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The problem with the growing CEO to worker compensation ratio is well known. CEO compensation has grown 940% from 1970 – 2018, surpassing 1000% from 2020 onwards. CEOs, in 2019, made 320 times more than a typical worker, on average, and it seems that this disparity would continue to rise, as this ratio increased 14% in 2019, which was 12.25% higher than the rate of inflation. (Economic Policy Institute., 2020; Economic Policy Institute, 2019).
Numerous authors from a broad spectrum of backgrounds have written about this condition and explained/expounded the insidious impact of inequality of compensation in firms. Nonetheless, while understanding problems at a granular level is beneficial, in all practicality, solutions are what amend problems and help us move forward in an improved state.
This work presents practical solutions/analysis regarding what can be done to rein in CEO salary growth/lower the CEO to worker compensation ratio, so shareholders and stakeholders are permanently relieved of this issue. A solution would also assist in elevating the morale of all employees and ensure a more equitable distribution of organizational benefits.
While defenders of high C-suit salaries argue that this ratio is high because of a globalized workforce of corporations; they argue that the costs of living of employees in, say Mexico, is different from the cost of living in San Francisco; thus, it is not an 'apples to apples comparison.' It is also argued that the burden of responsibilities and the stress that comes with it, is much higher on C-suit executives than on a typical worker whose tasks may lack complexity and ambiguity; the stress that C-suits executives have to deal with, and its emotional burden on them and their families, it is argued, must be compensated handsomely.
Effective leaders, it is argued, are in high demand, and if they are not compensated handsomely, they may be enticed by competitors, and the firm may lose effective professionals. The superior performance of stock prices of top corporations is also mentioned as evidence of the effectiveness of the top management team (TMT) and is usually brought up in this discussion. While these arguments may be logical, there are dozens of CEOs receiving salaries north of $25 million, just in the US, which equates to $100 thousand per day, for an average year with 250 working days, equaling $12,500 per hour. At the same time, the US federal minimum wage stands at $7.25 in 2021 (DOL, 2021), 99.99942% lower than $12,500 per hour.
It would, therefore, be reasonable to say that the compensation packages of some CEOs are irrationally oversized, and a solution is needed to ensure that executive compensation is rational.
What are the possible solutions to reduce the CEO to worker pay ratio?
While some circles may be hoping for new direct legislation regarding this issue from congress, it must be noted, nonetheless, that such an action is unlikely. There are too many variables, conflicting interests, and lobbyists that make legislative action on this issue improbable.
The most practical and quickest solution no. 1
The fastest solution that is compatible with rising ESG (environmental, social, and governance) concerns is the addition of a specific CEO to worker salary ratio limit imposed by the major stock listing exchanges as a listing requirement.
For example, as a requirement for listing or for maintaining listing, major stock exchanges can impose a condition on the listing corporations of a CEO to worker pay ratio ceiling; this ceiling may be different in different sectors of the economy, depending on the severity of the situation, or it can be a flat ceiling.
For example, the New York Stock Exchange (NYSE) implements a listing requirement of a CEO to worker salary ratio of, say, 250. Firms, to maintain their listing, and to be compliant with the listing requirements, would need to ensure that their CEOs salary isn't more than 250 time that of a typical worker. If a typical worker makes, say, $15 hourly, this listing requirement will ensure that the CEO isn't paid more than $3,750 an hour, ensuring a maximum salary within the limits of $7.5 million for a CEO, for 250 days with 8 working hours.
Of course, the ratio limit that is added in the regulation can be studied in-depth to decide the ceiling for the subject ratio. This method, even if it is set at a ratio of, say, 300, would ensure that the future growth rate of CEO salary, in relation to the salary of other employees, is limited; this method would also incentivize the TMT to increase the average salary in their organization, as only then would they be able to increase their own salaries; thus, ensuring an alignment of interests.
The most practical and quickest solution no. 2
The views of shareholders on the remuneration of executives are increasingly gaining importance in the eyes of regulators and companies. Say on pay is a concept that enables shareholders to vote on the matter of executive remuneration. It was first introduced in the UK in 2000. Say on pay was first seen in action in 2003 when GlaxoSmithKline's shareholders rejected the remuneration report on executive compensation. This concept spread quickly after its adoption in the UK and was included/implemented in the Dodd-Frank (2011) (Miller, 2019; Hodgson, 2009).
In a number of instances in 2018, shareholders voted against proposed compensation packages in several companies. For example, 52% of shareholders of Walt Disney voted against excessive executive remuneration packages (Retuers, 2018). Internationally, however, the effects of this concept vary; some countries have a non-binding, non-mandatory version of this system implemented, where shareholders' signal' rather than enforce (for example, Canada).
In other countries, say on pay is mandatory but not binding (France, South Africa, and the US). Shareholders are required to vote on the compensation packages in these countries; nonetheless, the board does not have to comply with the result of the vote on compensation. However, Making the result of the vote binding would significantly improve the condition of excessive executive compensation, as the opinion of the majority of shareholders would essentially govern the pecuniary packages of executives.
But as mentioned earlier, legislation on this matter is unlikely due to a wide variety of reasons. Therefore, this concept can more practically be imposed as a listing regulation by the exchanges, for rapid implementation. Moreover, such a move would significantly aid in aligning the interests of shareholders and agents as well.
Shareholder activism can also aid in remedying the problems of excessive remuneration. Shareholders or their proxies can push to include say on pay as binding in the company's bylaws, through the bylaw amendments vote. Such a move would eliminate the requirement of implementing listing regulations or legislative action. As more and more companies amend their bylaws to empower their shareholders on the matter of compensation, the pressure would build on other companies to do the same, to follow ESG best practice.
The proposed solutions are the most practical, with rapid implementation possible. However, investors, hedge fund managers, or other investment managers, may have questions regarding this issue, such as whether or not such a move would be beneficial, strictly financially.
If exorbitant CEO and executive salaries are capped, the money should go back into new projects, retained earnings, or maybe paid out as dividends; either way, those holding equity or debt of the company should benefit if the CEO salary is capped, but performance isn't impacted.
On the other hand, it is important to note that the TMT may try to raise salaries across the board so they can then increase their own salaries in a justified manner. At first, one may think that such a move would lower net profits and negatively impact the analysts' view on investment position in the subject company.
However, empirical evidence suggests that higher wages can increase productivity; hence, such a move may first appear self-serving and counterproductive, one that may cause a reduction in the operating and net profits. Nonetheless, higher wages motivate employees (increasing job satisfaction) to perform better and attract top talent from external markets (Fisman & Luca, 2018).
Therefore, even if the TMT increases salaries across the board, so they can increase their own salaries, if the increase is within the bounds of rationality, the company should benefit through increased productivity, which would, of course, appear in the companies performance indicators, increasing its credit ratings and stock price, benefiting all investors.
DOL. (2021). Minimum Wage. US DEPARTMENT OF LABOR. Retrieved from https://www.dol.gov/general/topic/wages/minimumwage#:~:text=The%20federal%20minimum%20wage%20for,of%20the%20two%20minimum%20wages.
Economic Policy Institute. (2019). CEO compensation has grown 940% since 1978. Retrieved from https://www.epi.org/publication/ceo-compensation-2018/
Economic Policy Institute. (2020). CEO compensation surged 14% in 2019 to $21.3 million. Retrieved from https://www.epi.org/publication/ceo-compensation-surged-14-in-2019-to-21-3-million-ceos-now-earn-320-times-as-much-as-a-typical-worker/
Hodgson, P. (2009). A BRIEF HISTORY OF SAY ON PAY. Ivey Business Journal. Retrieved from https://iveybusinessjournal.com/publication/a-brief-history-of-say-on-pay/
Luca, R. F. (2018). How Amazon's Higher Wages Could Increase Productivity. Harvard Business Review. Retrieved from https://hbr.org/2018/10/how-amazons-higher-wages-could-increase-productivity#:~:text=First%2C%20higher%20wages%20allow%20firms,raise%20their%20wages%20as%20well).&text=Paying%20wages%20that%20are%20above,for%20your%20existing%20employee%20base.
Miller, Rena S. (2019). The Dodd-Frank Wall Street reform and Consumer Protection Act : Title VII, derivatives. Washington DC: Library of Congress. Congressional Research Service (CRS).
Retuers. (2018). BRIEF-Disney shareholders elect 10 directors, reject executive compensation. Retuers.com. Retrieved from https://www.reuters.com/article/brief-disney-shareholders-elect-10-direc/brief-disney-shareholders-elect-10-directors-reject-executive-compensation-idINFWN1QQ0WK