A Matter of Fairness

May 31st, 2018 by under Business and the Economy, Uncategorized. No Comments.

Each year the New York Times works with Equilar, a compensation consulting company, to identify the 200 highest paid CEOs in the U.S. (NYTimes, 5/27/2018). For the first time this year public firms are required to publish the median pay of their employees. As might be expected there is a huge mismatch between these numbers. A Walmart employee would have to work more than 1000 years at a median salary of $19,177 to earn the pay of its CEO, some $22.2 million. Live Nation’s CEO made $70.6 million last year compared to the company’s median pay of $24,406. That median employee would have to work 2,893 years to earn the CEO’s salary.

The gross disparities between CEO pay and that of other employees has been a topic for critics of business for decades. And CEO pay continues to rise despite the criticisms. Are CEOs so valuable that they should earn tens of millions of dollars a year in salary and stock options? Are there highly qualified people who would fill that role for less compensation?

What is to blame for what many people consider to be outrageous pay packages for CEOs? There are many possible causes including competition for talent, interlocking board memberships where CEOs sit on each other’s boards and compensation committees, compensation consultants, and demands from CEOs themselves.

While all of the above probably influence the run-up in pay, my candidate for villain is the board of directors, especially board members on the compensation committee. These people are the only ones who have the ability to rein in CEO compensation because the committee recommends the CEO’s pay package to the board who then approves it. Inside directors who work for the company may feel they have no choice but to approve generous compensation for their leader so it is up to the independent board members to question recommended pay.

How might a CEO reduce the chances for anyone to object to his or her compensation? A clever CEO can choose friends and associates for independent board members. The CEO can arrange for director compensation to be very generous, hundreds of thousands of dollars a year, so that a director who loses favor and is not put up for re-election incurs a substantial financial loss.

How, then, can CEO compensation be brought into line with the value the CEO represents for the company? One could try to implement rules for board members, but there is a simpler solution now that firms publish median pay: establish a range of multipliers that apply to median pay when computing CEO compensation (including stock options). For example if the range of multipliers was 300 to 500, the board at Walmart could choose pay for its CEO ranging from (200 x $19,177 to 500 x $19,177) or between approximately $3,835,000 and $9,588,500. Certainly a living wage. The numbers above are arbitrary and there are those who will object to a CEO making 200 to 500 times the median pay of workers.

Let’s have a discussion of the numbers, agree on a range, and then have the SEC recommend (require?) that CEO compensation fall with the defined range. While not popular with CEOs, I suspect there are board members who would welcome this kind of guidance. The world is not a fair place, but we should strive to improve fairness where we can.