showed that of the two hundred largest U.S. companies at the end of 1929, 44 percent were controlled by managers rather than by their owners. An even greater share of the wealth of America’s top companies was in the hands of the managerial class—58 percent of the top two hundred companies, as measured by market capitalization, was manager ruled.
Means saw this ascendant managerial class as self-selecting and self-perpetuating: the only institutional parallel he could come up with was the clergy of the Catholic Church. In a book he and Adolf Berle, a professor of corporate law at Columbia, cowrote the next year, they described the rising managerial elite as “the princes of industry.” Berle and Means saw the shift from owners to managers as comparable in its significance to the switch from independent worker-artisans to wage-earning factory employees.
Berle and Means worried about how to keep this managerial aristocracy in check. Thanks to the ability of the publicly traded company to attract capital from millions of retail investors, this managerial class presided over firms of unprecedented scale and power. But the market incentives that governed the actions of owners didn’t necessarily apply to their stewards. In fact, their interests were “different from and often radically opposed to” those of the owners—the hired managers “can serve their own pockets better by profiting at the expense of the company than by making profits for it.”
Berle and Means were leading architects of the New Deal—Berle was an original member of FDR’s “Brain Trust,” and Means, working as an economist in the Roosevelt administration, waged a campaign against price fixing in the steel industry. Their prescription, accordingly, involved state and social intervention. Government should regulate managerial princes who overstepped the mark, and a new set of social conventions should be developed requiring managers to be “economic statesmen” who ran their companies in the collective interest.
Murphy’s “Worth Every Nickel” essay was a robust public statement of a radically different solution to the problem Berle and Means had identified. Like the New Dealers, Murphy and his confreres believed that managing the managers was the central problem of twentieth-century capitalism. But instead of trying to get corporate executives to behave more like public-spirited civil servants, Murphy and his fellow business school professors thought the answer lay in the opposite direction: the stewards needed to be turned into the red-blooded founder- owners they had replaced. To do that, their financial incentives needed to be aligned as closely as possible with the success or failure of the companies they ran. That wouldn’t give them as powerful a profit motive as owning the whole company, to be sure, but it would be a close second-best.
The “Worth Every Nickel” movement was in part a response to the success of the New Dealers’ efforts to create a social and political order in which managers were constrained. Thirty years after Berle and Means worried that managers would be tempted to profit at the expense of the companies they ran, here is how John Kenneth Galbraith, hardly an apologist for the C-suite, described the ethos of corporate America: “Management does not go out ruthlessly to reward itself—a sound management is expected to exercise restraint…. With the power of decision goes opportunity for making money…. Were everyone to seek to do so… the corporation would be a chaos of competitive avarice. But these are not the sorts of things that a good company man does; a generally effective code bans such behavior.”
In a follow-up to his
Jensen and Murphy agreed with Galbraith’s explanation of what was going on—social pressure was limiting CEO salaries: “Political forces operating both in the public sector and inside organizations limit large payoffs for exceptional performance.”
The Means and Berle solution to the rise of the managerial class had prevailed, and it seemed to be working. America’s companies were no longer run by their vigorous and self-interested robber baron founder-owners, but the new salaried stewards who had replaced them weren’t looting the corporate kitty. Governed by a “remarkably effective code,” their incomes were actually falling. They seemed to be doing a pretty good job, too. The companies under their stewardship doubled in size between 1932 and 1976, the total real compound annual return on the S&P 500 was 7.6 percent, and America’s GDP had quintupled.
But by the late seventies and the eighties, when Jensen, Murphy, and their like-minded peers began to investigate CEO pay, the economic picture was starting to darken. Economic growth seemed to stall even as inflation rose—remember stagflation. Corporate America, too, seemed sluggish, risk averse, and under threat from more innovative foreign rivals. These were the conditions that inspired the liberal economic revolution more generally, and also a rethinking of what was happening in the corner office.
As Berle and Means had warned in the 1930s, the problem started with the twentieth-century fact that the economy was largely run by “stewards” rather than owners. But the New Dealers’ fear that these managerial aristocrats would line their own pockets hadn’t come true—indeed, the opposite was the case. And that, Jensen and Murphy warned, was the problem. The social constraints that prevented executive looting also meant executives had weak economic incentives to do an outstanding job. The New Dealers had transformed hired-gun CEOs into capitalist civil servants—public-spirited and self-restrained. The “Worth Every Nickel” business school professors wanted to turn the managerial class into red-blooded capitalist owners.
Their solution was “pay for performance.” Managerial compensation should be more tightly tied to how well they did their jobs and, in particular, to how well their companies performed.
By one measure, the academic advocates of pay for performance were remarkably effective. After falling steadily during the postwar years, CEO salaries began to soar. The real takeoff was during the 1990s: by the end of that decade they were growing by 10 percent a year. As Roger Martin has calculated, for CEOs of S&P firms, the median level of pay soared from $2.3 million in 1992 to $7.2 million in 2001. That’s a lot of money, and a growing share of the overall income of corporate America. Between 1993 and 2003 the top five executives of America’s public companies earned $350 billion. Between 2001 and 2003, public companies paid more than 10 percent of their net income to their top five executives, up from less than 5 percent eight years earlier.
These were, of course, the decades when the 1 percent broke away from the rest of the pack in society as a whole. That happened inside corporations, too. Rising CEO compensation pulled the boss ever further from the factory floor or the cubicle rows. In the early 1970s, CEOs earned less than thirty times what the average worker made; by 2005, the median chief executive made 110 times what the average worker did. And just as income inequality in society overall has become more pronounced at the very, very top, the gap has grown between CEOs and their direct reports. Until the early 1980s, the chief executive earned about 40 percent more than the next two most highly paid managers; by the early twenty-first century, he made more than two and a half times as much.
This gap is no accident—it is inevitable in an economic model in which the CEO has gone from being the company man of Galbraith’s postwar account to the free-agent superstar of the pay-for-performance era. That shift was made starkly apparent when two economists at the London School of Economics asked a simple question: “Does it matter whether you work for a successful company?” The answer from HR is—of course! And our corporate Web sites duly urge us to be team players and to root for our firm’s overall success. But when Brian Bell and John Van Reenen looked at what actually happens in a sample of companies covering just under 90 percent of the market capitalization of Britain’s publicly listed firms, they came up with a chilling reply. CEOs and executives at the very top are rewarded for corporate success, but almost no one else is: “A 10 percent increase in firm value is associated with an increase of 3 percent in CEO pay, but only 0.2 percent in average workers’ pay.”
These growing chasms within companies didn’t just mirror the broader rise of the 1 percent, they also drove it. Executives working outside finance (a category all its own) were 31 percent of the 1 percent in 2005, the single largest group. They account for an even larger share of the 0.1 percent—42 percent in 2005.
A couple of decades earlier, Gyorgy Konrad and Ivan Szelenyi had revealed the politically uncomfortable truth that in the so-called workers’ states the real winners—and the real bosses—were the intellectuals, particularly their
