February 24, 2016

Sharp rise in CEO pay could be countered by pay ratios

The rate of CEO compensation has risen alarmingly quickly in recent years.

According to the High Pay Centre, CEOs at major British companies earned roughly 15 times the average employee salary in 1980. Within 20 years this had risen to a rate of 47 times, and in 2014 it rose to a staggering ratio of 183:1.

This figure is even higher in the US, with statistics from the AFL-CIO placing salaries for CEOs at S&P 500 companies at an average of 373 times the salary of the average worker – for example, $13.5m compared to $36,000.

There have been attempts to justify high pay in relation to the company’s overall performance, and the CEO’s efforts being intrinsic to this success. However, research from the Social Science Research Network does not support these claims. CEO compensation now continually outpaces company performance.

A suggested solution to curb this would be to make it mandatory for companies to publish their pay ratios. This initiative is being introduced in the US by 2017, after the Securities and Exchange Commission voted in favour of the rule last year.

Although companies in the UK are already required to disclose CEO compensation in comparison to their employees, they only need compare their pay with a select group of employees, and are not required to include significant long-term pay incentives such as shares.

Introducing pay ratios could force corporate boards to rethink excessive CEO pay and also potentially force an increase in the pay offered to lower-level employees.

Michael L. Bognanno has considered this steep rise in CEO pay in his article for IZA World of Labor. He shows that the pay-setting process is “unduly influenced by the CEO”, and the “pay of top executives has grown noticeably in relation to overall firm profitability.” To combat these issues and move CEO pay towards fairer levels he recommends measures that “enhance the transparency of compensation packages strengthen the shareholder voice on pay issues, and limit the CEO’s freedom to exercise stock options”.

Related articles:
Efficient markets, managerial power, and CEO compensation, by Michael L. Bognanno