CEO Pay in the US: Debunking One Of The Reasons It Is So High

I have talked quite a few times in these pages and in my two books about CEO pay, especially in the US.  Why is this?  Because I believe the way it is set it is a fundamental building block for worker engagement, or a destroyer of that.  Why do I say that?  Let’s start with the basics:

–CEO pay in the United States is way, way higher than anywhere in the world, in fact it is in a world of its own.  Fortune magazine* said in November 2011 that the ratio of CEO pay to average worker had climbed to 475:1 by 2010.  Yes that is not a misprint, it is a fact.

–It has not always been so, as the chart below shows:  using data from four different sources, you can see that there has been an “arms race” since the 1960s, in which CEO pay has gone from a ratio of about 20:1, then edged up to 25:1, went sideways for a while and finally began its incredible hike up to its current level. What makes this even more amazing is that these stratospheric ratios have endured in spite of the worst recession since the Great Depression, since 2010 was officially after the recession had reached its bottom. Had the 2008-2009 Crash devastated US CEO pay and brought it down to earth closer to that of average workers, we would see it by 2010…but we do not.

–While there might be some relatively small differences between the sources of data, there is no disagreement on the over trend we see here:

–By way of comparison, European CEO pay ratios are below 20:1 in most countries and we would see riots in the streets in they went any higher, especially in the current “austerity” climate which permeates that continent.  Lets see some of those numbers, also from the Fortune article*, and quoted in our book:
Hong Kong: 44:1
Britain: 22:1
Canada: 20:1
France: 15:1
Germany: 12:1
Japan: 11:1

Are executives really worth so much less in all these countries, or are we simply paying too much in the US? Its hard to imagine all the great CEOs that exist throughout the UK and continental Europe, in Canada and Japan, being totally demotivated by their pay yet running such great organizations as they do. Having consulted very extensively in the US, as well as throughout Europe, I can say that is NOT the case. So what are the justifications for high pay? John Mackey, Co-CEO of Whole Foods, demolished these one by one in a superb piece which is well worth reading. Mackey himself sets his pay and that of his Co-CEO at a maximum of 19 times the average Whole Foods worker, and its stock is at record levels…cause and effect? Yes, its just one sign of great management. Moreover, Graef Crystal, one of my favorite people in the esoteric world of executive compensation, and now retired, devastated the argument that this high pay was simply performance-driven. In an extensive study he showed that there was in fact zero correlation between pay and company performance! Instead it was driven by size of the organization regardless of performance. No wonder US CEOs strive to grow companies in the US through acquisition (most of which fail)…it is a path to personal riches simply by increasing size!

This is a big topic and one which I have covered in our new book in a chapter about the ego and in these pages at length.  Yes I think a lot of this is ego driven. The ego HATES it when the other guy…or gal…is paid more! Cooperative and captive Boards of Directors (ones that are too dependent on the CEO for their continued presence on that Board and lucrative stock options, etc.) are also a problem.

But now comes a new piece of research by Charles M. Elson, director of the John L. Weinberg Center for Corporate Governance at the University of Delaware, and Craig K. Ferrere, one of its Edgar S. Woolard fellows, which will really throw a wrench into the cogwheels of executive comp, as we call it. The researchers have demonstrated that one of the core mechanisms for high executive pay in the US, the comparison of the CEO with a “peer group” of such talent, is essentially deeply flawed. They show that:

–the skills of CEOs usually can’t be successfully transferred from one organization to another. ““It’s a false paradox,” Mr. Elson said in an interview with the New York Times’ Gretchen Morgenson recently. “The peer group is based on the theory of transferability of talent. But we found that C.E.O. skills are very firm-specific. C.E.O.’s don’t move very often, but when they do, they’re flops.”

In other words, you have no peer group, Mr or Ms CEO, you have only yourself and while you can do quite well here, you are unlikely to do well elsewhere….or even to be invited to work elsewhere.  This decreases your value!  On the subject of being able to work elsewhere, listen to Morgenson: 

“One study, a 2011 analysis of roughly 1,800 C.E.O. successions from 1993 to 2005, found that less than 2 percent had been public-company chief executives before their new jobs. Nevertheless, the notion persists that chief executives and their skills are transferable — and that they will walk if their pay doesn’t keep rising.” 

To add insult to injury, these authors point out that peer comparisons conducted by Boards or their consultants  often use extremely successful CEOs as the benchmark while not adjusting for the performance of their own CEO against this high bar.

At this point you might be wondering how I can connect this to worker engagement: well its actually quite simple and is the reason that companies like Whole Foods and BMW control this aspect of their culture so carefully. The reason is that these management teams wish to demonstrate to their workers that everyone is in this together, that they, the executive team, are not on another planet. As I found out when interviewing BMW for the new book, the carefully crafted “personnel politics” as they call it, the desire to “stand close to the workers”, proved to be a bonanza for the company when the 2008-10 “Great Recession” eased and the company found itself with overwhelming demand for its products in Asia. The workers pitched in with unprecedented levels of overtime. At General Motors, which had had typical “supersized” pay for executives, the only “bounce back” that they could manage was one which the bankruptcy court shepherded them through, a cruel comparison to their competition in Bavaria. The same was true for Chrysler, and Ford barely escaped with its life.

Controlling executive pay is important all the time, not just in recessions, its just that recessions reveal the damage which poor management practices have created in these companies. If you want to stand in front of your workers, in good times and bad, and say “we’re all in this together” you had better make that a reality with your pay practices…or risk their private scorn and resulting lower engagement. Boards should take this into consideration, along with the fact that, no matter what they say, CEOs really don’t have many other places to go!

* Fortune Magazine, November 7th, 2011, page 28
Chart is modified from one in The High Engagement Work Culture:  Balancing ME and WE (Palgrave-Macmillan), copyright 2012 David Bowles and Cary Cooper

Image courtesy of sheelamohan / FreeDigitalPhotos.net

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