Attacking CEO pay is misguided

(Flickr / Paul Bica)

(Flickr / Paul Bica)

A popular attack to level at successful companies these days is that of unfairness, specifically with a new measure called the “CEO-to-worker pay ratio.”

The statistic purports to compare the pay of the chief executive with that of a median worker at the same company, and in doing so, expose inequality in the name of social justice.

Though media outlets have quickly seized upon the CEO-to-worker ratio as a tool to decry growing inequality, their ire is misguided. The statistic doesn’t really tell us as much as we think, and making the data public may actually worsen the problem.

First, the CEO-to-worker pay ratio is misleading (as is common with quick, catchy statistics meant to provoke political anger).

Take the campaign catchphrase from Hillary Clinton that “the average CEO makes about 300 times what the average worker makes.” Mark Perry of the American Enterprise Institute demonstrates that this statistic includes only about 300 CEOs from large, publicly-traded companies in the S&P 500.

When the data is expanded to include all 250,000 CEOs from across the country (not just the most wealthy), the ratio is closer to 4 times (not 300). According to Perry, when all CEOs are considered, “the average worker last year saw an increase in their pay that was more than 30% greater than the increase in pay for the average US CEO.” That’s something you’ll never hear from proponents of the statistic.

There’s also doubt about whether this ratio is really relevant to purchasing decisions.

For example, research by Harvard Business School professors concluded that consumers would be more willing to buy products from a company that had a 5-to-1 pay ratio instead of 1000-to-1. But the study simply asked the subjects for their preferences – it did not measure actual buying decisions. It also assumed that consumers would know the exact pay ratios of each company while shopping.

In the real world, it’s unlikely that consumers will take the time to look up each company’s pay ratio and willingly pay more for towels, cereal, or televisions (some of the products measured by the Harvard study) in order to avoid supporting companies with a high ratio.

Tellingly, the study’s sample also included more than twice as many Democrats as Republicans. Democrats were much more likely to say that this ratio would play any role in their buying decisions.

Even if you believe that the CEO-to-worker pay ratio is too high, there’s evidence that public disclosure requirements actually make it higher. In his book Predictably Irrational, Dan Ariely argues that requiring companies to disclose the salaries of their highest paid executives actually led to drastic increases in compensation for these executives. “Rather than suppressing the executive perks, the publicity had CEOs in America comparing their pay with that of everyone else,” said Ariely. “In response, executives’ salaries skyrocketed.”

There’s also the question of authority. The Securities and Exchange Commission (SEC) recently adopted a new rule that requires companies to disclose this CEO-to-worker pay ratio every year. Leaving aside the fact that this reporting requirement will cost over $500 million a year (money that could instead be spent on creating new products and hiring more employees), should we really use the power of the SEC for a political agenda?

Thaya Knight, the associate director of financial regulation studies at the Cato Institute, wrote in the Wall Street Journal about some of the other consequences of the SEC’s new rule. Companies are unlikely to cut CEO pay in response to political pressure over a high ratio, especially when the CEOs can easily go elsewhere.

“More likely is that the company will try to goose the ratio from the other direction, by figuring out how to shed its lowest-paid employees,” said Knight. “It might lay off full-time permanent staff, and replace them with a raft of contractors and temps provided by staffing companies, which are explicitly not included in the calculation of the ratio.”

It’s okay to be upset about the discrepancy in pay between a retail CEO and a cashier. But forcing companies to publish misleading statistics that may end up hurting the lowest-paid workers is not the way to solve the problem.

Published on Opportunity Lives

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