How justifiable is high CEO pay in the United States?

Table of Content

Index of Abbreviations

Table of Figures

1 Introduction

2 Executive vs. Employee Compensation

3 The Wealth of CEOs

4 Trends of CEO Pay in Recent Time

5 General Issues Regarding CEO Pay

6 CEO pay in the US
6.1 US CEOs compared to German CEOs
6.2 Referendum in Switzerland

7 Discussion in the Media
7.1 Arguments for CEO Pay Being Excessive
7.2 Arguments for CEO Pay Not Being Excessive
7.3 The Public Opinion

8 Conclusion

9 References

Index of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

Table of Figures

Figure 1: CEO compensation compared to top wages and income (1947 - 2012)

Figure 2: CEO pay in regards to company size

Figure 3: CEO pay in regards to type of ownership

Figure 4: CEO pay in regards to industry

Figure 5: Trends in CEO pay (1965 - 2013)

Figure 6: Average CEO pay (2007 - 2015)

1 Introduction

The high compensation for executives and in particular for CEOs has been a topic of debate for many years. Increasing salaries and bonuses for leaders of companies have mostly been criticized and even pointed out as a key factor for a rising wealth distribution inequality.

Especially in the United States, where CEO pay is most extreme, the public as well as the media ask for new regulations and political intervention. But are these high compensations really undeserved and unfair? How much do top managers actually earn and why do businesses support it?

This academic paper will first give an overview of some important numbers and statistics in order to have an idea of how high a CEO’s income is compared to an average employee. It will also explain how to properly interpret these data and how much an executive’s income can vary depending on different factors.

After analyzing the recent history and developments in CEO pay, chapter 8 will provide the necessary economic background to help understand companies’ decisions and see high wages from a business point of view.

Although the paper will focus on CEO earnings in the US, it will give examples of differences in other countries and systems. Due to a distinct set of labor regulations, we will draw a comparison to CEO pay in Germany and furthermore illustrate the event of a political referendum in Switzerland.

Finally, we will pick on various arguments by media, the public, as well as renowned economists, listing a series of pros and cons for excessive CEO pay. An insightful survey, conducted in the US, will then close the debate and leave the reader with the final thoughts of the conclusion.

2 Executive vs. Employee Compensation

The topic of high compensation for executive managers and CEOs has been widely covered by global media and especially in the United States of America. It has not only been criticized, it also has been pointed out as one of the main reasons for the rising income inequality.^[1]

But how significant are the differences between an executive’s pay and a common worker’s pay? And who can actually call themselves an executive?

An executive may be any high-level manager within a business enterprise, e.g. a chief financial officer or a chief operations officer. However, the discussion focuses mainly on the president of a company, the so called chief executive officer (CEO). This person is running the entire company as well as leading it by making important decisions. His rank is higher than that of any other executive. Though, the CEO is not to be confused with the owner. Unlike an owner or shareholders, the CEO does not possess any equity in the company per se.

Having an executive pay usually means there are at least a few additional components other than the base salary. Those can be in the form of short-term or long-term incentive pays, an enhanced benefits package including a Supplemental Executive Retirement Plan (SERP), extras such as cars or club memberships, as well as deferred compensation earnings. One of the reasons for all these benefits and extras is minimization of tax, government rules and financial reporting. These payment plans are taking current tax laws into consideration, trying to get the greatest benefit while maintaining a certain competitive wage for the executive.^[2]

To answer the question of how big the gap between an executive’s and a worker’s pay is, it is important to look at some numbers. In 2013 the average worker in the US earned USD 35,239 throughout the year^[3], whereas the average CEO earned USD 11,664,109 – that is 331 times as much.^[4]

If we look at the federal minimum wage in 2013, a full-time worker earned only USD 15,080. That means 774 workers on minimum wage would have the same amount in earnings as one company’s CEO.

It is important to keep in mind that these calculations were made using data of 350 companies in the S&P 500 which includes only the 500 wealthiest companies in the US. So we have to consider, that, when we talk about enormously high CEO salaries, we mainly focus on a small minority of companies. CEOs of small and medium enterprises most certainly do not earn millions of dollars.

Nevertheless, taking an average of 350 CEO salaries means, there is also a number of people who earn more than his fellow CEO colleagues. And when we take a look at some specific salaries, we’ll find out the gap between average and highest is huge.

For instance, J. Michael Pearson, CEO of Valeant Pharmaceuticals International, made the top of the list for highest paid CEO in 2015. Throughout the year and including a variety of bonuses, he earned USD 143,077,442. Going further down the ranking to the third place we can see Lyndon R. Rive who is CEO of the SolarCity Corporation, getting paid ‘only’ around half that amount at a total of USD 77,318,016.^[5]

When analyzing data from different years, it has to be pointed out that the CEO pay has been significantly increased over the past years. As it has been mentioned earlier, the ratio of CEO earnings to average worker earnings in 2013 was 331:1, meaning that 331 workers earn the same amount of money within a year as one CEO (of the S&P 500 companies). Only one year later, in 2014, the ratio has increased to 373:1, meaning that one single CEO now earns the equivalent of a 373 workers’ salary.^[6]

CNBC calculated that from 2013 to 2014, the 200 highest-paid CEOs in the US received a 9.1% increase in their total compensation. At the same time, the increase in the average worker’s salary only came down to 2.2%.^[7]

When we discuss the gap between an executive and the average worker, we also have to consider the income inequality between labor force and skilled workers. Most people would agree this gap is completely fair regarding different education and qualifications. But how large can this gap be without being unfair?

In the past years, not only CEOs were able to earn more, skilled workers have increased their wages, too. Some analysts suggest, that the high demand for skills and professionals is driving the rise in CEO compensation. Other groups with high income (excluding managers) have had a similar growth in earnings. This is due to the competitive market for talents.^[8]

Figure 1: CEO compensation compared to top wages and income (1947 - 2012)

illustration not visible in this excerpt

Source: Economic Policy Institute (2014)

In order to see the development of CEO compensation ratios to the top earners and incomes, we compare data from 1947 to 2012. The diagram illustrates how much more a CEO earns in relation to the highest-earning 0.1% individuals (dark blue curve) as well as in relation to the top 0.1% household income (light blue curve).

CEO compensation in 2012 was 1.85 times higher than the top household income. The same ratio as an average of the years from 1947 to 1979 was 1.11, which means two-thirds less. CEO pay relative to the highest wage earners was 4.75 times higher in 2012, while the average ratio from 1947 to 1979 was at 3.25 (meaning in 2012 the ratio was 1.5 times higher than historically).

As CEO compensations rose again after 2012, we can expect even higher ratios today.^[9]

What we can also see from the graph is that CEO pay, in comparison to the top earners, has been relatively constant over most of the time. It only began in the 1990s when CEOs started to earn significantly more than other highly-paid individuals. Nevertheless, the income ratio decreased after the stock market shock in 2000 and again after the financial crisis in 2008. After 2009, CEO compensations, relatively to high income of other groups, seem to be on the rise once again.

3 The Wealth of CEOs

When we talk about “the CEOs”, we should be more specific. Being a CEO or having the job title doesn’t make you rich. In fact, the vast majority of CEOs works for small or mid-sized enterprises. There are 5.7 million companies all over the United States, out of which only 5,292 can be found on the NYSE^[10] or NASDAQ stock market (0.09%).^[11]

Figure 2: CEO pay in regards to company size

illustration not visible in this excerpt

Source: CEO & Senior Executive Compensation for Private Companies 2015-2016 Report

A CEO’s salary depends a lot on the size of the firm. The larger the company is, the higher is usually his income. Not only the salary increases when running a large-revenue company, the bonuses are higher as well.

Important to note about these statistics is the fact, that compensations have been measured regardless of industry, type of ownership and geography or location of the firm.

Running a public company involves higher risks and complexity than running a privately owned company of the same size. Therefore, we can observe huge pay gaps, which are even larger when we focus on big companies. The average CEO of a company, that makes USD 100 m. to USD 249.9 m. in revenue, earned around USD 524,500 in 2014, while a CEO at a public company of the same size received 2.8 times that amount.^[12]

Even the term “average CEO” can be misleading, because very few actually earn around the average amount. The top 25% of CEOs within the dataset^[13] earned 81% over the median^[14] compensation amount, although the bottom 25% of CEOs only earned as much as 57% of the median CEO.^[15] That means there are huge gaps with a lot of CEOs receiving a much smaller compensation and a significant number of CEOs receiving much more than the average amount.

Another factor that influences CEO pay is the type of ownership of the company. If we only consider this factor and leave others out (e.g. industry, geography, etc.), we get the following output:

[...]

^[1] John Cassidy (2014/03/31).

^[2] PayScale (2011/02/28).

^[3] According to the Bureau of Labor Statistics data for production and nonsupervisory workers.

^[4] 2013 CEO to average worker pay ratio calculated based on AFL-CIO (American Federation of Labor and Congress of Industrial Organizations) analysis of 350 available companies in the S&P 500.

^[5] According to the American Federation of Labor and Congress of Industrial Organizations.

^[6] Tim Mullaney (2015/05/18).

^[7] According to the unemployment report from the Labor Department.

^[8] Alyssa Davis, Lawrence Mishel (2014/06/12).

^[9] Alyssa Davis, Lawrence Mishel (2014/06/12).

^[10] The NYSE (New York Stock Exchange) is the world’s largest stock exchange by market capitalization.

^[11] Chief Executive Magazine (2015/10/19).

^[12] Chief Executive Magazine (2015/10/19).

^[13] The data contain compensation and best practices data from 1,186 private companies, with over 3,000 current CEO and executive compensation data points.

^[14] If a set of data is divided into a part with low values and one with high values, and each of these parts contain 50% of the data, then the median is the value right in the middle and between the two parts.

^[15] Chief Executive Magazine (2015/10/19).