Stop This Madness: It's Time To End Ridiculous CEO pay!

CEOs of the world's biggest companies continue to earn more and more. Not just in absolute figures, but also in relative terms. It's one of the most embarrassing symbols of corporate greed.

In this blog post we address the why, how and what-the-hell of outrageous CEO salaries.

The problem

Recently, the Economic Policy Institute - a US based think tank - published a showing the painful inequality between CEOs and employees. Here are some of the mind-boggling findings:

• The average compensation for CEOs of the 350 largest U.S. firms was $17.2 million in 2018.
• CEOs make 278 (!) times more than typical workers. To put this in perspective: this means that on the 2nd of January, CEOs had already earned more than workers will earn during the entire year.
• CEO pay has grown 940% over the past 40 years. At the same time, worker pay has risen only 12%. Let's put that in a graph to show how fucked-up that situation is. (Tip: grab your magnifying glass to spot the worker's compensation growth):

This growing inequality is immense. The graph below (with data from the Economic Policy Institute) shows how the ratio of CEO-to-worker compensation has grown over the last 50 years. The dot-com bubble and the financial crisis brought it back down slightly, but soon after each dip it quickly regained momentum.

All of these insane amounts of CEO compensation is money that can't be spent on raising wages for workers, improving working conditions, making new investments, putting purpose more at the forefront, et cetera.

Do we really believe CEOs bring so much value that they should earn 278 times as much as the typical worker? Are their skills really so unique we should pay them ridiculous amounts? Is it really true that, if companies don't offer these sky-high paychecks, that they won't be able to attract talented people to lead their organization?

Of course not.

In fact, if you attract CEOs with such packages, apparently one of the selection criteria is greed. If these people only want to work for your company if they earn these crazy amounts, are they truly the people you would want to be in charge?

Still, many might wonder: "Aren't they just paid for their performance? If the company is doing well, shouldn't the CEO earn a lot of money as well?" There's a lot to be discussed here. Is it just the CEO and the top leaders who should be rewarded with huge sums? How about the people that are doing the actual work? You know, the people who CEOs love to call "their most important asset"?

And what about the tough times? Should CEOs suffer from under-performance of the company? Well, it doesn't seem to work like that. Facebook's CEO Mark Zuckerberg's pay increased 147.8% in 2018, while the stock fell 25%. Similarly, interim CEO Joe Ianniello received a decent $27.4 million even as the stock dropped 25.9%.

A bit of history

A prime question comes to mind when diving into this topic: how have these wacky compensation packages actually come to exist? How come we so desperately continue to increase income inequality? Here's a bit of history from Steven Clifford - a man who helped craft some of these CEO compensation packages.

In The Atlantic he states: "Through the 1970s—when the ratio of CEOs’ pay to that of the average worker was much lower, at somewhere between 20:1 and 30:1—the lodestar was “internal equity,” or how an executive’s pay compared with that of other employees in the company. A nascent industry, executive-compensation consulting, changed this." Consultants advised a switch to "external equity" - pay based on what other CEOs earned.

It happened. Steven: "Corporations adopted the standard of external equity, and CEOs got a lot richer."

Setting CEO compensation

So what does the process of setting CEO compensation look like in practice?

1. Setting up the compensation committee

First, a compensation committee is set up consisting mostly of a few members of the board and a few executives from other firms. The role of the committee is to recommend compensation packages for the CEO and a handful of senior leaders. Steven Clifford: "The company's board virtually always accepts the committee's recommendations."

2. Creating a peer group

The committee gets to work. First, they establish a peer group. This group of peers is recommended by compensation consultants. Peer groups can consist of a wide variety of peers that need not be in the same market. Steven: "For example, a health insurer might include in its peer group banks, food producers, engineering firms, and a number of other unrelated companies."

Obviously, this doesn't make any sense. The value of a CEO in one field can be highly limited in another. And many other factors are wildly different in unrelated sectors. Steven: "What does tend to unite peer groups, though, is that the companies in them usually have highly paid CEOs." Academic studies confirm this finding. Surprise, surprise.

3. Comparing compensation packages

Next on the agenda, the committee compares compensation packages with the CEOs in the peer group. Steven: "Every board I have ever sat on, or researched, benchmarked itself at the 50th, 75th, or 90th percentile, therefore targeting CEO pay at similarly exalted levels.

"Benchmarking below the 50th percentile says, We are a lousy company and don’t even aspire to be better. So in this sense all CEOs are above average: To be benchmarked at or above the 50th percentile, they need not do anything other than report to a board that considers its own company exceptional.

This sets in motion a vicious cycle of ever-increasing compensation. The CEO that's benchmarked above the median influences the peer group. Other CEOs in the peer group benefit from this as the pay in the peer group increases. In turn, their pay rise creates once again a higher baseline.

4. Pay for performance

As if this isn't enough, we've only talked about setting base compensation, so far. Mostly, the better the CEO performs the more he/she gets paid. It's up to the compensation committee to find a way to measure performance.

Steven: "This process usually involves negotiating with the CEO, much to his advantage: The board wants to keep the CEO happy since they are the captain of the team and since they holds the implicit threat of moving to another company for better pay. Enhancing these negotiations from the CEO’s standpoint, they pocket what they get, while the directors are paying not with their own money but the shareholders’."

What makes the pay-for-performance even more shady is the fact that it's often based on malleable metrics. For example, some companies use earnings per share as a metric for determining CEO performance compensation. Steven: "Using a few accounting tricks, CEOs can make EPS do their bidding. The stock may be down, the competition dominating the market, but the CEOs still get their bonus if they hit the EPS target."

Break with tradition

All in all, it's easy to spot the silliness of this process. At the same time it gives a good indication of why CEO pay has - over decades - gone through the roof.

Obviously, this begs important questions: What are other ways of going about this? Is there a way to influence this foolish practice? How can companies break with these absurd compensation packages?

Any suggestions? Share your thoughts in the comments below.