When Roberto Goizueta died in 1997, he was a billionaire. Other billionaires had made their fortunes by founding companies or taking them public. Goizueta made his as the CEO of Coca-Cola.
His timing was impeccable. In 1980 he became the chief executive of a company that owned no natural resources and had precious little physical capital. The talent economy had just come of age, and his company was among the most valuable in the world for its iconic brand and the talent that built and maintained it.
A century ago natural resources were the most valuable assets: Standard Oil needed hydrocarbons, U.S. Steel needed iron ore and coal, the Great Atlantic & Pacific Tea Company needed real estate. The status quo began to change in 1960, with an extraordinary flowering of creative work that required substantial independent judgment and decision-making. The top 50 market cap companies in 1963 included a new breed of corporation, exemplified by IBM. Natural resources played almost no role in IBM’s success, and its intensively creative employees were at the heart of its competitive advantage.
By 2013 more than half the top 50 companies were talent-based, including three of the four biggest: Apple, Microsoft and Google.
FROM DREAM ASSET TO DREAM DEAL
Through the 1970s the CEOs of large, publicly traded U.S. companies earned, on average, less than $1 million in total compensation (in current dollars) – not even a tenth of what they earn today.
After 1980, however, it seemingly became essential to motivate people financially to exercise their talent. Skilled leaders saw a major boost in income for two reasons:
HIGH EARNERS KEPT MORE MONEY. The top marginal tax rate plummeted from 70% in 1981 to 28% in 1988. Thus, $1 million earners saw the amount they kept after federal taxes increase from $340,000 to $725,000.
THEY WERE PAID IN STOCK AND PROFITS. Stock-based compensation has done wonders for CEO pay, which doubled in the 1980s, quadrupled in the 1990s and has continued to grow in the 21st century.
Ordinary employees have long accepted this rebalancing of income, but today people are increasingly asking whether talent is overcompensated.
THE DOWNSIDE OF THE DEAL
Our basic grievance with today’s billionaires is that little of the value they’ve created trickles down to the rest of us. Our current system of rewarding talent actually makes the economy more volatile.
Evidence can be seen in the Forbes 400. Over the past 13 years the list’s number of hedge fund managers has skyrocketed from four to 31. Hedge fund managers don’t care whether companies in their portfolios do well or badly – they just want stock prices to be volatile. Stock-based compensation motivates executives to focus on managing the expectations of market participants, not on enhancing the performance of the company. So the effect of modern stock-based compensation is to drive volatility, not appreciation.
The income gap between creativity-intensive talent and routine-intensive labor is bad for social cohesion. The move from building value to trading value is bad for economic growth and performance. The increased stock market volatility is bad for retirement accounts and pension funds. So although it’s great that the economy is so richly endowed with talent, that talent is being channeled into unproductive activities and egregious behaviors.
THE RISE OF THE TALENT ECONOMY
SAVING THE TALENT ECONOMY
In 1935, the Roosevelt administration passed sweeping pro-labor legislation. From 1935 to 1954, unionization rates rose from 8.5% to 28.3% of U.S. workers, and real wages for unionized employees rose faster than both nonunion wages and general economic growth.
It seems clear that the economy is heading toward another 1935 moment. Unless the key players work together to correct what’s causing the current imbalance, the 99% will vote in a rebalancing that is radically in their favor. To avert that, three things have to happen:
TALENT MUST SHOW SELF-RESTRAINT. Perceived greed will encourage retribution. If top financiers and executives want to avoid that, they need to scale back their financial demands.
INVESTORS MUST PRIORITIZE VALUE CREATION. Pension and sovereign wealth funds have become the largest owners of capital in the world. The top 50 combined invest $11.5 trillion. They currently engage in three practices that facilitate abuse by talent:
+ They supply large amounts of capital for hedge funds. The problem is that hedge funds achieve their returns by encouraging volatility; pensioners want and need steady appreciation.
+ Pension and sovereign wealth funds are the world’s leading lenders of stock, and short-selling hedge funds are its leading borrowers. This lending facilitates approximately $2 trillion worth of short selling on a perpetual basis, generating volatility that is great for hedge fund financial engineers but bad for the pensioners whose funds they use.
+ They support stock-based compensation. But broad returns on public equities have gone down while volatility has increased as stock-based compensation has increased.
All democratic capitalism is heading in the same direction, so a U.S. effort alone would be ineffective in correcting it. Just 35 funds from 15 countries could put $10 trillion in assets behind this goal. If they stopped funneling capital to hedge funds, lending stock and supporting stock-based compensation, it would be hard for smaller funds to justify not following suit.
THE GOVERNMENT SHOULD INTERVENE EARLY. Governmental regulation to rein in the excessive appropriation of value by the top 1% is preferable to a radically anti-talent agenda that could seriously compromise America’s entrepreneurial capabilities. The government might consider:
+ Regulating the relationship between hedge funds and pension funds. Stock lending by fiduciary institutions should be banned if pension funds don’t voluntarily cease the practice.
+ Taxing carried interest as ordinary income. This would promote tax fairness – hedge fund billionaires would no longer pay lower average income tax rates than ordinary laborers – and would reap additional billions for the Treasury.
+ Taxing trades. Anything that discourages high-frequency trading strategies is an unalloyed good.
+ Revisiting the overall tax structure. The U.S. taxation strategy features a very low personal income tax, a very high corporate income tax and no national value-added tax. No evidence suggests that this tax regime has benefited the U.S. economy, though it has clearly contributed to the dramatic rise in income inequality.
Goizueta lived to see talent’s rise to become the key asset in the modern economy. But he died before the positive aspects of this phenomenon began to give way to its dark side. The trend cannot proceed unabated in the United States without provoking a political reaction. Top executives, private equity managers and pension funds can avoid such a reaction by modifying their behavior to create a better mix of rewards for capital, labor and talent.
(Roger L. Martin was the dean of the Rotman School of Management at the University of Toronto from 1998 to 2013. His most recent book is “Playing to Win: How Strategy Really Works,” written with A.G. Lafley.)
