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My Two Cents

A smarter way to set CEO pay

Chris Farrell Mar 31, 2009

I’ve waded into the CEO pay debacle once again:

The opening sentence of Alexis de Tocqueville’s Democracy in America, the social philosopher’s magisterial epic investigation into early 19th century America, highlights how central the idea of equality has been in society: “No novelty in the United States struck me more vividly during my stay there than the equality of conditions.”

But a visit to 21st century America might give de Tocqueville pause.

The era that the French author chronicled and the periods that followed were indeed a time of unparalleled opportunity. Immigrants swarmed to the U.S. to make a better life for themselves and their families. Americans looked at themselves as middle class, neither aristocrats nor working class, just common folk trying to get ahead, making a better life for their children. “Ordinary Americans came to believe that no one in a basic down-to-earth and day-in-and-day-out manner was really better than anyone else,” writes Gordon S. Wood in The Radicalism of the American Revolution. “That was equality as no other nation has ever quite had it.”

A Society Open to Talent

Of course, equality, so appealing in theory, was hard to obtain in practice. African Americans were excluded. So were the people who lived here before the European settlers. Society divided along the lines of money, power, and education. The gulf was wide between first class and steerage on the Titanic or the gilded mansions of Newport and the crowded tenements on New York’s Lower East Side.

Nevertheless, the American economy was more egalitarian and open to talent than anywhere else. Horatio Alger’s working boy heroes and Charles Foster Kane are fictional characters, but for Daniel Boone and Andrew Carnegie the climb from rags to riches was very real.

Indeed, it’s striking that Americans have long tolerated greater income inequality than other major industrialized nations. One reason is the powerful belief in equality of opportunity, that society rewards merit, pluck, risk-taking, and luck. Another factor is that for long periods of time the economic gains of rising productivity and increased innovation were widely shared.

A Small Few Have Benefited

A less savory influence on the acceptance of greater inequality is a cottage industry of consultants, lobbyists, and think-tank entrepreneurs that justified the extraordinary gains at the top of the income spectrum as the just rewards for brains and merit.

Problem is, none of these arguments hold anymore. Corporate America’s productivity gains of the past three decades or so have largely gone to a relatively small number of executives. The ominous combination of recession and credit crunch makes it hard to argue that the gains have been the returns to “talent” in the 2000s.

Perhaps most disturbing, Corporate America is becoming a pay-for-failure economy for its top executives and a Darwinian existence for everyone else. There’s something wrong in a world where former chief executives like Stanley O’Neal of Merrill Lynch, Charles Prince of Citigroup (C), and the retention bonus bunch at AIG (AIG) and others lose billions of dollars of shareholder money yet pocket millions on the way out.

I go on to argue that there is a good model to emulate: The Entreprenuer. You can read the rest of the argument here.

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