One of the disturbing features of American income inequality is the rising disconnection between the wages of ordinary workers and the compensation of a small cadre of executives. Despite huge gains in productivity over the last three decades, median wages are actually lower than they were in the 1970s. Part of the answer seems to lie in a simple reality: when companies do well profits are plowed into generous stock options and other forms of fringe benefits for top-level employees. The U.S. tax code actually incentivizes this behavior by providing favorable tax treatment to stock options, thus allowing executives to avoid paying high corporate taxes. Meanwhile, the productive labor – from low-level managers down to the people stocking shelves – rarely see corporate profit in their paychecks.
In a new policy paper, Richard Freeman and coauthors suggest a simple solution – require that companies either extend stock options down to lower paid workers, or forego the tax benefits.
Although this idea seems borderline socialist in the United States, it actually is consistent with the tax treatment of other fringe benefits such as health insurance – companies are required to provide such benefits to virtually all workers, or forego the tax break on the benefit (which is not to say that companies do not find ways to skirt the regulations by reclassifying workers). Moreover, providing stock options to all employees is actually company policy at a few major companies including Wegmans grocery, which has a large lower-educated workforce. According to an industry profile, Wegmans has higher than average labor costs, but has substantially lower turnover of low-level workers, which induces greater productivity of labor.
The authors provide a fairly convincing survey of the economic and business literature on broad-based incentive systems, and conclude that on average firms that have broad-based incentive compensation systems have better outcomes, and work best when workers are given greater autonomy in their jobs. (The authors do not discuss the issue at length, but among the 100 plus studies they review, only one is a controlled experiment, and most of the others do not provide any exogenous variation in the “treatment”, so we should be a bit cautious about the sunny assessment of such programs when there is likely to be a fair amount of selection bias).
More to the point, the current narrow compensation system is not working. Not only does it contribute to income inequality as noted, it also generates a host of perverse incentives such as backdating stock options in order to inflate their value. To some extent, broad-based compensation schemes might curb these practices, or at least increase the level of scrutiny among shareholders, which would then be broadened to include more workers.
Plenty of challenges remain including the need to provide workers with sufficiently diversified investments (it is risky to tether too much compensation for lower-income workers to the performance of a single company), and also the likelihood that many companies would opt out of such a scheme entirely, still it’s easy to make the case that such a system would do much more to serve the interests of ordinary workers. And it would do much more to affirm the value of all workers, from the CEO downward.