1st of a Multi-Part Series
Is CEO pay back in the crosshairs of the President of the United States? One could infer such a position after President Biden’s recent visit to the United Auto Workers (UAW) strike where he jumped in the picket line alongside union workers who are striking in protest for more pay and benefits. Specifically, two items the UAW is asking for from the “Big Three” automakers (GM, Ford, Stellantis) are 40% more pay and a 4-day work week. The rallying cry the UAW is using to rationalize their demands: CEO pay. The UAW claims CEO pay of the Big Three has risen 40% in the prior 4 years, and the CEO-to-median employee pay ratio of 350x is too high. The UAW advocates CEO pay should be curbed by linking a ratio to union worker pay or median employee pay as opposed to market economics dictating pay.
It is interesting that when CEO pay ratios are brought up to curb CEO pay or raise employee pay, other market sectors are ignored. The ratio of an NFL All-Star versus the lowest paid employee in that organization is not the issue. However, the ratio is likely far greater than the CEO pay ratio. Added, when Dodd-Frank tackled this topic and required public companies to disclose the ratio in a proxy statement, no one suggested the post-service earnings for the President of the United States (typically $100mm) should be tied to the median government employee retirement benefit.
Evolution of CEO Pay Ratio
The CEO pay ratio is a debate that started with Plato. Yes, the philosopher that lived in 400 BC. His ratio: 5-to-1 (noting this was the ideal ratio was for highest paid to lowest paid). The management guru, Peter Drucker, picked up this philosophy over 2,000 years later in the 1980s and suggested 25-to-1. Ben & Jerry’s Ice Cream decided to put it into practice. The company started with an admirable 5-to-1 ratio. That theory lasted as long as Ben & Jerry were at the helm. The main source of wealth creation for Ben & Jerry came in the form of profits as owners of the business. That idealism got put to the test when it came time for the company to hire a new CEO in 1994. The result? 5-to-1 was raised to 7-to-1, then 17-to –1; with that ratio getting applied to cash compensation only (which is not how it’s calculated today per Dodd-Frank). Long-term incentive compensation, delivered in the form of stock options, was conveniently excluded from the pay ratio restriction. Finally, the CEO pay cap was dismissed altogether when the company was acquired by Unilever in 2010.
The reality here, backed by statistical and empirical evidence, is that the CEO pay ratio should not drive decision-making when establishing appropriate compensation for the role. Why? The succinct answer is it is not market driven. Trying to tie compensation for one employee group to another employee group through a synthetic ratio will almost always ignore market conditions, such as: industry-specific macroenvironments, what peer companies pay for a similar role or skillset, supply and demand tensions for a particular role or skillset, the impact of different geographies and cost of living, etc. Market conditions are in a state of constant change and this explains why CEO pay ratios vary dramatically by industry, company size, multinational footprint, global HQ, etc.
While CEO pay ratios will continue to be a PR soundbite for anyone willing to listen, they are proven to not work as a driver for determining compensation levels for companies looking to attract, retain and motivate top talent.
