Is sky-high CEO pay bad for business?

Home » Insights » Is sky-high CEO pay so bad?
Smiling businesswoman with  lots of money

The Teamsters scored a victory when shareholders at drug supplier McKesson Corp. voted against a CEO compensation plan. The effort is part of a strategy by unions fighting to stem what they see as exorbitant pay.

The AFL-CIO created an entire department dedicated to encouraging investors to vote against large CEO compensation packages. Think tanks, including the Economic Policy Institute, have released data showing CEOs make about 300 times more than the average worker.

Critics argue that bloated CEO compensation packages lead to wage stagnation for the average worker, which leads to low morale and reduced productivity.

"What we've heard when the employees see that these CEOs are getting paid exorbitant salaries and they're struggling to get by, it undermines morale because their work is not valued," Heather Slavkin Corzo, director of the AFL-CIO's Office of Investment, told Bloomberg BNA. "This makes people less excited to go to work every day."

Despite the public outcry and union opposition, new research is showing the opposite: Paying c-suite executives tens or even hundreds of millions of dollars can be a good investment in the company.

Executive talent comes at price

Some research has found higher pay of CEOs correlates with higher market value for companies, said Tharindra Ranasinghe, an Assistant Professor of Accounting and Information Assurance at the University of Maryland Business School.

He defines "market value" as a company's equity compared with its book value. He doesn't have research that proves higher company value is the direct result of CEO pay, but Ranasinghe thinks the connection is obvious.

"You get better results if you have better CEOs," Ranasinghe said. "If you want better CEOs, naturally you have a higher pay ratio."

CEOs also play the biggest role in the company and affect the largest number of people, so why wouldn't they be paid more.

Jordan Sheppard is an international consulting business designed to help companies find top c-suite executives. CEO Lou Dobrev commented: "It's so important to have the right person because they're affecting more than just employees. Appointing a CEO can affect 40,000 if you consider employees and their families. So imagine if you put the wrong CEO in place; this is a massive impact."

Merit versus manipulation

A common criticism of CEO salaries is that they aren't derived from merit. Lawrence Mishel, president of the Economic Policy Institute, told Bloomberg BNA that, more often than not, what a CEO earns is what he can pressure the company to pay him rather than what he's actually worth.

"It seems to me that CEO compensation has risen far more than the pay of the most talented Americas, far more than stock prices or the market," Mishel said.

The average CEO pay at the top 200 U.S. companies rose 39% from 2010 to 2017, according to Bloomberg data. The latest figures put the average at $17.7 million.

Public companies have been required to let shareholders weigh in on c-suite executive pay since 2011. That's when a section of the Dodd-Frank Act became effective that gives stock owners some "say on pay."

The Securities and Exchange Commission now requires companies to report what their CEO is paid in reference to the average worker at their company.

A CEO's performance is tied to stock prices in many cases. Theoretically, the more the stock value rises, the more money a company can pay a c-suite executive, Mishel said. But stock prices aren't always connected to how well a CEO performs.

Mishel added. "That makes stock prices a faulty metric to measure CEO performance and salary. If the stock market as a whole goes up, that isn't a signal that you're doing something special for your firm,"

It could be attributed to a growing economy or a burgeoning market for a particular industry.

How the sausage is made

CEO pay is set largely by the company board's compensation committee, which is in charge of narrowing down candidates for the job and eventually presenting one with an offer.

Where it can get controversial is how committees choose to create the potential CEO's compensation package, Steven Clifford was CEO of King Broadcasting Co. for five years and National Mobile Television for nine years and published a book, 'The CEO Pay Machine.'

According to Clifford, compensation committees base salary offers largely on what other c-suite executives in the job candidate's peer group are making. But the problem with relying on peer group data is often the salaries being compared are for jobs that aren't at all related.

Clifford uses a former CEO of United Health Group as an example. He said: "His peer group included American Express, Apple, Coca-Cola, General Electric, and Google. He worked for an accounting firm and a health-care company. None of those other companies would have hired him because he doesn't have the relevant experience."

Another factor pushing up CEO pay is the power of group-think within compensation committees. Typically, committees like to think their potential CEO is better than the average candidate, so he should be paid more than the average candidate.

That pushes up the pay range of each candidate's peer group, which pushes up the average pay of CEOs. "You get caught in this mathematical spiral when the peer group average keeps going up and up and up," Clifford added.

What pay means for average employees

According to AFL-CIO's Slavkin Corzo: "With CEOs making so much more than the average Joe, the gap is disheartening and may lead to lower productivity"

Ranasinghe's research found that lower morale doesn't necessarily mean lower profits for companies. Any productivity loss due to employees being exposed to their boss's pay isn't significant, according to Ranasinghe. His research suggests a talented CEO who can strategise to improve the performance of workers outweighs any negative effects of low employee morale.

"Overall, the more capable CEO aspect dominates over the morale aspect," Ranasinghe added.

Is high CEO pay even fair?

Ranasinghe also commented: "When the organisations become more complex, it seems quite natural that compensation for the top end of the organisation could become higher. A lot of this anger over the higher pay ratio is based on notions of social justice and issues like that and in our paper, we're not looking at those, we're just looking at this from an economic point of view."

But according to Clifford. pay inequality and the social justice issues that result from it are problems that hurt the economy, and eventually democracy as well.

He warned: "An economy that serves only one per cent of the country is not compatible with democracy. It's plutocracy thinly disguised as democracy. Something has to give."

And if workers can't afford to buy the products they help produce and sell, the economy stalls. Slavkin Corzo added: At a certain point, workers can't spend money they don't have, so if they're not being paid appropriately, then the economy starts to shrink because workers don't have money to spend to drive growth."

Author: Jacquie Lee: jlee1@bna.com
Editors: Peggy Aulino atmaulino@bna.com; Terence Hyland thyland@bna.com; Chris Opfer atcopfer@bna.com
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.