Unionization and Jobs/Wages in Today's Economy

Evan Soltas’ blog posts and chart, following his Bloomberg View article ("Is the U.S. Better Off Without Unions?"), are quite interesting and worth reading. I tend to agree with his observations on why unionization has declined in the US (and apparently other developed countries) in the second half of the 20th century and I also question the focus on unions as a key method of addressing unemployment and wage pressure challenges faced by US workers. However, I am not convinced that Soltas' ideas to address the issue are that effective. So, I'd like to offer a different perspective on this subject given my background as an executive in the Silicon Valley tech industry. This perspective focuses on the after-effects of stock-based compensation on various macro factors.

First, some context. In Silicon Valley, tech labor has tended to be non-unionized for quite some time. Additionally, over the last two decades, I've seen software design, hardware manufacturing, hardware design and other functions move outside of the US (I have also been in positions where I have moved certain jobs overseas). The reasons are simple. There are qualified workers who can do these jobs outside the US, typically at a much lower cost. Moreover, when a company's competitors move jobs or are located overseas in cheaper labor markets, for financially competitive reasons the company ends up having to do the same. Additionally, some of the larger tech companies that sell directly in non-US end markets need workers in those regions. Despite this trend, and despite many tech jobs being non-unionized, Silicon Valley has managed to maintain a decent jobs picture (example) for well-paid employees - I think primarily because US tech companies continue to be at the forefront of driving significant innovation where more experienced US workers have an advantage over workers is job markets outside the US. My experience suggests that at least in Tech, where workers tend to be paid relatively well because of their skills, unionization has not been a significant factor in driving employment or wage trends. I can’t extrapolate from this to infer that the tech experience should be applied to every other industry but it is suggestive that we need to look for deeper explanations for increases in income inequality and decline in unionization in the US and other economies.

Second, my view is that most of discussions I have seen regarding “full” employment, rising income inequality, decline in unions, etc. are missing a more fundamental factor that is a common thread across all of these challenges. That factor is simply that CEO performance gets measured by how much they increase earnings per share (EPS) and stock prices. EPS maximization requires one or more of the following:

• Increase revenues strongly if expenses cannot be reduced – this gets to be a particular challenge when GDP/economic growth is at best modest and worse, negative
• Reduce expenses – labor or non-labor, including capital expenditures
• Share your profits via dividends – this makes it more difficult to use profits for ongoing re-investment, but is more palatable for CEOs because re-investment increases operating expenses / costs in the earnings statement
• Use profits to buy back shares – which reduces the denominator in “EPS” thereby possibly boosting share prices and also avoids the issue of increasing operating expenses /costs via re-investment of cash

Some of the above pressures to reduce costs are made worse by the increasing presence of large competitors to US companies that operate in lower cost countries – which makes it difficult for even well-intentioned American CEOs who might be concerned about US job losses, to argue for a greater US workforce presence with their Boards or shareholders. I briefly mentioned some of these challenges in a post in 2010 after a discussion with President Bill Clinton at the Clinton Global Initiative that year.

The use of EPS and share prices to measure CEO performance – and the treatment of certain types of stock-based compensation as capital gains rather than regular income - has several understandable consequences. For instance, it encourages even well-intentioned CEOs to:

• Continually focus on expense reduction by reducing expensive jobs (either through layoffs or through migration of jobs to other lower labor cost geographies – see JPM charts) and/or reducing capital investment (see Robin Harding in the FT) - this can lead to reduced jobs in the US and the lack of any real bargaining power for US employees or unions given it is increasingly very easy to do a significant chunk of even complex work overseas
• Use profits, and sometimes take on debt, to buy back shares to reduce EPS dilution - this can exacerbate the trend towards lower investment (see JPM analysis)
• Ensure they are well rewarded through stock based compensation considering their performance is after all measured by stock price and EPS typically above everything else - such gains can be quite large in many cases (widening pre-tax income inequality) and some of this compensation is taxed at the capital gains rate (which could increase post-tax income inequality)
• Use cash for dividends over investment (see Economist/Andrew Smithers) - in general dividends are a reasonable way to provide income to shareholders, but they do come at the cost of reinvestment that can create more jobs

The use of share prices and EPS as the primary performance metrics to evaluate CEOs also has other consequences such as a tendency to reduce expenses in areas not considered to be legal obligations of CEOs – one such example is sustainability (as exemplified in the recent demand to Apple CEO Tim Cook and his admirable response). Note that in highlighting the above consequences, I do not blame CEOs for doing what they do. In most cases, I believe they are responding to an incentive structure that generally requires them to do one or more of these things. Naturally, the above trends get exacerbated in recessions and when revenue growth is challenged because of modest to weak economic growth.

Third, as Cornell University’s Lynn Stout has discussed quite compellingly in her must-read book “The Myth of Shareholder Value”, the notion that corporations must be run by CEOs or Boards in a manner that always maximizes share prices – usually at the expense of many other things – is not a premise that has any meaningful legal basis nor is it one that is required per corporate statutes. She argued this well in her American Enterprise Institute debate with Jonathan Macey of the Yale Law School. Note that in citing her work, I am not arguing that corporations do not have a right to run according to the rules they choose – one of which could certainly be to maximize share prices – but only that a focus on this above many other aspects tend to not be in the long-term interest of the corporation or many of its stakeholders (I’ve discussed some elements of this in my comments on a Q&A with President Bill Clinton at the 2011 CGI). To further clarify, I am not recommending we eliminate or get rid of stock-based compensation. I have seen many rank-and-file employees in the tech sector benefiting from stock based compensation. [Disclosure: I have also personally benefited from this – even when I was not an executive. For example, it was instrumental in allowing me to buy my first home when I was an engineer.] I’m only saying that how and when we award stock-based compensation needs a re-look.

In conclusion, my view is merely that any solution to income inequality or unemployment or real wage pressures must start by looking at the incentive model for CEOs of businesses. Even if a CEO wants to do the right thing for US employees and workers, the fact that he or she will receive a performance review based on the company’s EPS and stock price appreciation is a factor that is not really in their control for most CEOs. Focusing on unions is in my view is a much less effective way to address the root cause of the challenges we are dealing with in the US – to me, unionization is a band-aid to address the symptoms, and one that is increasingly ineffective with today’s significant global capital and labor mobility. To be clear, I don’t have anything against unions – I just don’t see them being very effective in dealing with today's business realities. I also welcome discussions on other ideas – such as those around creating full employment – but I fear that we will continue to focus on band-aids and Government support if we don't take a deeper look at this issue. I personally think there are some CEOs who might actually welcome this debate given how a focus on EPS and stock price can tie their hands and prevent them from investing in new innovations that might carry a longer-term high-risk, high-reward profile – the kind of profile that keeps US tech at the forefront of the world and enables companies ranging from Amazon to Tesla.