The median CEO in the United States earns 354 times the median income of the median worker.
Is this a problem?
A year ago I would have told you no.
Lately, however, with legislation passing in various countries throughout Europe giving shareholders binding say on executive pay and non-binding say on pay legislation passing throughout the U.S. I’m starting to change my mind.
1. Further, as someone who is a huge believer in the individual finding a way to maximize his earnings if he feels he is worth more, I typically get a little annoyed when I hear someone complaining about the earnings of others (CEO or otherwise). Companies should do their best to maintain pay equity within jobs (for both legal and employee engagement reasons), but the market is generally getting pretty efficient at paying for talent. The growth of social media has made it easy for recruiters to find even the most passive candidates. As such, if an employee is underpaid it isn’t difficult for him to go out into the market and get a more competitive job offer… and as the economy improves it will get easier still.I don’t care about what others make. 1 Many people do, though. And there is a lot of evidence that when income inequality reaches a certain point it can lead to social and political unrest.
I’ve talked before about why executive compensation packages are as large as they are (and why the ratio is growing). The market for executive talent is fundamentally different than the market for talent in the rest of the workforce (in the same way that the real estate market in NY City is fundamentally different than the real estate market in rural Illinois). This won’t change anytime soon for a variety of reasons, but lately I’m wondering if those reasons will be good enough for the general public.
What do you think? Are executive pay practices in the United States going to be forced to change due to social, political and cultural pressure, or will the improving economy and rising employment numbers cause this issue to fade away?
Further, as someone who is a huge believer in the individual finding a way to maximize his earnings if he feels he is worth more, I typically get a little annoyed when I hear someone complaining about the earnings of others (CEO or otherwise). Companies should do their best to maintain pay equity within jobs (for both legal and employee engagement reasons), but the market is generally getting pretty efficient at paying for talent. The growth of social media has made it easy for recruiters to find even the most passive candidates. As such, if an employee is underpaid it isn’t difficult for him to go out into the market and get a more competitive job offer… and as the economy improves it will get easier still.
I had a great conversation with a mentor/friend yesterday around (non-executive) pay disclosure. It was a good exchange of ideas, so I’m writing about it here.
My thinking on the subject is that widespread accessibility to pay information leads to more efficient markets, in the same way, increased accessibility to information improves market efficiency in any other industry.
The current relationship is as follows: An employer wants an employee for as cheaply as possible, and an employee wants to provide their service for the maximum possible rate. As such, when the two parties seek an agreement there is a give and take (i.e. negotiation).
…The thing is, in the market as currently constructed the employer has a lot more leverage than the employee because the employer has greater access to information. I don’t view this as fair or unfair – it is what it is.
With that said, this creates inefficiency in the market place. Instead of the best people working for the employers most willing to pay for (and assumingly generate the most return from) their services, they instead work for the employers who happen to offer the best extrinsic/intrinsic reward package that they know of.
Increased pay disclosure in the labor market would change this dynamic.
I think the executive pay market is a good example of pay disclosure working in the labor arena. Mostly due to government disclosure rules, CEO/CFO pay rates are widely available to anyone interested (one need only make a trip to the SEC website). As such, when a company evaluates a CEO’s compensation for fairness they benchmark against the executive’s peers.
A CEO that is paid below the median of his/her peer group has an easy argument to make for being underpaid since the data on CEO pay is accurate, available in a consistent format, and easily accessible to anyone interested in it. The question of if an employer can afford a particular CEO is a matter of supply and demand – they can pay the market rate for the talent they want or they can’t. If they can’t afford the market rate for the talent they want then1. There are certainly some real issues with the executive pay structure in the United States (specifically that all employers target p50 or higher which creates a ratchet/lake Wobegon effect), but underpay for services rendered is not one of them. If similar disclosures existed for pay philosophies/market rates, we would probably see less pay disparity, and it would largely be because pay disclosure forced employers to pay competitively for positions that they’ve historically been able to underpay for.they look for someone who will work beneath it. 1
As a huge free-market guy, I certainly respect and endorse the decision of employers (typically) not to disclose pay information (it’s in their best interest not to), but I also recognize that the lack of available wage data creates an economic environment in which the overwhelming majority of employees aren’t paid a wage in line with the value they add to their respective organizations. 2 This not only creates a market inefficiency that harms the employee, but it also damages the economy as a whole. 3
Competition is good for the market (although perhaps not for any individual company). To see this is true one must only think of how almost2. There is a great article from the Economic Policy Institute that summarizes the issue well, but in short: Employers are realizing the gains of increased productivity, but most employees’ wages have held largely flat over the past several decades. any other market outside of the labor market works:
Example: If I go into a store I can see the price of every brand of gum in that store. This doesn’t disrupt the competitive balance of the market. Companies charging higher prices compete with lower-priced gums based on quality, brand, and shelf space/positioning, etc. This same reality holds true for thousands
3. Much of this is also cultural. Employees don’t discuss salaries with one another as it is considered taboo (though this is rapidly changing). Most employers insist employees disclose their current wages before extending a competitive offer (while often refusing to disclose pay range or philosophy on their end). It’s a lopsided arrangement that heavily benefits employers.(millions?) of other products. Consumers go to gas stations and pay premiums for the products there (as opposed to going to supermarkets) because of convenience. People buy technology devices based as much on supplementary product offerings as the price of the product itself. Even in markets where there is a range/unclear market signals (like when buying a car), both parties are on relatively equal footing since a car customer can choose not to disclose the most he is willing to pay (and has dozens of easily accessible online resources that show what competitors are offering for similar vehicles, etc.). Only the labor market (and a few others) is fundamentally different here because the value of labor is such a closely held secret.
If starting tomorrow employees knew more about the value of their labor, in the short term there would probably be a rise in market turnover. Afterward, however, I think the markets would stabilize; employers would both pay more competitively *and* draw more lines in the sand (there would be fewer counter offers) I also think you would see wages as a whole rise… and employers who couldn’t compete on wages would start to compete on fringe benefits / intrinsic rewards instead.
Of course, pay disclosure on any wide scale level is unlikely to ever happen. Employers paying below p50 (and perhaps even p75) would lose far too much talent to competitors if wage info were to become widely available in the way that executive compensation is.
I will say that I think there will be a shift to the center here going forward (with employees gaining more leverage). Gen Y is much more open to sharing salaries with one another. We typically don’t share salary info internally (there is an implicit understanding that there is blowback if the employer finds out), but we share much of this info freely amongst friends outside of our organizations. Much of my social circle is in HR/Marketing/Finance, and we all know one another’s salaries (and the salaries of friends of friends in some cases as well). If someone in my peer group is unhappy with pay it isn’t hard for him/her to learn the names of 10 companies that pay better for similar work. A decade ago those same people would have just had a sneaking suspicion they were below the market average.
Between informal social networks and sites like Glassdoor / Payscale (which are getting cleaner in their data collecting methodology), employees are becoming more educated around pay. Whether that creates any leverage or not remains to be seen.
The idea that one’s perception of pay is a core component of pay satisfaction is a simple – perhaps even intuitive – concept.
If someone perceives they are being compensated at an appropriate rate then the actualities of the market are almost besides the point.
In point of fact, however, this principle is not in wide use. Companies routinely spend significant sums of money raising pay (base and at risk) to drive performance. What they should be doing is looking at how employees perceive the plan design and tinkering with it in more cost effective ways.
Anna Krasniewska Shahidi has an interesting spotlight on World at Work TV that touches on just this idea.
She goes on to expound on sales compensation best practice (individual performance incentives, team based incentives, the role of compensation1. It really is a good video (and it’s less than 7 minutes long). I’d recommend watching the whole thing. functions in administering sales comp etc. 1), but what I want to focus on are three core elements of pay perception that she says drive performance:
1. Fairness – Is effort aligned with returns?
2. Complexity – Is the plan design easy to understand?
3. Risk Component – Is the employee population / individual employee comfortable with the level of pay at risk?
If the answer to all three of these questions is yes then one is well on the way to achieving the most difficult – and important – component of effective plan design:
The sense that the employer has the employee’s best interests in mind.
If a company’s employees believe they are being taken care of, the details of the compensation plan just become a series of affirmations supporting that belief.
Or do I have it wrong?
The Dodd–Frank Wall Street Reform and Consumer Protection Act has1. I love the requirements around disclosure of pay versus performance, have mixed feelings on the clawback policy, and think the say on pay vote provision causes more problems than it solves. both positive and negative components 1, but one thing I definitely hate about the act is the pay ratio mandate.
The HR Policy Association does a fantastic job of explaining what the pay ratio mandate is, so rather than bloviate about the concept I’ll share its simple(r) explanation below:
The pay ratio provision requires publicly held companies to annually calculate the median total compensation for all employees globally, as defined under the SEC’s executive compensation disclosure rules, and disclose a ratio of the median employee’s compensation to the CEO’s compensation.
I want to point out that I get the public outrage around executive pay (although I don’t agree with it). I also want to say that contrary to the claims on many large-cap companies, I don’t think that it would be that difficult for2. To get an employee population median, a company need only pull a listing of their population’s salaries, sort by country, and do a currency conversion to USD. From there, it’s just a matter of querying the median salary from the data set. Any company with a half-decent HRIS could get a reasonable approximation of this number in under a day or so. most organizations to calculate the ratio.
Yet I am still against the pay ratio mandate for two reasons:
1. I don’t think investors really care about the number
2. The number literally doesn’t matter as it concerns the health of an organization
The 2nd point isn’t an exaggeration. In a May 23rd testimonial before a House Subcommittee, in response to an AFL-CIO claim that “[the bill to abolish the Dodd-Frank pay ratio mandate] is designed to hide material information from investors, encourage runaway CEO pay and increase economic inequality,” Center On Executive Compensation CEO Charlie Tharp pointed out that there is no correlation between company performance and the CEO Pay Ratio. Tharp drew attention to the fact that based on data on the AFL-CIO’s own website, companies it considers to be “great” have a 412.5 average pay ratio compared against a 354 average pay ratio of all S&P 500 companies.
If anything, the evidence points the other way here.
Further, CEO pay represents only a few basis points for most large-cap companies. Ergo, the cost isn’t a concern either.
The only point of the ratio at this point is to satiate a small slice of the public that is (pointlessly) upset about what executives make. In my opinion, that isn’t a good enough reason to enforce the mandate.
…With all that said, this is going to be a hot button issue for some time to come. I’d ultimately like to see the pay ratio issue put to bed so that companies (and the consultants they employ to advise around this stuff), investors, the media, and analysts can focus on more important things.
First things first: This is post number 100 1. As such, I want to thank everyone (anyone?) who has read every day since the beginning.
…With that said, today I want to write a post inspired by an interesting conversation a friend and I had late Tuesday evening. We were discussing what degrees / skills etc. have the most compensable value in the market, before eventually touching on something relatively fascinating:
In many instances a company’s compensation philosophy has a larger impact on salary than performance and skill-set(s) do.
Allow me to illustrate:
In the above bell curve graph (courtesy of salary.com), we see that the median salary for an HR Manager is roughly $88,186. No data set is perfect, but let’s assume for the purposes of this post that this is an accurate picture of the market for HRMs.
Now, let’s look at how drastically compensation philosophy can impact what the median employee in a population earns:
We took our identified median (p50 of the U.S. national average for HR Managers), and divided it by half of the range spread. This is expressed formulaically as Min=Mid/(Spread/2). Put another way, we took $88,186 and divided it by 1.25. To get the maximum, we took the minimum and multiplied it by the range (in this case 1.5).
This is expressed formulaically as: Max=Min*Spread. We can check our math here by taking (Max-Min)/Min to get the range spread (it should be 50% in this case).
For our first example, let’s assume a hypothetical widget technology company wants to target the 50th percentile of the U.S. national average salary for the midpoint of their HR Manager pay grade. Let us further assume that the company intends for the median employee in the HR Manager population to fall at the midpoint of the job’s pay range. Finally, let us assume that the pay range spread (i.e. the distance between the bottom and top of the range) is 50%.
These are all reasonable assumptions, and in line with best practice for what a company might do with its compensation plan design.
No let’s look at what happens if we hold everything else the same, but target p75 of the market as our midpoint:
Now finally, let’s look at an HR Manager working at a company targeting p10 of the market as a midpoint:
WOW! The maximum of the p10 company’s range is lower than the minimum of the p75 company’s range! This means that the lowest paid HR Manager at a company paying at p75 of the market for its midpoint (with a 50% wide range) makes more than the highest paid HR Manager working at a company paying p10 for its market midpoint (50% wide range).
Finally, as you can see above even the difference between a p50 and p75 company is substantial (nearly $14,000 at the midpoint). Put another way: In this example, an employee at a p50 company has to be in roughly the 90th percentile of wage earners within his population to earn the same amount as someone in the 50th percentile at the p75 company.
The pay for performance implications here are troubling to say the least, but they illustrate an interesting fact about pay in the marketplace: It is highly variable.
With that all said…
Closing, I want to point out that this *doesn’t* mean you’re better off finding a company with a market-leading pay philosophy and trying to get a job with them. Even if your goal is to maximize lifetime earnings, you’re ultimately probably best off sticking with the company that offers you the greatest opportunities for progression.
An HR Executive at a company targeting just p10 of the market for their midpoint is still likely to out-earn an HR Manager working at a company that3. Caveat: One should always consider the time value of money when doing these sorts of cost benefits analyses as well. If it takes 25 years to make the move from HR Manager to HR Executive at a p25 company, it’s entirely possible you’d have been better off financially having spent your career as an HR Manager at a p75 company (even if you never actually make the leap to executive).targets p90 of the market for their midpoint. 3
As a general rule the biggest jobs pay the best, so look to work at places where you have the greatest opportunity to move up.
I want to share a great video on behavior based recognition programs:
1. It’s been a long day for me, so let’s go with a video in lieu of a deep dive. I intend to write on this topic more in the near future, however, and this is a good primer.
Over the weekend I was thinking about comp structures, 1 and I designed what I think is a wonderfully ambitious compensation program.
It’s based around a “pay for points” system. The structure goes:
Midpoint = Job Points * Function Multiplier + Sweetener
The structure isn’t designed at all around the market rate for jobs (for the most part), and is instead almost entirely based on the internal valuation of work. The Function Multiplier is between 100 (Clerical) and 500 (Executive), with each function having its own specific multiplier based on its relative value to the business. The “Sweetener” is a job specific number that is added on to a job if the internal structure isn’t yielding wages competitive enough in the market to attract talent (in which case the job is market priced and the sweetener is added as a supplement to bring the job to p50).
The jobs point system works using the following criteria:
- Education / Technical skill required to do the work
- Impact the job has on the P&L (from either an earnings or cost savings standpoint)
- Human relations skills required to do the job
- Span of control
- Safety / Working conditions
The factors are weighted using the following ranges (percentage weights were assigned to each factor and then given a range starting and ending at the beginning and ending of the adjacent levels, respectively):
So if one wanted to grade an HR Manager on this structure they might get:
In the above case the midpoint for the HR Manager would be 425*150+0 = $63,750 and the salary range is +/- 20% of the midpoint
What’s wonderful about this though is that each level actually has ranges. An HR Manager could theoretically be at a midpoint of:
670*150+0 = $100,500
… If the site he or she supported was large enough.
I love this system because it recognizes that there are different levels of work within any given job while also recognizing differences in the value that various functions bring to the organization.
…Of course, this would be a nightmare to manage as it requires analyses of every job in the organization. Additionally, it has lots of subjective elements (what’s the difference between 13 points and 14 points?) and basically ignores the market (instead looking to attract talent with equity stakes – which I didn’t get into here as I’m still thinking about it).