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Should CEO Executive Pay be Capped?
Philip Kotler
Suppose you work for Amazon and you are at the median pay level of $33,000. You just learned that Andy Jassy, Amazon’s CEO, had a take home pay in 2021 of $212 million that he can cash in over the next decade.[i] This CEO pay ratio is 6,424:1(212,000/33,000). How do you feel?
Is Amazon paying it’s CEO too much? You may remember reading that Peter Drucker, the “father of modern management,” stated in 1965 that a reasonable CEO pay ratio is 20:1. In this case, Andy Jassy, Amazon’s chief executive, is vastly overpaid. It is even worse if we calculated the CEO pay ratio to the lowest full-time paid worker in Amazon. The CEO pay ratio to the lowest paid Amazon worker would be considerably higher than 6,424:1.
Consider that the CEO has a free apartment, the company pays for his golf games, and he has a chauffeur who drives him to work. The Amazon CEO pay ratio is even much higher than 6,424:1.
Also consider that when the CEO gets a very high pay, the other senior officers also receive high pay. The Financial Vice President might be paid at the level of 2/3 of the CEO’s pay. The other Vice Presidents are also paid handsomely. This places a huge burden on U.S. firms competing with foreign firms in that the foreign firms have much lower executive costs and can compete with a lower price.
What is the Normal CEO Pay Ratio?
In 2010, Congress passed the Dodd-Frank bill requiring companies to publish in their annual report the ratio between the pay of their CEO and the median pay of the company’s workers. Dodd and Frank wanted the American public to be reminded annually of the high pay going to top management. The public could see which companies and industries pay the most to their CEOs.
Many Republican members of Congress were unhappy with the passage of Dodd-Frank legislation. They fought to delay its implementation. Finally, in 2018, U.S. companies begin to report their CEO pay ratios. On average, U.S. companies were paying about 300:1 to their CEO.[ii] Some CEOs took home less than 300 times the median worker pay in their firm. On the other hand, other CEOs took home a much higher pay ratio than 300:1. Fran Horowitz, CEO of Aberchrombie & Fitch, had a CEO pay ratio of 3283:1.
American Opinion on CEO Pay
In 2009, a study reported that 59% of the American public said they would support a bill that capped CEO pay.[iii] Then in April 5, 2018, the Gallup Poll reported that 47% of Americans favored having the government limit executive pay. So support of capping CEO pay dropped to 47% but is still significant.[iv] In both cases, a large block of Americans believe that the government should take steps to limit the pay of executives at major companies. Here are the questions companies need to ask:
· How do our customers feel about high CEO pay? Do they know about it or care? Are some of our customers leaving us because of our high CEO pay?
· How do our employees feel about high CEO pay? Are they complaining or working less hard? Are they favoring organizing a union as a result? If they have a union, is the union actively pressing to keep CEO pay down during contract negotiations?
· How do our stockholders feel about high CEO pay? Do they know or care? Do they think that our high pay has produced our superior competitive performance?
· How does the Federal Government feel about high CEO pay? Are some government agencies discriminating against companies who have a high CEO pay ratio?
How is CEO Pay Determined
Let’s start with the Board of Directors who must decide on the pay to offer a new CEO. The Board spells out what skills and responsibilities it wants in its new CEO. The Board then chooses a search firm that will identify leading experienced candidates for this job. The search firm finds a few candidates for the Board to consider. Some Board members arrange to meet a few of the best candidates to see how they would answer important questions. By this time, the Board pretty much knows who it wants to hire. The question is: What pay terms to offer the preferred candidate?
The preferred candidate knows what the company paid to its previous CEOs in terms of cash, stock, and options. He or she doesn’t want less and will actually want more. The search company will explain to the Board that CEO pay has been rising steadily and that this isn’t the time to lose a promising candidate. The Board members want the search to be over and often agree to what the candidate wants. In this way, CEO pay rates are moving up an escalator with no limit in sight.
Is the High Pay of CEOs producing the intended results?
Companies need to rethink their pay level and components as to whether they produce the desired results. There are two concerns.
The first concern is whether the companies that pay the higher CEO pay ratios are outperforming their competitors. The shareholder advocacy group, As You Sow, has produced an annual list since 2015 of “The 100 Most Overpaid CEOs” by correlating data on CEO pay with figures on total shareholder returns. Their finding: “According to this correlation, companies with the most overpaid CEOs have consistently fared worse financially than the average S&P 500 company. The cumulative underperformance was 20 percentage points.”[v]
The second concern is whether tying CEO pay largely to stock price improvements results in largely short term performance. The CEO will do everything to get the stock price higher (including reducing R&D, ignore climate change, etc.) and hope to make up for it later. But this behavior can seriously hurt long term performance. Some critics think that stock price performance should not be included or given less weight in judging the CEO’s performance.
The third concern is whether the compensation plan is sufficiently tied to rewarding CEOs for practicing sustainability and meeting ESG (Economic, Social and Governance) goals. There is evidence that some pay packages pay little or no attention to social issues and other pay packages may overdo it and end us hurting current performance.
What Can be Done to Lower the High CEO Pay Ratio?
Different proposals have been made for stopping this rising pay escalator.
· Congress could pass a new law that the CEO pay ratio cannot be higher than 100:1 median worker pay in their company. Congress would describe why a pay of 100:1 is generous, adequate and reasonable in relation to CEO pay levels of other industrial countries.
· Congress could ask U.S. government agencies not to buy products and services from companies whose CEO pay ratio exceeds the 100:1. In the past, the Department of the Treasury limited executive pay at companies that were receiving federal stimulus money. The Obama administration also sought more oversight of pay for top executives at publicly traded companies. The United Kingdom, Switzerland and a few other nations have considered this approach.
· Congress could make it easier for workers to organize a union. Unions have substantially declined since the 1960s as businesses keep opposing their organizing. Today bitter unionization campaigns are fought at Starbucks, Amazon, Apple, Lowe, and elsewhere. A key union message to rally union support is to complain about the company’s overly high CEO pay ratio. If the union gets established, one of union’s pressures will be to reduce the CEO pay ratio.
· Congress can encourage more widespread public knowledge of high CEO pay ratios and encourage consumers to buy less or avoid buying from companies with high CEO pay ratios. If enough customers switch away from high paying CEO companies, this will bring down the CEO pay levels.
· Congress can encourage more companies to issue stock to their employees so that the employees also gain when the stock price improves.
· Congress might fight high CEO pay by raising its tax rates on income and wealth. Today the maximum income tax bracket rate is 37%, Congress needs to add several more brackets with a rising progressive tax rate. Someone earning $1 million a year and someone earning $5 million a year should not both pay a tax rate of 37%. The person who takes home $5 million instead of $1 million should be paying a higher tax rate than 37%.
Will There Be Enough Qualified CEOs if the CEO pay ratio is lowered?
If Congress passes the 100:1 CEO cap on pay, many experienced CEO’s will quit CEO positions. This cap means that these companies can’t hire their first choices. The good news is that this will open up CEO positions to younger men and women who are eager to achieve company sales and profit goals without needing an extreme level of pay. One can expect more fresh thinking to occur about the future of the company and its fairness in sharing productivity gains equitably with all the stakeholders.
Conclusion
Many Americans believe that CEOs are overpaid. The percentage tends to increase during down periods in the economy or when Democrats are in power. As the gap between the earnings of CEOs and other rich Americans and the average pay of workers widens, the issue of pay equity will grow more intense. When the nation’s productivity grows, why should most of the gain go to the rich rather than be shared with the working class. Shouldn’t companies encourage their workers to buy stock in their company on special terms so that the workers get rewarded in good times not only in higher wages but also in stock price improvement. We listed several possible solutions to bringing down the high CEO pay ratio. It is time for more companies to reexamine their assumptions about what makes a generous and acceptable pay package for their CEOs.
[i] See Sarah Murray, “How to pay executives in the age of stakeholders,” Financial Times, December 15, 2002.
[ii] The CEO pay ratio is probably more than 300:1. According to the Economic Policy Institute, whose calculations include estimates of the worth of granted shares when cashed in, the average CEO in the top 350 US public companies by revenue earned 399 times more than a median employee,
[iii] See Frank Newport, “Americans Split on Government Action to Limit Executive Pay,” April 5, 2018, Politics.
[iv] Ibid.
[v] Op.cit, Sarah Murray.
