It seems to be the season for talking about CEO pay—especially the ratio of CEO to more typical employee pay. It’s not clear why that is happening now—possibly a slow news time—but nevertheless, the topic is making headlines, with the operative questions being, why does CEO pay keep going up and does it matter what that ratio is?
When the Dodd-Frank Act was enacted in 2010, public companies started being required to report the total compensation of their CEOs and how that compares to the pay of their median employees. And, with typical government speed, the SEC translated it into a reporting requirement eight years later.
Depending on which companies one wants to look at, that ratio is now from 200 to as much as 400 times the pay of the median employee—and it has been rising rather steadily for as long as attention has been paid to it. For instance, average CEO pay in 2022 was up 7.7% in a year when the stock market was down and average employee compensation rose 4.8%. The amount of pay is, of course, staggering: Google’s CEO led the pack at $225 million, still down quite a bit from the leaders in 2021, who were earning $1 billion.
Just. For. That. Year.
The evolution of CEO pay—and ratios
The idea behind reporting the pay ratio was really to embarrass CEOs and their boards about what was perceived to be excessive and rapidly rising levels of CEO pay. What is interesting about the rise in CEO pay is that most observers date the truly explosive growth in CEO pay to another regulation introduced in 1993 that limited the tax deductibility of compensation for CEOs and the top four executives in public companies to $1 million—a figure that seems quaint today.
The result was that companies shifted the composition of pay heavily to stock that was not covered by the regulation just before the sustained stock market boom. Then, pay headed toward the heavens, where it remains today.
The question underlying the news stories is whether the public pay ratio matters. For certain, it does not seem to be providing any restraint on CEO pay. ProPublica reports evidence suggesting that pay rose faster in those companies subject to reporting the CEO ratio than in those that did not (although those companies are different in other ways as well). There is some evidence that boards shifted the components of pay to those that would receive less attention.
To back up a moment, what’s the purpose of CEO pay? Since the shareholder value goal took over, post-1980s, the idea was to get CEOs to think and act like shareholders so that they would be rewarded when share price increased. But that is an argument about the composition of pay, not the level. Am I more motivated to get $300 million than $3 million? Probably, especially if I already have $3 million. At some point, though, the money, per se, is not the motivator. It is keeping score as to how I am doing against other CEOs—measured by money.
The fundamental issue with the level of CEO pay is governance. Boards set CEO pay, and at least in the U.S., those boards in the biggest companies are heavily influenced—if not controlled—by the CEO. A majority of the biggest companies still have CEOs as chair of the board. In other words, the CEO runs the group that sets their pay, often appointing the people who do so. There is some evidence that the CEO/chair role is being split up, but an analysis by the BoardEx company finds that more of the S&P 500 companies moved to combine the two roles since 2015 than moved to separate them.
Companies and their boards always had the ability to push CEO pay way up, and it would have been even easier to do when boards were weaker. The reason they did not was because of the belief that it was not appropriate to do so—perhaps because employees would then find it hard to believe the CEO was an employee working together with them.
What has changed, however, is the general view of business: The CEO is there to be the instrument of shareholders. We know their interests are not the same as those of the employees, and employees do not see them as being in the same boat with them.
Impact of soaring CEO pay
So, does the CEO pay ratio matter to employees? I doubt it. CEO pay is already so far beyond anything they could have imagined in the past that going even higher will not matter.
Does it matter to society? Yes, it does—in part because it changes what we think is normal to pay leaders in organizations where the goal is not just to make money. In higher education, for example, 66 private university presidents now make over $1 million, as do 11 state university presidents.
And pay is not closely associated with the quality or complexity of the institution: Harvard’s president is 51st on that list, while Savannah College of Art and Design’s president is No. 1, at over $5 million. As with corporate CEOs, that “pay” figure does not count everything these leaders receive. My own university’s past president just received $23 million in deferred compensation when she retired.
See also: Why pay transparency is turning CHROs into ‘chief human financial officers’
Yes, university presidents have hard jobs, but they also represent organizations that are not about maximizing profits—and they lead faculty who are primarily committed to values other than making money. They have enormous influence and prestige in the broader society because of their roles. Why did we decide that they had to be paid bonus money to motivate them, as virtually all university presidents now are? Because that’s how CEOs are managed—so, that is how trustees think university presidents should be managed.
If you are one of those presidents, would you object to getting all that money to do something you would have done anyway?
