Inequality of pay in business has become a crisis, fueled mainly by the excessive pay of CEOs. In 1965, the average ratio comparing CEO pay to the median worker’s was 20:1. Today CEOs earn more than 300 times that of a worker, or 300:1. This alarming disparity has stimulated a widespread negative reaction, as the passionate response by Millennials for Bernie Sanders has demonstrated. Even more disconcerting is evidence from studies showing that the highest-paid CEOs are often the worst performers. In short, the growing problem of inequality and extreme paychecks for CEOs has undermined the brand trust of many corporations.
This glaring divergence raises some fundamental issues: stagnation of middle class wages, whether/how our corporations can be better governed, where capitalism fits within globalization, and the risks of a deteriorating brand image of CEOs. Key to all these problematic trends is the challenge of justifying such high compensation and restoring trust in today’s management.
The 2016 Edelman Trust Barometer found that over half the population doesn’t trust business executives to do what’s right (51%), saying that CEOs focus too much on short term financial results (67%), and lobbying (57%), but not enough on job creation (49%) or the long term impact (57%). Instead, 80% of those surveyed say a CEO should be personally visible when discussing societal issues like income inequality.
The difficulties of accurately tying pay to performance cannot be understated, but recent cases of big pay increases concurrent with dismal business results cannot be ignored either. For example:
• The BP CEO (Bob Dudley) got a 20% bump in compensation in 2015 after overseeing the company’s biggest-ever operating loss.
• Marissa Mayer, CEO of Yahoo, will receive more than $100 million from the sale to Verizon, even though the value of Yahoo declined by over $2 billion.
The dubious justification of these examples of over-payment has been substantiated in recent studies. In particular an assessment of 1,500 companies with the biggest market caps by Professors from University of Utah, Purdue, and the University of Cambridge revealed that the companies run by CEOs in the top 10% of pay scale had the worst performance between 1994 and 2013: they returned 10% less to their shareholders compared to industry peers. A similar report by the research firm, MSCI, looked at 800 CEOs at 429 large and medium-sized companies between 2005 and 2014, and concluded that high CEO pay was not consistent with long-term stock performance.
This concern over excessive CEO pay and resulting inequality is not unique to America. Britain’s new Conservative prime minister, Theresa May, wants to focus on “inequality, executive pay, and trust between business and society.” Related to this position, a report by the Executive Remuneration Working Group in the UK concluded that “current levels of executive pay and its complexity lead to levels of remuneration which are difficult to justify,” and wants boards to explain why the ratio between the pay of the CEO and medial employee “is appropriate for the company.”
Trust is essential for a successful brand, so this growing inequality and the justification for these high levels of executive pay are becoming a toxic challenge, eroding the credibility and perceived integrity for CEOs and businesses on both sides of the Atlantic. Unfortunately, the fundamental conditions behind the excessive CEO pay are not easy to untangle. One of the main contributors is the chumminess between CEOs and their boards, especially from their long service together. A Wall Street Journal survey showed that long-serving directors made up a majority at 11% of the largest US companies in 2005, but this has increased to 24% today. Just 7% of the 4,500 board members of S&P 500 companies turn over every year, and only Facebook and TripAdvisor have boards with a median age below 50. Furthermore, every board wants their CEO to be paid as much as than those in comparable companies, which leads to a spiraling upward pressure for their compensation.
The complexity of measuring performance is a big issue. Setting detailed targets can encourage gaming and distorting behavior, for example. There has been widespread resistance to greater transparency and suggestions for making CEO pay more credibly contingent on company performance. In 2012, Dodd-Frank recommended a requirement that firms divulge the ratio between CEOs and median worker pay, but the SEC has yet to order this. This regulation also gave shareholders a “say on pay” vote, although less than 1% of S&P 500 firms suffered a defeat on pay last year.
Any chance for significant improvement will most likely come from investors. When things are going well, shareholders don’t care so much, but major investors are starting to resist when they suffer and executives don’t. Institutional Shareholder Services, an advisory firm, said that 86% of those advising a “no” vote on pay reflected a concern about disconnects between remuneration and performance.
It will be difficult to reduce this severe level of inequality in the short term, but the declining trust and negative impact on corporate brands and the reputation of their CEOs may trigger a positive movement, especially if/when the Millennials become a dominant force for change in our business and political systems.
