CEO pay: Should we worry?

Published July 3, 2014 by Philip H. Umansky, Ph.D., CPA, Ph.D.

During the plast year, the political class has raised income inequality as an issue either to be embraced as a verification that the United States is not (or should not) be more socialistic, but should stay a primarily capitalistic economy. Superior skill and talent should be rewarded.

Others, however, point to a related issue: the middle class is declining with a big chasm between the upper 1 percent and the lower 99 percent, which is not favorable based upon criterion of equity. CEO pay is a subset of the broader issue of income equality.

So what are the facts related to CEO and employee pay? For 2013, the median pay of a public corporation CEO rose to more than $10 million, according to an Associated Press/Equilar pay study. This is an increase of 50 percent from the depths of the recent Great Recession in 2008 and is 257 times the pay of the average worker now, the highest to date.

One of the criticisms of CEO pay has been the need for a stronger linkage between CEO pay and performance. There have been changes regarding CEO pay, with a greater portion of compensation being in the form of shares of stock with less through stock options and cash. Obviously, the higher the stock price, the greater the compensation of the CEO, and to the extent that stock price reflects the “bottom line” financial performance of the company, there is a stronger linkage.  

As indicated above, criticism of CEO pay is primarily made on the issue of equity and less on performance, talent or productivity. The CEO pool for large public companies is small, and the skills needed to navigate the increasingly competitive business environment — marked by rapid change in such factors as technology, consumer tastes, regulatory requirements and internationalization — require a competitive compensation. In comparison to these highly sought after CEOs, many employees at the bottom of organizations have a limited ability to increase productivity just due to the nature of the job.

Americans preoccupation with inequality of wealth and income, some say class envy, is relatively new and a potent political tool for those on the left. But historically Americans compare their compensation with those within their own socioeconomic reference group or profession as opposed to their CEO. As long as the employee is doing well within his or her reference group, he or she will feel satisfied with their pay. In addition if the economic pie is growing and the employee is “keeping up,” then class envy will be less. It is the job of the CEO to make the pie grow larger for his/her company. To the extent that this occurs, and the employee progresses through increased salaries and promotional opportunities, then envy of the CEO should be lessened. 

Unfortunately, there is a significant skill divide in the United States, with CEOs in general possessing extraordinary business skills, while the public education system is not performing well in equipping workers with even rudimentary entry-level skills that would allow the employee to progress up the corporate hierarchy. According to the Bill & Melinda Gates Foundation, “Only 25 percent of public high school graduates have the skills needed to succeed academically in college, which is an important gateway to economic opportunity in the United States.”

Even if there is a significant redistribution of income, and it is given directly to low-income workers, there is not enough to go around to make an appreciable impact upon their lives and would do nothing to reduce the skill divide (unless it can be used to increase the quality of education.) CEO pay does not need to be reduced as a matter of public policy, but the skill divide does.

 Philip H. Umansky, CPA, Ph.D., is chair of the Department of Accounting and Finance at Virginia Union University in Richmond.