‘Excessive CEO Salaries’: Unravelling the Complexity of Executive Compensation and Regulatory Reform

By many measures, we live in a world plagued by heightened economic inequality that is accelerating to unsustainable levels. The share of wealth between the world’s richest and the world’s poorest continues to grow, to the point now, that just eight men have the same wealth as the world’s poorest 50 percent. All eight share common bonds too, as CEOs of the companies that made them so profoundly rich.

The Oxfam report highlighting this ‘eight men’ statistic shared similar stories of astounding CEO wealth. It described how CEOs of FTSE-100 companies earn as much annually as 10,000 garment factory workers in Bangladesh, and how the CEO of India’s top information technology services firm makes 416 times the median salary of his employees. Due in part, to such headline-grabbing statistics, the world’s richest are finding themselves under increased scrutiny, and executive compensation is a prime target in this regard. One result is mounting public pressure for policy changes to address this ‘excess’.

Do such statistics actually help us?

Dr Alex Edmans, a Professor of Finance at the London Business School, has pushed back against ratio-based arguments. He claims they are misrepresentative and can lead us astray, undermining the good intentions promoting their use. In a recent article for the Harvard Business Review, Edmans mounted a convincing argument against salary comparisons, or ratios, like those seen in Oxfam’s report.

For one, a CEO and a janitor operate in different markets, so linking their pay is questionable; like comparing a solo singer to a bassist when the two are importantly different. Similarly, the scale of markets has grown – undoubtedly helped by globalisation – dramatically increasing the scale of influence a CEO wields. A CEO today can create more value than one could a decade ago, while a janitor’s influence remained roughly similar. This is reflected proportionally in today’s salaries, and the widened gap between them. The same is true, for example, of modern superstar athletes who benefit from significant increases in the sports entertainment market and enjoy corresponding salary increases.

Another issue is that of unintended consequences. By focusing on ratios, we incorporate assumptions that certain numbers would be acceptable or even desirable. This is dangerous because it encourages manipulation of the statistics more than it does actual change – the former usually being much easier than the latter. We have seen this story before in many contexts: A focus on short-term earnings targets or stock price gains incentivises ‘quarterly capitalism’. This typically worsens the lives of average workers while richly rewarding CEOs, a situation where ‘excess’ is a thoroughly deserved descriptor of their compensation. The phenomenon shouldn’t be unfamiliar: In education, a focus on student test scores incentivises teachers to cheat or ‘teach the test’. In law enforcement, arrest rate quotas produced terrible outcomes (does anyone remember HBO’s The Wire?).

In this same way, a focus on pay ratios alone could result in the outsourcing of low-paid jobs, a shift toward part-time over full-time employment, accelerated investment in automation rather than labour, and a slashing of benefits to increase base salaries. These are all poor outcomes for workers, yet ones which would achieve some hypothetical target ratio. Edman et al’s past work showcases 80 years of such backfires in regulatory approaches to executive compensation, proving the necessity of holistic solutions and highlighting the danger in facile scapegoating and silver-bullet fixes; precisely the sort of thing abundant in Facebook memes and the like. Edman suggests we focus on raising everyone else’s pay, and not reducing that of executives – on growing the pie instead of obsessing over how much we all get. Oxfam appears to share this argument, in a way, by choosing to move well beyond any singular focus or method of combating poverty and inequality.  

I would argue, however, that this same ‘growing the pie’ mentality, with its focus on value creation, could equally lead us astray. Overall economic growth in America, the world’s largest economy, has not been shared equally for some time. In an alarming graph, American economist Pavlina Tcherneva shows just how poorly the bottom 90 percent of Americans have fared, despite immense value-creation occurring since the 1980s. This is the same type of value creation Edmans speaks so highly of and holds aloft as an aspirational mindset.  

Distribution of average income growth in the US over the last 65 years.

If value-creation has occurred, then why have the bottom 90 percent of Americans not only seen their share of that pie shrink but also turn negative, all while the top 10 percent laps up those ever-increasing gains?

Explaining why and how this occurred is a complex issue well beyond my abilities. I don’t study economics, so I’ll spare you the second-rate analysis, but some driving forces are relatively easily understood. As Oxfam points out, wealth begets further wealth. The rich are freer to invest, whereas the poor spend all or the majority of their wealth on daily living expenses. The rich can afford better investment advice, and better tax advice too, and on it goes. Equally, that money can influence the policy-making process, creating environments that favour further wealth accumulation.  

With these things in mind, it’s clear that there is more for CEOs to do in tackling economic inequality than just growing the pie. Equally, it is evident there is more to do in addressing economic inequality than targeting CEOs. They are a deserved point of concern, since wealth accumulation is self-perpetuating, and significantly accelerating, but there are more wealthy people than just high-profile CEOs. We must realise that the picture is complicated and that singular focal points for legislation and reform can backfire, as they have in the past.

Ultimately, there is more common ground between Edman and Oxfam than this article might suggest. They both believe in addressing economic inequality, and both advocate for evidence-based approaches. Both sides, for example, agree that a return of progressive taxation targeting all wealthy people – and not just high-profile CEOs – would be a good start.  

So perhaps the issue isn’t one of ‘excessive CEO salaries’, after all, but of excessive salaries in general? A conversation for another article, and hopefully with brighter economic minds leading it than mine!

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