.

By 1980, only about 30 percent of CEOs had been granted company stock options, and by 1994, 70 percent were getting options. By 2000, “mega-option grants” of a million shares or more had become the norm.
Perhaps unwittingly, the Clinton administration fueled the option trend by limiting the tax deduction that companies
could take for executive salaries to $1 million. Options were not counted under that ceiling. What also made them attractive to corporate boards was that for many years stock options theoretically cost the company nothing. They were not counted as an expense. They were a freebie with an enormous bang, and no buck, and that lasted until international regulatory changes forced reforms in America in 2006.

But from the 1980s onward, the corporate options game touched off what
New Yorker
writer John Cassidy called “
an orgy of self-enrichment.” Payoffs were huge, even for failures. CEOs learned how to game option grants. Some, such as Al Dunlap, would talk up their stock price and cash in before the stock dropped. In other cases, boards would time massive option awards to the CEOs just before announcing major expansion plans that shot up the stock price. The whole operation smacked of insider trading, ripe for manipulation.

“
There was a sea change in the mid-1990s,” observes Stephen Young, executive director of the Caux Round Table, which studies business ethics and promotes moral capitalism. “I think it was a generational shift. It was when baby boomers became increasingly important as CEOs. Baby boomers are the Me generation. If we are running a company, we are running it for ourselves. We have performance standards that always come back to
us
—stock options, golden parachutes. We are not in it for anybody else. CEOs are not doing moral capitalism because that’s not what’s being rewarded on Wall Street or at business schools.”

Sometimes there was a connection between pay and performance, but just as often there was not. Year after year,
The Wall Street Journal, The New York Times
, and a few independent executive compensation experts such as Graef Crystal would run exposés showing that many CEOs had harvested inflated incomes from stock options, even when stockholders lost money.
Bob Nardelli, for one, was forced out as
CEO at Home Depot in 2007 because of the company’s disastrous performance under his leadership. But Nardelli walked away with $210 million.

Probably the most egregiously distorted pay packages went to the Wall Street bosses at Bear Stearns and Lehman Brothers, who drove their companies to extinction in 2008. A Harvard University study documented how the top five executives at these two banks piled up private fortunes worth $2.4 billion in stock option profits and cash bonuses, even as they left stockholders with next to nothing. From 2000 to 2008, the study reported, Lehman CEO Richard Fuld cashed out $461 million in stock options—more than $160 million in the final months. Bear Stearns CEO James Cayne cashed out $289 million in stock options, much of it as Bear Stearns went into its death spiral.

And as the housing bubble rose and went bust,
Angelo Mozilo, CEO of subprime lender Countrywide, pocketed $410 million in salary, bonuses, and stock option grants and then got another $112 million in his severance package when his company went bust.

The options game had an even more sinister flaw. At several hundred major corporations, including Apple, UnitedHealth Group, and Silicon Valley start-ups such as Symbol Technologies and Mercury Interactive, CEOs cheated their shareholders by manipulating their stock options.

When their company’s stock did not go up and deliver them easy profits, these CEOs persuaded their boards of directors to rig the game. The boards would backdate the CEO’s stock options to a lower strike price, or buying price, than originally granted, so that even if the company’s stock had gone down, the CEO and senior executives would still get a handsome payoff while shareholders lost money. For example, if the original options were issued at a stock price of $50 and the stock went down to $40, the CEO got the board to pick an
earlier date for the options grant, when the price was only $30 a share. Suddenly, the CEO could cash in his options for a $10 profit on each share. A million options equaled $10 million. So the CEO made money while the shareholders were losing. This, of course, defeated the entire concept of pay for performance.

In addition, ordinary taxpayers took a hit from options cheating.
The SEC found that some CEOs were falsely reporting their option strike date so that the stock price would appear higher than what they actually paid, thus reducing the taxes on their gains.

The highest-profile case of stock option payola involved the late Apple CEO Steve Jobs. After ducking media inquiries about whether Apple’s board had improperly changed the dates of its stock option grants, Apple finally admitted to the SEC that between 1997 and 2002, there were 6,428 separate instances where the dates of Apple stock options had been altered.

Steve Jobs had been personally involved in picking “favorable” dates for backdating options, Apple confessed. Nonetheless, Apple’s internal report cleared Jobs of wrongdoing. Initially, Apple said Jobs had not profited personally, but it later turned out that Jobs had made a whopping profit, getting $295.7 million from selling half the shares that he’d been allowed to buy for $75 million. Worse, Apple disclosed to the SEC that it had fabricated—that is, totally made up—a fictional meeting of the board of directors in October 2003 that supposedly approved 7.5 million options for Jobs. That meeting never took place, Apple admitted; in fact, the options had been approved on December 18, 2001, when they would have cost Jobs more.

Apple’s whitewash of Steve Jobs met with catcalls of corporate hypocrisy. “They pretty much admitted he was directly involved in the fraud,” asserted New York University finance professor David Yermack. “You are torturing the English language to say he did not benefit from the options,” echoed Patrick McGurn of Institutional Shareholder Services. Even with Apple shareholders grumbling, there was no legal prosecution. Strange as it may sound, while backdating options is obviously fraudulent, it is not against the law.