Post-World War II Business and Accounting
I wonder how many people would have thought at the end of World War II that the capitalist system would be one that was meeting the challenges and making things better for people as we approach the 21st century.
—Sandy Weill
Once Germany attacked Poland and both Great Britain and France declared war, it was inevitable that the United Stated would enter—President Franklin Roosevelt called America the “arsenal of democracy.” It came when Japan attacked Pearl Harbor December 7, 1941. It may have been inevitable, but the surprise attack created both a social and market panic. Military setback continued, but progress started by mid-1942. The industrial might of America meant victory would come eventually. Auto companies, airline manufacturers, and most of the rest of industry turned to military equipment, requiring immense spending, huge taxes, and massive borrowing. The big innovation on the tax front was income tax withholding from each paycheck beginning in 1943.
Many executives now worked for the government as “dollar-a-year men,” also suggesting that the remaining execs should not increase salaries or corporate profits. However, war profiteering (as with all wars) resulted in several scandals. Consequently, the Senate created a Special Committee to Investigate the National Defense Program in 1941. Senator Harry Truman chaired the committee and traveled the country to investigate industrial and other war plants. Truman’s committee discovered defective military equipment (such as defective motors from Curtiss-Wright, an aircraft builder) and billions of dollars of overcharging. Partly because of the Truman Committee, a 90-percent excess-profits tax was passed and the Office of War Mobilization had the mandate to eliminate war profiteering.
Washington became a world center of power and the Pentagon a gigantic bureaucracy. The federal government became enormous, topping out at $100 billion annually and creating a national debt over 120 percent of GDP. Virtually all the Treasury debt was owned domestically, spurred on by patriotism and lack of alternatives to spend money—the IRS also collected enough revenues to give lenders confidence of future repayment.
Post-World War II
The post-World War II period can be considered the early years of restructuring the world economy including the creation of the United Nations, World Bank, International Monetary Fund, the North Atlantic Treaty Organization, and the beginnings of what became the European Community. This could include the period up to 1971 when the United States went off the gold exchange standard1 and currencies were free to float. It could include the period sometimes called the Great Compression, roughly until the 1970s when median incomes continued to rise and executives generally paid what most people considered they were worth. The big event in financial accounting was the new standard setting body, the Financial Accounting Standards Board (FASB), created in 1973. The period could include the entire Cold War period which ended about 1990—or some other definition. This chapter will stop around 1990, about the time of the collapse of the Japanese stock markets and real estate bubble, plus the reemergence of the United States as the world’s dominant industrial economy. The tech bubble, economic expansion, growing executive compensation, the return of financial dominance (and risk taking), and certain accounting issues were big stories beginning in the 1990s.
The end of World War II saw America at its most dominant economically, producing about half the world’s industrial production; much of the rest of the industrialized world was decimated from the war. American growth and innovation continued, while the rest of the developed world also expanded and much of the developing world was in fact developing. The Cold War and related stories (e.g., communists in America, plus devastating wars) got most of the headlines, but the big stories were the economic miracles over major parts of the world (United States and Canada, Western Europe and the developing Common Market, and several East Asian countries). U.S. GDP per capita rose from $764 in 1940 to $32,579 in 2000 (a 440 percent increase when adjusted for inflation).
Charles (“Engine Charlie”) Wilson, chairman and president of General Motors (GM) made the bald statement: “What was good for the country was good for General Motors, and vice versa.” The statement has been mocked ever since, but he had a point. The “American Model” of giant industrial plants—perfected at GM in the 1920s—was the most efficient in the world, due in part to substantial innovations in managerial accounting. This would continue for a couple of decades until Japanese and other export-dominant countries learned how to compete, producing first cheaper and eventually higher quality products. The result was a growing trade deficit and declining manufacturing.
William McChesney Martin, Fed Chairman (1951 to 1970) for much of this period, stated: “The job of the Federal Reserve is to take away the punch bowl just the party gets going.” In other words, the Fed would hit the tight money brakes2 before boom periods turned into bubbles. Inflation stayed down, but frequent recessions were common, including three minor recessions in the 1950s. But the mid-1960s included a war on poverty and an actual war in Vietnam, meaning big budget deficits and rising inflation and interest rates. Martin’s replacement at the Fed, Arthur Burns, was more political and tried to promote Richard Nixon’s chances for a second term by keeping interest rates low as the economy (and inflation) were heating up—the punch bowl stayed put.
A major postwar factor was declining tax rates, from a top rate of 91 percent under Eisenhower, to 70 percent under Kennedy, to 50 percent under Reagan’s first term, to 28 percent (with fewer deductions) in Reagan’s second term. This was extraordinarily beneficial to high-income taxpayers and probably the biggest single factor to rising executive compensation beginning in the 1970s (and exploding in the 1990s). As top tax rates dropped, incentives for rising compensation increased. Greed is greed and follows closely on the heels of incentives. Simultaneously, with reduced revenues, the budget deficit expanded. The political and economic power of labor (especially labor unions) fell roughly as that of executives rose. Global corporations had more power. If local labor was intransigent, the corporation could move South (to more favorable business climates with lower labor power) or overseas to take advantage of lower labor and other costs. Domestically, business could rely on what became “corporate welfare,” benefits to particular companies and industries such as tax and zoning breaks to move to a particular location, and state and federal legislation greased by campaign contributions and lobbying.
Equity investors stayed traumatized until well after the end of World War II. The Dow Jones industrial average (DOW) fell to 111 after Pearl Harbor and did not hit 150 until 1945. The stock boom started in the early 1950s and the DOW rose to 500 by 1956 and to 670 by the end of the 1950s. The boom would last until 1966. The accumulating economic problems would turn the market bearish until the 1980s (the result of either or both the Volcker or Reagan Revolution).3
Inflation became the big issue in the 1970s and early 1980s. The rising federal deficit, increased regulatory costs (e.g., the Environmental Protection Agency, EPA, was created in 1970)4 and energy cost were major factors. The Arab countries of the Organization of the Petroleum Exporting Countries (OPEC) declared on oil embargo on the United States and the West in 1973 over the Yom Kippur War causing rationing, disruptions, and big price increases in oil. A cycle of rising costs and wages led to a double-digit inflation rate and rising unemployment (called stagflation).5
Federal Reserve Chairman from 1979 to 1987, Paul Volcker, used the finance system to fight inflation based on “tight money.” Inflation as measured by the consumer price index (CPI) was over 10 percent in 1979 and the “misery index” (inflation plus unemployment rate) hit more than 20 percent. Volcker raised short-term interest rates above 20 percent, causing both borrowing pain and a short recession. The tight money eventually worked and inflation fell below 4 percent by 1983 (and the misery index dropped below 10 percent by 1986). Reagan and his tax cuts got most of the credit for the recovering economy. The stock market roared, Communism fell, and most of the 1990s decade came under Democratic control with Bill Clinton as president. The stock market continued up and the decade was all about high tech and the resurgence of America.
Financial Accounting Issues
Business and economic problems usually meant related accounting issues. Many of these issues were long standing, such as dealing with inflation and other reasons for changes in values in long-term assets, pension and other long-term employee benefits, acquisitions, stock options, and other derivatives issues. New issues appeared such as special purpose entities, made critical after the collapse of Enron.
Accounting standards, standardized procedures based on GAAP, were initially in the hands of Committee on Accounting Procedure (CAP), an insider committee mainly of practicing CPAs under the AIA (and from 1957 the AICPA). Over 20 years (1938–59) the CAP (with a major focus on uniformity) issued 51 pronouncements called accounting research bulletins (ARBs) which established basic accounting and financial reporting rules. An area of massive manipulation during the 1920s was the use of fair values to inflate asset values and record unjustified gains, such as Unsell’s utility empire. Consequently, both the CAP and the Internal Revenue Service favored historical cost. In other words, balance-sheet values were based primarily on original cost (less depreciation or amortization).
The Accounting Principles Board (APB) replaced the CAP in 1959, presumably to fix perceived weaknesses in the process; particularly lack of research on specific issues, no guiding principles—related to the idea of accounting theory, and no formal process for deciding which issues to consider for new standards. The APB was still a part-time committee mainly of practicing CPAs and it got off to a poor start by picking a fight with the SEC on a new tax credit. President John F. Kennedy introduced investment tax credits (which became part of the 1962 Revenue Act) to encourage capital assets. APB Opinion No. 2 required the credit to be deferred over the life of the asset, consistent with uniformity and economic substance. The SEC, following the idea that an immediate credit for encourage more capital spending, allowed both the deferral and immediate recognition methods. Because the SEC has the force of federal law behind it, the APB almost immediately backed down and issued APB No. 4, allowing both methods. Tensions would continue between the SEC and the APB and later the FASB.
The AICPA created a research division that issued accounting research studies (ARSs) as a source of accounting principles. Presumably, the ARSs would serve as accounting theory to be used by the APB. The ARSs proved to be relatively impractical additions to the complex brew on accounting theory, which meant that the APB stayed more pragmatic (and political) with their pronouncements. Over the life of the APB some 31 Opinions were issued, including several complex and controversial topics such as stock options, mergers, and pensions.
The main characteristics of the complex issues were legitimate alternatives could be favored for various issues (such as original costs versus any number of fair value alternatives), issues were complex and required multiple approximations (e.g., pensions), and uses kept changing (various derivatives); therefore, they would be reconsidered periodically and new pronouncement issued. Major reasons include politics (major lobby groups could influence the SEC and Congress for more favorable treatment) and circumstances change (e.g., the level of inflation had a major impact on considering alternatives to historical cost accounting; the ability to price derivatives based on the Black Sholes and related models greatly influenced the ability of banks and investors to trade derivatives; therefore, the need of accountants to more accurately account for them). One “solution” to difficult issues was the requirement for substantial footnote disclosure (or elsewhere such as management discussion and analysis), resulting in a long annual financial report.6
The deficiencies of the APB were considered too great for the committee to continue. The AICPA created the Wheat Committee in 1971 (named for Chairman Francis Wheat, corporate lawyer and former member of the SEC) to recommend an organization structure to achieve better results quicker. The 1972 report recommended what became The FASB, with a complex structure and a substantial budget. The FASB would be an independent body made up of seven full-time (and well-paid) members serving 5-year terms (with the potential of being reap-pointed once) picked by another new body, the Financial Accounting Foundation (FAF). The majority of the FASB members would be non-CPAs. Funding for the FAF and picking the committee members would be by sponsors including the AICPA, Financial Analysts Federation, and other organizations.7
Other committees established were the Financial Accounting Standards Advisory Committee (FASAC) to provide information on technical issues and an Emerging Issues Task Force (EITF) to identify early new issues to be considered. The FASB has a research director and initially had a staff of about 70 people (slightly smaller today). The Government Accounting Standards Board (GASB) was established under the FAF in 1984 for state and local governments, with a structure paralleling the FASB.
The structure of the FASB and related organizations was designed to solve the perceived problems of the CAP and APB. The FASB was designed to be independent of the profession, therefore the creation of the FAF to select the members. “The FASB has an agenda, a formal process that includes researching agenda items, public input throughout the process, a theoretical base (called the Conceptual Framework [CF]), and a strategy (subject to change) for solving accounting issues.”8
Due process is extensive. The EITF is a source of new agenda items (i.e., those likely to lead to new pronouncements). Once a topic goes on the formal agenda, a task force is appointed to provide advice. Staff is selected to analyze and develop a Discussion Memorandum (DM) which defines the specific problem(s), project scope, and possible alternatives to solve the issues involved. The DM is publicly available and public hearings held. Based on input the staff produces an Exposure Draft (ED), the FASB’s proposed solution included the rationale for the specific rules presented. Again, subject to public hearings and written comments to Board, which can issue a new pronouncement (possibly with modifications based on public input) or in more controversial areas reevaluates the problem and probably issues a revised ED.
An interesting issue is the focus on “rules-based” versus “principles-based” pronouncements.9 One of the first projects of the FASB was a new focus on accounting theory based on the development of a CF. One of the most interesting documents on financial accounting theory was the 1976 DM for the CF, laying out “a constitution” of objectives that could lead to consistent accounting standards. The layout of the DM included the objectives of financial accounting and reporting, qualitative characteristics, defining assets and other “elements” of financial statements, how to measure the elements, based on what unit of measure (this was a period of high inflation, when other measures beside the dollar were considered). Over the years, the FASB issued eight concept statements, identifying objectives, qualitative characteristics, elements, and measurement.10 The effort on theory suggests that the FASB was all in on a principles-based approach, but focus has shifted over the years based on specific board member, political considerations, and the need for pragmatism. Perhaps the most rules-based issue has been leases, which has always had detailed rules and limited interest in such principles as economic substance. Beginning with Statement No. 13 in 1977, the FASB has issued over a dozen lease pronouncements, the most recent as Topic 840 in early 2016.11
From its founding in 1973 until 2009, the FASB issued 168 statements, plus interpretations and other pronouncement.12 After that the FASB shifted to an Accounting Standards Codification—in four volumes! Topic areas include: (1) general principles; (2) presentation area; (3) assets, liabilities and equity; (4) revenues and expenses; (5) broad transactions; and (6) industry.13
Corporate Mergers
Big business often meant corporations wanting to get even bigger. Reasons include economies of scale (bigger organizations could mean lower unit costs), reduced competition (and therefore likely higher prices, lower volatility, and less need to innovate), and outright power for a giant organization. Acquisitions included horizontal, vertical, and conglomerate mergers.14 Particularly useful were accounting alternatives that allowed vast manipulation possibilities, because economic reality was typically not an important consideration. Key questions were: At what price should assets and liabilities of an acquired company be recorded? How should operations be recorded in the year of the merger and shortly after? How should acquisition and reorganization costs be handled? Goodwill can be “created” with a merger, which requires additional considerations.15
The most basic accounting alternatives were pooling of interests and the purchase method. Pooling, theoretically a “combination of equals,” more or less used historical costing (book value based on depreciated cost, with unrecorded costs such as patents developed through research and development staying unrecorded). This usually allowed low future operating costs and therefore greater accounting profits. The purchase method has the dominant company “buying” the acquisition and recording the purchase at actual purchase price. This is considered the most accurate in terms of an economic transactions, but usually records assets and liabilities at much higher prices and greater recognition of future operating costs (lowering income but also reducing corporate income taxes).16
The major problem with acquisition accounting was the potential for manipulation, especially using “dirty pooling.”17 Profits could be inflated, stockholders’ equity (“book value”) could be inflated or reduced, or taxes lowered. Massive goodwill could be recorded or not at all. Thus, acquisitions could have major effects on future financial statements irrespective of actual operations results. Antitrust laws were used by federal regulators to disallow some of the most egregious mergers.
Especially since the 1950s, conglomerate mergers became a fad.18 Conglomerate mergers caught on as investors drove up stock prices. Executive argued that good management could take poorly run firms and use standardized approached to maximize efficiency, cut costs, and increase sales. Diversification and certain economies also were stressed. The companies were good at generating profits, but possibly the result of accounting manipulation rather than management operating skills. When conglomerates were trading at premiums (usually based on high price/earnings or PE ratios), acquisitions selling at much lower PE ratios were easy pickings.
Special Yarns became Textron in 1944, becoming one of the 100 largest companies by 1960. James Ling created Ling-Temco-Vaught (LTV) in the 1950s. Acquisitions included Jones and Laughlin Steel, Braniff Airlines, Wilson Meat Packing, National Car Rental, and Wilson Sporting Goods. LTV mastered manipulation and avoided bankruptcy until 2000. International Telephone and Telegraph (ITT) started in the 1950s and became the 8th largest American company by 1970, after some 350 acquisitions. Antitrust cases followed earnings overstatements—estimated at 70 percent by the justice department. Litton and Gulf + Western and, later, Tyco were other examples—more on Tyco later.
Lawyer Joe Flom created various aggressive acquisition strategies. When investment bank Morgan Stanley hired Flom to enter the hostile takeover business—with International Nickel raiding Electric Storage Battery (ultimately, United Aircraft acquired Inco), investment banking changed. Acquisition strategies became nasty and bankers chose sides: black knight or the white knight defender of existing firms. The bear market of the late-1960s and 1970s made corporate acquisitions relatively cheap. Seemingly, corporations were net losers while banks (charging a fortune) were big winners. The Reagan win in 1980 meant little interference on antitrust grounds and acquisitions expanded.19
Junk Bonds, Insider Trading, and the S&L Industry
Enter junk bond king Michael Milken, innovative banker and Ivan Boesky, arbitrageur—both crooks and eventually convicted felons. Milken figured out that junk bonds were underappreciated by bankers and investors and therefore a great value.20 As mergers, especially hostile takeovers, increased, junk bonds became a major funding source for less-than-blue-chip transactions. Milken and his staff at investment bank Drexel-Burnham almost single handedly created this market as the remaining investment banks dealt almost exclusively with investment grade bonds. Milken supported corporate raiders with less than stellar credit (one form of private equity) that used mainly junk bond debt to finance deals—called leveraged buyouts. As a virtually unregulated market, Milken had a monopoly position to buy and sell junk bonds to create massive profits for Drexel and his team.
The Milken and Boesky conspiracy (especially when combined with the related savings and loan debacle) became one of the largest business scandals in modern history. In addition to information from corporate raiders he supported, Boesky traded for his own account. Insider information on acquisition deals guaranteed massive profits, “bought” from several investment bankers, including Dennis Levine and Martin Siegel. Boesky bribed Siegel and Levine to provide insider information on other upcoming (investment grade) acquisition deals. Generally, the bankers encouraged Boesky and others to buy and sell specific stocks to move the market favorably for their clients. Levine had a bribery formula with Boesky—5 percent of Boesky’s profits from the stock tips. This included a merger of Houston Natural Gas with Internorth which created Enron—more on Enron in the next chapter.21
Milken and Boesky began “collaborating” in the 1970s, in part to enrich Milken secretly because Drexel Burnham did not permit Milken to trade himself. A famous example involved Ted Turner’s Cable News Network which hired Milken to get Metro-Goldwyn-Mayer/United Artists (MGM/UA). Boesky was told by Milken to buy MGM stock, which put the deal in play. Turner got $1.4 billion in junk bonds from Milken for a financing fee of $66.8 million. Milken and Boesky split another $3 million from Boesky’s insider trades.
Milken found buyers by demonstrating a higher return for little extra risk with a diversified junk bond portfolio. Investors included pension plans and insurance companies. A new group of willing buyers were savings and loan associations (S&Ls) after the industry was deregulated in the early 1980s. The S&Ls were financials specializing in mortgages financed by low-rate savings deposits. When interest rates rose rapidly (as did mortgage rates) the S&Ls lost depositors while holding long-term mortgage portfolios with declining values. Congress’ solution was allowing the S&Ls to spread the losses over the life of the mortgages (a form of accounting manipulation actually created by regulation),22 then deregulating the industry, allowing them to diversify beyond mortgages plus other funding sources such as “jumbo certificates of deposits” (CDs). S&Ls reorganized, organized crime and other shady investors moved in, and the industry moved to temporary and unsustainable success.
With high-priced CDs and other deposits (and limited regulation given the focus on deregulation),23 S&Ls looked for lucrative investments, including shady real estate deals and Milken’s junk bonds. As naïve buyers, Milken made untold profits from S&L bond purchases—while convincing them of the great deals they got. The industry managed to destroy itself with reckless practices and a large share of the firms failed. Many of the executives were sent to jail including CEO Tom Spiegel of Columbia S&L of Beverly Hills and Charles Keating of Lincoln Savings. The Resolution Trust Corporation (RTC) was created by Congress to sell off the assets and mortgages of the failed S&Ls at a final cost of $165 billion to taxpayers.24
Both Milken and Drexel were indicted under the Racketeer Influenced and Corrupt Practices Act (RICO—originally designed to combat organized crime). The junk bond market, which Milken helped prop up, collapsed after the fall of Milken. Drexel declared bankruptcy and Milken pled guilty to conspiracy and securities fraud, then sentenced to 10 years in jail and fined over a billion dollars. Upon release, Milken concentrated on philanthropy with his remaining fortune. After cooperating with the government to catch other insider traders, Boesky pled guilty to a single count of securities fraud and served 2 years in prison.
Big Frauds, Little Companies
Fraud, extortion, bribery, embezzlement, and other forms of corruption did not disappear, but seldom made the business headlines during much of the postwar period. There were several sophisticated (and not so sophisticated) accounting frauds worthy of mention without having a perceptible effect on the economy. Fifteen minutes of infamy candidates included Billie Sol Estes, Bernie Cornfeld, and Robert Vesco at Investors Overseas Services (IOS), Equity Funding, National Student Marketing, EMS Governmental Securities, and ZZZZ Best, big frauds at relatively small companies.
Equity funding was an insurance/investment hybrid, selling life insurance but allowing holders to buy mutual funds using policy cash values. This combination did not attract enough business; therefore, fraudulent insurance policies and fake mutual fund purchases were created to show growth. This was an early use of computer technology in the 1960s, feeding false accounting data into the computer system. The downfall of Equity Funding in 1972 by the SEC came from a whistleblower rather than an audit or regulatory oversight. Auditors and regulators had to play catchup in computer technology, requiring massive investments in technology and training—an ongoing process.
ZZZZ Best went from carpet cleaning in teenager Barry Minkow’s garage to a giant insurance restoration company based on huge growth. Minkow did not let lack of business stop him and used petty crime—stealing, check kiting, fake accounts, and bank loans based on false information—to stay in business and claim success. An initial public offering and an acquisition of a bigger carpet cleaner financed by Michael Milken-provided junk bonds followed. The Los Angeles Times uncovered much of the story and auditor Ernst and Whiney (now Ernst & Young) uncovered the fraud. ZZZZ Best collapsed and Minkow was sentenced to 25 years in jail for securities fraud and embezzlement, serving 7. National Student Marketing, established by Cortes Randell in 1964, was another scam based on bogus customers and earnings. Randell cashed out before NSM failed, but convicted of stock fraud.
EMS Government Securities was a broker/dealer in municipal securities.25 The owners covered up a $3-million loss and attempted to recover the funds using speculation. The auditor eventually discovered the fraud and bribed EMS to cover up the crime. The losses got bigger and the owners gave up and confessed their crimes. The auditor was convicted of bribery and sent to jail—one of the few cases of a crooked CPA (at least one that was caught, convicted, and jailed). Home State Bank lost some $150 million in bank loans to ESM and the bank’s owner famously complained: “I never made a dishonest dollar in my life. It’s all the accountant’s fault.”26
Billie Sol Estes, one of Texas’ most infamous wheeler-dealers, focused on real estate and exploited federal farm subsidies to the limit. Millions of dollars were borrowed based on bogus collateral. He claimed some 30,000 fertilizer tanks, while owning only a few but spread out across West Texas. Auditors inspected the tanks by serial number, meaning his cohorts almost immediately painted or spot welded that number on a tank and the auditors were escorted to the new tank of record. Disagreeable journalists investigated and turned incriminating evidence over to the FBI. Billy was arrested in 1962 and served 6 years after convicted of mail fraud and conspiracy. For this and other crimes he claims to be a “Texas Legend” on his “billiesolestes” website.
Seldom does one crook hand off a corrupt business over to another, but such was the case of Investors Overseas Services (IOS), a Swiss mutual fund. The 1960s founder was Bernard Cornfeld, catering to wealthy clients demanding tax evasion services. With billions in assets IOS went public in 1969, allowing Cornfeld and other investors to cash in. The stock crashed which Cornfeld attributed to a German bank bear raid. Bernie, apparently pocketing stock proceeds, got dumped, then spent quality time in Swiss jails. Robert Vesco took over the company in 1970 on the usual borrowed money, turned IOS into a holding company, and then looted it using dummy corporations—to the tune of $235 million. With embezzlement charges filed by the SEC, Vesco “retired” to Costa Rica and Cuba. His contributions to Richard Nixon during Watergate mired both in further infamy.
Although these were hardly massive frauds, Congress held hearings both in the House by John Moss and Senate by Lee Metcalf in the 1970s, followed up by Congressmen John Dingell and Jack Brooks in the 1980s. A major factor was the expectation (later called the “expectations gap”) that auditors should find fraud where it exists. In fact, auditors have a poor record finding illegal acts—or at least seldom notified authorities of potential crimes. Federal legislation to regulate auditors was proposed but failed to pass, with many provisions finally implemented in 2002 by the Sarbanes-Oxley Act.
Executive Compensation: From Great Convergence to Great Divergence
The postdepression period was not good for enriching executives for almost half a century. During the mid-1930s the SEC and other federal agencies accumulated executive salary information, demonstrating that some execs made millions although most made less than $100,000. The SEC continued to gather executive pay information, which probably embarrassed the CEOs (and the board) to keep compensation in check. During World War II many executives volunteered their services to the war effort as “dollar a year men.” The willingness of some to sacrifice insured that corporate salaries and bonuses did not rise—plus federal laws that limited both worker and executive salaries. The top individual income tax rate stayed above 90 percent until the 1960s, making large incomes undesirable (but not untaxable benefits such as health insurance and pensions).
During the post-World War II period worker salaries rose (in part because of the rising economic and political power of unions) while executive wages remained relatively stagnant, creating the great convergence—executives made more but not much more than workers. Executives were not enthusiastic about cash bonuses because of high tax rates. Stock options were more acceptable because taxes would be deferred until the options were exercised and stock sold and then taxed as the lower capital gains rate. However, the bear market from the mid-1960s until the early 1980s made generating stock gains difficult.
The great convergence slowly began to shift in the 1970s when options could be priced using the Black-Scholes Model. The Reagan years were good for the economy and stock market and tax rates plummeted. Labor unions lost power and workers were increasingly unable to get sizable wage increases—employee benefits such as pensions often were cut. Global companies could threaten to move operations overseas and did. The great divergence was on. Once the FASB failed to require the expensing of stock options in FASB Statement No. 123 in 1995 (basically options could be awarded at zero cost on the income statement), the option explosion was on. Go-go tech companies of the 1990s issued options instead of big salaries and public companies (especially big ones) began issuing massive numbers of stock options to executives.27 After the tech crash early in the 21st century and the Sarbanes-Oxley Act of 2002, the FASB issued Statement 123R (i.e., a revised statement), requiring stock options to be expensed. Public corporations issued fewer options but more restricted stock,28 and executive compensation remained high.
The SEC required the annual disclosure of executive salaries (the specific requirement changed over the years) beginning in the mid-1930s. Initially, this probably kept salaries down out of embarrassment (and the related problem of outraged employees). At some point executives seemed to compete for outrageously high compensation relative to competing firms. Robert Goizueta, long-time CEO of Coca-Cola, became the first nonowner executive to receive over a billion dollars in total compensation over his career (1981–97). Other well-known CEOs such as Steve Jobs at Apple and Jack Welch of General Electric also were well-rewarded for great performance. On the other hand, several lucrative termination packages for execs doing a terrible job were handed out. Disney CEO Michael Eisner was fired in 1997 and got a $550 million exit package. Robert Nardelli was fired from Home Depot, taking home $210 million.29
The huge executive salaries, declining power of workers, loss of middle class jobs, plus a relatively flat (i.e., not very progressive) tax system focused attention on the growing public policy issue of income inequality. Thomas Piketty in his 2014 bestseller Capital in the Twenty-First Century emphasized this as a long-term problem that peaked, for example, just before the French Revolution in France and just before the Great Depression in the United States. As a political issue, the topic has been controversial.