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Commentary: Pay Gap Between Workers and CEOs Should Change

Aug 28, 2012

What’s the value of a typical worker’s contribution to a company’s success compared to that of CEOs of the largest companies? The CEO’s contribution is about 380 times more valuable, according to the AFL-CIO’s 2012 annual report on pay disparity.

380 times more valuable! Not only it is more valuable, but its value rises faster than inflation. Last year CEO pay rose 14% to nearly $13 million. What was your pay raise last year?

CEOs have a great deal of serious responsibilities including accountability for a company’s success or failure. CEOs have vice presidents and other officers who help them with oversight of business operations. But ultimately, the buck stops with the CEO. CEOs deserve to get paid a great deal. However, you would think that the pay would be tied to the company’s long term performance. It’s not necessarily.

How, you may ask, is CEO pay calculated?

In the largest companies, the Board of Directors and the CEOs choose the members of a compensation committee to figure out CEO pay. Since the members of the compensation committee are usually CEOs themselves, they have an interest in keeping pay high. CEOs don’t want to upset their colleagues and don’t want to be viewed as mediocre. So, according to Warren Buffet, a man who has a reputation for being a fair CEO, during the compensation committee meetings, “Too often, collegiality trumped independence.” So I ask you, when was the last time you were able to vote or decide what your pay (or pay raise) would be?

To add insult to injury, CEO pay is not based on performance. CEO pay rises even though company performance has been average, or worse. Many boards use a formula that calculates compensation—they set their own CEO’s pay so that it fits within the top 25% of CEOs. Setting high pay for CEOs differs from setting high pay for athletes and performers.

Athletes’ pay is negotiated based on performance and evaluation of net return on investment. Some athletes supplement their pay through product endorsements negotiated based on the anticipated impact of the endorsement on product sales. Actors, actresses and musicians’ pay is based on historical and expected returns from ticket or music sales. Not so with CEOs.

Note that leaders and other business executives claim that high CEO pay is essential to attract and keep the best CEOs. The argument is that these CEOs create jobs for workers and profits for shareholders. This argument is not borne out by statistics. According to MIT economist Gabaix and NYU economist Landier, the differences in performance of the top executives is less than 2%.

How does this pay gap affect employees?

According to Peter Drucker, who many call the father of modern management theory, CEO pay of more than 20 to 25 times the average workers’ pay reflected poor leadership—leadership founded on privilege rather than responsibility. According to studies, wide pay gaps can create resentment, affect employee morale, productivity and turnover.

Solutions? I strongly support the Dodd Frank Act’s requirement that the Securities and Exchange Commission adopt a rule that requires companies to close the gap between the median pay of company employees and that of the CEOs. If Whole Foods and Costco can do it, so can others.

The views expressed on The Moral Is are those of the author and do not necessarily represent the views of Valley Public Radio.