Executive pay drives increasing wage gap

It was the 1970s, and the chief executive of a leading U.S. dairy company lived the good life. Kenneth Douglas earned the equivalent of about $1 million today.

He and his family moved from a three-bedroom home to a four-bedroom home, about a half-mile away, in an upscale Chicago suburb. He joined a country club. The company gave him a Cadillac. The money was good enough, in fact, that he sometimes turned down raises. He said making too much was bad for morale.

Forty years later, the trappings at the top of Dean Foods, as at most big U.S. companies, are more lavish. The chief executive, Gregg Engles, now averages about $10 million in a typical year. He owns a $6 million home in an elite suburb of Dallas and 64 acres near Vail, Colo., an area he frequently visits. He belongs to as many as four golf clubs at a time.

Douglas' office was on the second floor of a milk-distribution center. Engles' headquarters occupy the top nine floors of a 41-story Dallas office tower. When Engles travels, he takes the company's $10 million Challenger 604 jet, which is largely dedicated to his needs, both business and personal.

The evolution of executive grandeur — from very comfortable to jet-setting — reflects one of the big reasons for the widening gap between those with the highest incomes and everyone else.

For years, statistics have depicted growing income disparity in the U.S., and it has reached levels not seen since the Great Depression. In 2008, the last year for which data are available, the top 0.1 percent of earners took in more than 10 percent of the personal income in the U.S., including capital gains, and the top 1 percent took in more than 20 percent.

But economists have had little idea who these people were. How many were Wall Street financiers? Sports stars? Entrepreneurs? Economists could only speculate.

Now a mounting body of research indicates the rise in pay for company executives is a critical feature in the widening income gap.

Landmark analysis

The largest single chunk of the highest-income earners, it turns out, are executives and other managers in firms, according to a landmark analysis of tax returns by economists Jon Bakija, Adam Cole and Bradley Heim. These are not just Wall Street executives, either, but also from companies in relatively mundane fields such as the milk business.

The top 0.1 percent of earners make about $1.7 million or more, including capital gains. Of those, 41 percent were executives, managers and supervisors at nonfinancial companies, according to the analysis, with nearly half deriving most of their income from their ownership in privately held firms. An additional 18 percent were managers at financial firms or financial professionals at any sort of firm.

Other recent research, moreover, indicates executive compensation at the nation's largest firms has roughly quadrupled in real terms since the 1970s, even as pay for 90 percent of America has stalled.

This trend held at Dean Foods. From the 1970s until today, while pay for Dean Foods chief executives was rising 10 times over, wages for the unionized workers declined by 9 percent in real terms, according to union-contract records. It is now about $23 an hour.

"Do people bitch because Engles makes so much? Yeah. But there's nothing you can do about it," said Bob Goad, 61, a burly former high-school wrestler who is a pasteurizer at a Dean Foods plant in Harvard, Ill., and runs an auction business on the side for extra income. "These companies have the idea that the only people that matter to the company are those at the top."

Engles declined to be interviewed. Company officials threatened to call police as a reporter interviewed workers outside one dairy.

Recurring debate

Defenders of executive pay have argued that today's chief executives are worth more because, among other things, companies are larger and more complex.

But critics question why so much growth in income should go to the wealthiest. Douglas, the Dean Foods chief from the '70s, died in 2007. His son, Andrew Douglas, said his father viewed wages, in part, as a moral issue.

If his father knew what executives make today, Andrew Douglas said, he'd be "spinning in his grave. My dad just believed that after a while, what else would you need the money for?"

Inequality, economists have noted, is an essential part of capitalism. At least in theory, "the invisible hand," or market system, sets compensation levels to lead workers into pursuits that are the most productive to society. This produces inequality but leads to a more efficient economy.

As a result, economists have noted, there is an inherent tension in market-oriented democracies because, while society aims to endow each person with equal political rights, it allows unequal economic outcomes.

Americans have been uneasy about the income gap since at least the '80s, according to polls.

Repeated surveys by the National Opinion Research Center since 1987 have found that 60 percent or more of Americans agree or strongly agree with the statement that "differences in income in America are too large."

The uneasiness arises from a fear that extremes of wealth can unfairly reduce economic opportunities and political rights of everyone else, according to sociologists. The wealthy, for example, can afford better private schools for their children or acquire political might by purchasing campaign advertising or making campaign donations.

"Americans think income inequality is excessive and have done so consistently for years," said Leslie McCall, a Northwestern University sociology professor who is writing a book on the subject. "Their concerns arise when it seems that extreme incomes for some are restricting opportunities for everyone else."

Income inequality has been on the rise for decades in several nations, including Britain, China and India, but it has been most pronounced in the U.S., economists say.

According to the CIA's World Factbook, which uses the so-called "Gini coefficient," a common economic indicator of inequality, the U.S. ranks as far more unequal than the European Union and Britain. The U.S. is in the company of developing countries — just behind Cameroon and Ivory Coast, and just ahead of Uganda and Jamaica.

Political theme

Democratic leaders, whose constituents have expressed more alarm over the divide, have used the phenomenon to justify their policies, such as universal health care.

"A nation cannot prosper long when it favors only the prosperous," President Obama said in his inaugural address.

But exactly what the government ought to do about the income gap has been unclear because economists have been divided over why it has grown. They weren't even sure who was making all that money.

Economists Bakija, Cole and Heim completed their massive analysis late last year.

They found that after executives, managers and financial professionals, the next-largest groups in the top 0.1 percent of earners were lawyers, with 6.2 percent, and real-estate professionals, at 4.7 percent. Media and sports figures, often assumed to be a large portion of very high earners, collectively made up only 3 percent.

"Basically, executives represent a much bigger share of the top incomes than a lot of people had thought," said Bakija, a professor at Williams College.

So what has happened since the '70s that has sent executive pay upward?

While no company can be considered completely typical, Dean Foods offers a better comparison than most because fundamentally it hasn't changed.

The dairy business is still the root of the company; it was on the Fortune 500 by the late '70s and remains there. It grew then and more recently through acquisition. And both chief executives — Douglas and Engles — could boast records of growing the company and its profits.

From 1970 to 1979, while Douglas was CEO, sales tripled and profit increased tenfold, to $9.8 million, according to company records. Similarly, from 2000 to 2009, sales roughly doubled, and so did profits, to $228 million. (Engles became CEO after the company he led bought Dean Foods in 2001 and adopted its name.)

Yet, there are vast differences in how the two men were paid.

In 1977, 1978 and 1979, Douglas made about $1 million annually in today's dollars. The largest part of that was a salary; some came from a long-term incentive, based on the stock price, that would not mature until he retired.

By contrast, in 2007, 2008 and 2009, Engles averaged $10.5 million annually, most of it in stock and options awards and other incentive pay, according to proxy statements. After an unusually bad year in '09, Engles' compensation dropped to $4 million in 2010. If profit returns, so will his higher earnings.

The case of Dean Foods appears to bolster the argument that executive compensation moves with company size: Dean Foods' profit in 2009 was roughly 10 times what it was in 1979, adjusted for constant dollars. Engles' compensation has averaged 10 times that of Douglas.

"It's a different company today," Dean Foods spokesman Jamaison Schuler said. He declined to comment further.

Shifting attitudes?

But some economists have an alternative, hard-to-quantify explanation: that social norms that once reined in executive pay have disappeared.

Harold Geneen, the president of ITT, at one time among the nation's largest companies, told Forbes in 1975 that while he might be worth six times as much to the company as he was making, he hadn't sought a raise.

"No one moved up there, and I didn't dare do it alone," he said.

At Dean Foods, Kenneth Douglas was likewise resistant to making more. Most years, board members wanted to give him a raise. He refused more than once.

"He would object to the pay we gave him sometimes — not because he thought it was too little; he thought it was too much," said Alexander Vogl, then a member of the board and chair of its compensation committee.

"He believed the reward went to the shareholders, not to any one man," said John Frazee, another former board member. "Today we get cults of personality around the CEO, but then there was not a cult of personality."

Employees interviewed outside a Dean Foods dairy said they only occasionally dwell on Engles' riches. Their focus is on making ends meet, they said.

Joe Bopp, 55, said he has a second job at a cemetery during the summer, mowing the grass and digging graves.

"Twenty-three dollars an hour sounds like a lot of money," he said. "But when you pay $4 a gallon for gas and $3.29 for a gallon of milk, it goes away real fast."