The gap between pay for U.S. chief executive officers and the people who work for them has widened six-fold in three decades. Do bosses work six times as hard these days, or have they gotten smarter or scarcer? Company boards seem to think it’s all of the above. They say large pay packages stem from fierce competition for talented managers capable of leading global organizations, and that pay is closely tied to performance. Critics argue that executives get rich at the expense of shareholders and other workers, abetted by pliant directors who Warren Buffett has called less “Doberman” than “Chihuahua.”
Starting this year, publicly traded U.S. companies must calculate how their CEO’s compensation compares with the median pay of all employees. The 2010 Dodd-Frank Act requires companies to disclose such pay ratios in regulatory filings. Prime Minister Theresa May is proposing similar disclosure rules for British bosses, even though remuneration for CEOs at large, publicly traded U.K. companies declined 17 percent in 2016. A German lawmaker in the European Parliament is also seeking to force banks in the EU to disclose a pay ratio. It’s all part of national efforts to tackle income inequality. A 2014 global survey showed people in many countries think pay gaps are smaller than they really are. U.S. respondents to the survey thought the ratio of CEO to average worker pay was 30-to-1. In reality, leaders of S&P 500 companies made about 347 times more than their employees in 2016, up from 41-to-1 in 1983, according to the AFL-CIO labor union. Pay for many Americans, meanwhile, has barely moved for decades. The Dodd-Frank law also requires companies to let shareholders approve or reject executive-pay policies. While these say-on-pay results aren’t binding, as they are in Switzerland, the vote itself has given investors a way to grab boards’ attention and publicly express discontent. Sometimes that prompts companies to change pay plans, since poor results can draw the attention of activist investors and embarrass directors. Still, a vast majority of corporations win these votes with flying colors.
Two key developments explain why executive compensation has risen astronomically in recent decades: the shift from cash to equity awards and the ability of CEOs to easily compare pay packages. Starting in the 1980s, many companies began favoring stock options over cash for executives, in part because they could be granted for free (that changed in 2006). Relentlessly rising equity prices made such awards balloon in value. At the same time, compensation consultants began helping executives compare their remuneration with their peers’. That put pressure on boards to be generous — and to use compensation to signal that their handpicked CEO is above average. Critics say this has caused a perpetual ratcheting-up effect, especially if directors cherry-pick highly paid CEOs at other companies as their benchmarks. Curbing perennial increases has proved difficult and even counter-productive. Since the financial crisis, mutual funds and other institutional investors have pushed boards to eliminate some of the most egregious compensation practices, such as guaranteed bonuses and country club memberships, and establish stronger links between pay and performance.
Almost everything about executive compensation is a hot topic of debate, including when a pay package goes from reasonable to excessive. There is a consensus that pay should be tied to corporate performance, but investors, executives and directors often spat over how to best measure performance. Stock return, the most commonly used metric, has been criticized for rewarding managers for market swings they can’t control and for spurring short-term financial engineering, such as share buybacks, at the cost of long-term investments. Some institutional shareholders say measurements such as carbon emissions, worker safety and sustainability should help determine executive pay. Opinions diverge on whether high compensation causes, or is merely a result of, improved stock performance. Some question the link between pay and share prices altogether, arguing that maximizing shareholder value shouldn’t be managers’ top priority. One former CEO thinks the U.S. professional baseball league offers the solution to soaring executive pay: Slap a luxury tax on anything over $6 million.
The Reference Shelf
- A Bloomberg QuickTake explainer on why companies don't want to disclose CEO-to-worker pay ratios
- A Bloomberg News article says America's highest-paid female executives lead technology companies.
- The AFL-CIO tracks corporate compensation at its Executive Paywatch website.
- William Lazonick, an economist, criticized pay-boosting stock buybacks in a 2014 Harvard Business Review article.
- The world's largest sovereign wealth fund weighed in on executive compensation.
- Steven Clifford, a former tech CEO, said pay for performance has become a scheme to transfer wealth from investors to insiders.
First published March 25, 2015
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Paula Dwyer at firstname.lastname@example.org