Why CEO Pay Grows Faster than Worker Pay

by JT McGee

Everyone knows the most important executive at any company is the CEO, or Chief Executive Officer. Most everyone would agree that CEOs do put in a significant amount of thought and time into making a company more productive, and that their work should be rewarded with pay—a salary.

What many find egregious, though, is the rate of change in CEO pay vs. other worker. The Economic Policy Institute produced a chart of CEO pay vs. worker pay and found that CEO compensation is on a completely different trajectory than that of the average worker:

CEO pay vs. average worker ratio grows considerably from 1965-2000

Some suggest that an upward sloping trend in average CEO pay vs worker pay indicates a difference in classes. American CEOs are supposedly getting fat on productivity increases even as the pay of the average worker inflates slowly. If a firm increases its productivity per worker then it does bring in more cash per employee. It could then afford to pay more to each employee.

But that doesn’t necessarily mean that businesses have the responsibility to pay employees more, just merely that businesses COULD pay more if they so desired.

I don’t want to reduce the argument to one of principle, so “could” and “should” are, in this case, words I’d prefer leave out. Much can be said about corporate responsibility, and this post is lengthy already.

Why the CEO Pay Ratio is Skewed

Whereas an employee may increase his or her own productivity by 10%, thus netting 10% more output for the firm, a CEOs decision-making affects everyone.

This can be made analogous to the examples in my post about Wall Street brain drain. A young, Ivy League-educated physics master might earn $200,000 working for a technology firm to make one product, as he or she produces only $250,000 in productivity at the tech firm.

However, the same person working for a Wall Street bank may design a new insurance product for the entirety of the technology industry, thus allowing his or her work to scale. On Wall Street, the physicist is paid significantly more, because he or she produces more output. Million-dollar salaries and bonuses are a normal occurrence.

Naturally, the CEO produces more in output than an individual worker. One awesome worker who increases productivity by 10% for his or herself generates maybe $10,000 per year in additional productivity. One CEO who produces 10% more output for the entirety of the firm, however, may produce tens of millions (even billions) of dollars in additional profits.

Average CEO Pay in 2010 vs. 2020

The Telegraph published an article about a study which sought to project CEO pay vs. worker pay into the future. This chart summarizes the future for CEO pay vs. worker pay exceptionally well:

The CEO pay ratio grows to more than 200x worker pay in 2020

It’s very easy to look at the chart and conclude that, in a vacuum, CEO pay is growing too quickly. Naturally, a rise from a ratio of 145:1 in 2010 to 214:1 in 2020 does seem exponential, if not meteoric. A simple linear regression analysis would tell us that in order for CEO pay to grow 47% faster than worker pay over 10 years, the CEO’s pay would have to increase at a rate roughly 4% faster per year.

The word “fast” is of particular importance to me because it is at the center of my argument as to why growth in CEO pay is justifiable. The world of business now moves faster than ever.

Here are a few examples of a faster-moving business climate:

  1. Newspapers once thought to be a necessity are now going out of business at a record pace. Confidence for the future of newsprint is confirmed with a 1997 century bond sale by Tribune Company.
  2. From 2000 to 2006, online retail sales grew 500%.
  3. Yum Brands, the owner of the popular KFC restaurant now derives 46% of profits from China, not the US.
  4. DVDs, popularized in the early 2000s, are now virtually defunct.
  5. Emerging markets have grown considerably since the global boom of the 1990s. A chart of growth in emerging market pay follows this bullet point. Emerging market consumers are wealthier than ever.

Wages rise in emerging markets, meaning CEOs have to deliver

In no more than 15 years, the business world has flipped on its head. The majority of people in the developed world now shop online. Direct to consumer sales growth isn’t in America, but in Asia. Businesses once thought unstoppable in the tech industry (HP, for example) are now clamouring for working business models.

The rate of change in business makes CEOs more valuable than ever and, unfortunately, employees more disposable than ever. In a world where business models can change with a few changes to programming languages or a reorganization of talent, those who make decisions are more important to the business.

Good CEOs change their minds

Good CEOs know when to make key decisions that fundamentally change a business. In fact, new businesses (read: startups) are most successful when they change business models more than twice. A report from Berkeley and Stanford professors found that startups that change direction see:

1. 260% more investment capital.
2. 360% more user growth

Startups that change direction are also 52% less likely to scale too quickly.

The modern CEO does work harder than they had in the past, and pay is catching up. Whether or not we can wrap our heads around a $50,000,000 compensation package is our problem.

The reality is, though, that the decisions a CEO makes today are, for the most part, far more important to the business than decisions made in 1965. Thus, it would only be logical that CEO pay would grow faster than worker pay.

{ 30 comments… read them below or add one }

Echo September 5, 2011 at 01:17

The landscape has also become increasingly more competitive for hiring executives. It’s like when free agency in sports drove up player salaries to what they are today. The more someone is willing to pay for a great leader, or for a great player, the higher the precedent is set for future contracts. Unfortunately, the average worker is not in such high demand, and their salaries will never grow at the same rate as the top dogs.

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JT McGee September 5, 2011 at 15:34

This is a great point. Maybe the growing gap in CEO pay vs. worker pay will encourage some workers to become a CEO of their own company?

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cashflowmantra September 5, 2011 at 09:03

You make a very good argument especially with the productivity angle. I would be curious to see what the graph of productivity per worker looked like from 1965-2005 and compared it to the CEO to worker pay ratio graph. It would be interesting to see if the slopes were similar.

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JT McGee September 5, 2011 at 15:35

It would; you’re right! I’m guessing the productivity measurements would be very different. It’d be hard to quantify on the CEO side, for sure.

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krantcents September 5, 2011 at 11:46

A good CEO is worth a lot! Steve Jobs is an excellent example. There are many overpaid CEOs who are probably not worth their compensation. Public company CEOs are supposed to increase shareholder value.

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JT McGee September 5, 2011 at 15:38

Yeah, there’s definitely more than a few overpaid CEOs. Microcaps are littered with overpaid CEOs who can’t quite come to grips with the whole CEO pay for performance thing.

I like it when CEOs put short-term shareholder value on the sidelines. Nothing like a CEO that says no to dividends and yes to buybacks. 😀

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Financial Success For Young Adults September 5, 2011 at 18:24

I can see why CEO pay is growing so fast. Like you said, they definitely make the decisions that would benefit the entire company. I also give a lot of respect to the CEO’s who decided to take a pay cut instead of firing so many employees. Because without the army, the chief is nothing.

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JT McGee September 6, 2011 at 13:17

I like your thinking. “Without the army, the chief is nothing.”

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Norman September 6, 2011 at 16:02

When it comes to CEOs, I don’t think we are getting our money’s worth. All most know how to do is lay off people and send jobs overseas. Some leadership!

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JT September 6, 2011 at 18:26

Well, sending jobs overseas is certainly true. I still think that some of it can be justified by the fact that more so today than at any point in history, the consumer is overseas.

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Ed September 7, 2011 at 00:43

A good CEO is worth a lot ..When it comes to CEOs, I don’t think we are getting our money’s worth..?

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David H October 11, 2011 at 18:30

One thing to keep in mind is that this growing gap is completely unsustainable. More and more of the wealth in this nation is held by a smaller and smaller percentage of the population. Left to continue unabated, it will all collapse at some point. I also find the use of term “justifiable” here to be as subjective a term as “could” and “should” since it implies that the action is just. The only real point you have made here is that CEOs can demand wage rates at a faster rate than the average worker, but that seems rather obvious based on the outcome, doesn’t it?

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Carl Frost February 9, 2013 at 12:16

David, you are absolutely correct. This is unsustainable. If you take the average growth of CEO pay (say 6%) and the CPI of an average of 4% then you have a CEO income is increasing. This is not a bad thing in and of itself. However if take the average CPI over 10 years (say again 4%) and an average wage increase for the average worker of 2% the result would be in 10 years the average employee is now making 20% LESS the 10 years earlier. This can not continue. It will only last until finally the average employee makes too little ot buy anything and then the economy will crash. Companies will claim to high of taxes ect ect. The people in charge do deserve higher wages. But do deserve their pay increasing the amount it has because they made a company more profitable (that’s why they get higher wages to begin with, that is what they are hired for). My wife is school teacher. She has a masters degree with 24 hours towards her PHD. She has been teaching for 15 years. She makes $38000 a year. Last year she got a $900 raise. Her Superintendent got a $14000 raise. I just recently found out after talking to someone who used to be on the school board that this happens because they are alloted so much money. The CEO then say’s “we can give much of a raise (4%) to the teachers and me a (4%), or we can give the teachers a (1%) raise and me a (6%). He pitches it to the board and they go for it because he just saved them (1%). They went for it. He just saved them money. Another thing to consider is the cost of production. CEO wages are not considered in the cost of production. This never made sense to me. Technically it is true, however their wages as well as workers wages all come out the profit. Period.

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Carl Frost February 9, 2013 at 12:21

I meant they do NOT deserve their pay increasing the amount it has, (about 8 lines down).

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RJ Miller November 11, 2011 at 18:51

“The only real point you have made here is that CEOs can demand wage rates at a faster rate than the average worker…”

No, his point was that CEOs can make or break any company on a much larger scale than the average worker and that the aspects of what a CEO must do in today’s economy has evolved.

Flipping burgers or working a cash register may not have changed much in the last decade but managing a company worth billions sure has.

This was definitely a mind-blowing piece though JT!

Thanks!

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David H November 12, 2011 at 15:03

The relative impact on productivity is not a new situation, so it cannot explain the differences in wage growth. The real change that counts here is the one about making employees more disposable. The performance of CEOs seems to bear too little impact on their pay. A metastudy published in the Journal of Management in 2000 found that company size accounted for 40% of CEO pay differences, while performance accounted for just 5%. Another study published last year in Organizational Research Methods confirmed the weak relationship between CEO performance and pay. The most “mind-blowing” aspect of this article to me is that people are accepting the conclusions without sufficient supporting evidence. I guess it fits in with what they want to hear.

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JT McGee November 12, 2011 at 15:20

The most “mind-blowing” aspect of your comment is that you think the statistic about company size has nothing to do with performance. If a company is larger, it would obviously prefer to pay more for a quality CEO.

A good CEO is as important to protecting a company as it is growing a company. Someone with a $50,000 car pays more for car insurance than a person with a $20,000 car. It’s only natural that you pay more to protect a more valuable item–car, business, whatever–than a less valuable item.

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David H November 12, 2011 at 16:19

Companies can grow in many ways, but the way a big company can get bigger most quickly is through mergers and acquisitions. Increased profitability may improve the ability to acquire other companies, but growth through acquisitions is not a function of performance. Growth through mergers is even less so.

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JT McGee November 12, 2011 at 15:04

Thanks for reading and commenting, RJ! You hit my thesis right on the head; the rate of change in skills necessary for leading a profitable company is far higher than the rate of change in low-level jobs. That’s why CEOs are earning more.

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David H November 12, 2011 at 15:23

If you look at the studies that show the major impact on CEO pay differentials to be company size, then the concentration of industries into ever-larger corporations seems to have much more explanatory power on CEO wage growth. BTW, RJ’s “flipping burgers” reference has little to do with the sorts of jobs that most people in corporate America have and understates the increased complexity of other positions. Wage growth in information services, for example, has not kept pace with CEO pay despite the fact that information technology has increased arguably as fast or even faster than CEOs’ responsibilities. Also, the thesis is totally powerless in explaining the rapidity of growth in CEO-worker pay ratios in the late 1990s. A tripling of the ratio occurred in just four years time, but the job complexity variable didn’t increase anything close to that order of magnitude.

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JT McGee November 12, 2011 at 15:31

I think you’re finding it difficult to discern between data that is actionable and data that isn’t. Talent at the CEO level does not stay within the same industry. Information services CEOs, for example, see their wages rise because C-level wages in other industries are rising, too. You’re essentially telling me that an accountant at Exxon Mobil should earn more or less as a result of the changes/earnings potential in the oil industry completely independent of the changes to the supply/demand or wages for accountants.

CEO wages are hard to price, as well, since the “transactions” that give CEOs a wage from one point to the next are few and far between. Kind of like how its hard to give a value to a certain piece of artwork because there are very few of them.

I can’t explain why CEO pay is growing in a short period of time. For the long-term, the trend is quite obvious. And I do agree that the concentration of companies and their earnings potential does create outliers. Obviously less companies of larger size means higher earnings. But why do companies pay more for CEO talent if there are less CEO positions needing to be filled? It’s harder to run a big company today than it was in the past.

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David H November 12, 2011 at 16:12

I made no claim whatsoever that the wages of everyone in an industry should be tied to the success of the industry. I simply argued that if changes in job complexity are to be used to explain changes in CEO pay, it would have to have far more impact on CEO pay than on other jobs with increasing complexity. I also argued that job complexity is powerless to explain the great volatility in the pay ratio over the past 20 years. Complexity did not increase fast enough to explain the increase from 100 to 300 ratio in four years, nor did CEO jobs suddenly get less complex relative to other jobs in the following two years. The rapidity of growth and volatility suggests that there are other factors much more relevant. Concentration of industry seems to be a major factor, as you have acknowledged. I also feel that changes in the laws concerning unionization and international trade have had major impacts on the valuation of labor.

Gail Gardner November 15, 2011 at 23:24

A major reason why what CEOs are paid grew so fast is creative accounting. For example, when IBM and 200+ other Corporations converted their employee’s REAL pensions to what were at the time ILLEGAL cash pensions that creative accounting allowed them to take away what we had been promised IN WRITING and use those funds to buy up stock to drive the stock values up.

The reason this was done is because CEOs and boards are often paid NOT on the PROFIT their companies earn but on the value of the stock. Any person with common sense could have predicted what would happen when that change was made.

I don’t care how important a CEOs decisions may be – there is still no ethical reason to pay them so much money while working their so-called “right-sized” employees LITERALLY to death. I resigned in disgust after 23 years at IBM partly because they reneged on their promises and proven themselves untrustworthy but primarily because they had piled so much work on so few that my phone interrupted my sleep almost every single night and I knew it was only a matter of time before I ended up falling asleep at the wheel and ending upside down in a ditch.

On top of that, they were breaking legal contracts with clients – such as the requirement that only SSRs holding secret clearances would work on equipment in accounts that required that level of clearance. And we could not provide decent service when they allowed bean counters to cut inventory on critical parts so low that I actually asked one major mainframe account to allow me to power down an entire string of tape drives so that another major mainframe account could get their payroll out. That is ridiculous.

Anyone who believes they can justify the greed of multi-national corporations is either hoping they can be just as successful at taking far more than their far share some day or is deluded – your choice.

I elaborate on that in one of my posts which I’ve linked to this comment. It includes this quote:

“In most organizations, marketing is paid much more because they are seen as an income source. The IBM salesman I knew best made 25 times what I made (and the IBM CEO pay is 530 times more) and their phones did not ring all hours of the day and night like mine did.”

While I do not discount the importance of the decisions made by the leaders of a company they do not need nor deserve 530x more money than the people who actually do the work in that company. Without them the company would cease to exist – and many companies stupidly believe that paying them as little as possible gives them the same workforce as paying for experience. BIG mistake.

I’ll be sharing this post and my comment on social networks, too.

P.S. The anti-spambot plugin you’re using was named by Andy @CommentLuv after my blog GrowMap.com and I really DO know what I’m talking about here.

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JT McGee November 15, 2011 at 23:46

First, great plug-in. I dig it.

I think stock compensation is a load of nonsense, and you won’t hear any disagreements from me on that. That’s from the perspective of a shareholder, and employee. No reason to give away a piece of the future value of a company for what someone does today, in my view.

Now, as far as what happened at IBM–I’m sure you know better about IBM than I do. But I won’t go so far to say that your experience at IBM is necessarily the same as any other multi-national.

Second, if we’re going to discuss stagnant wages for employees, I’d say much of it has to do with the reality that with each passing year we make more and more jobs illegal. It’s easy to drive wages down when there are fewer jobs people have to choose from. But jobs don’t leave this country for no reason, and wages don’t fall for only on reason. It might be more important to ask ourselves why wage workers aren’t keeping up. If we’re just going to talk about the wealth gap in general, the prevailing problem seems to be that there are two people in this world–people who save, and people who don’t. Before, everyone saved and invested because they had to. After a reformation of the tax code and higher FICA taxes, the pension went the way of the dinosaur. The middle class in this country doesn’t know how to save–it never has. The middle class only saved and invested when it was mandated by pensions.

As for the rest of your comment, welcome to the classic “front office vs. backoffice” conversation. CEOs play offense, workers play defense. Defense sucks. You can only lose because you’re supposed to be a great defender every day. If you do your job, well, no love for you. If you don’t, you get eaten alive. Again, FO vs. BO.

Playing offense is much harder than it used to be. Makes sense why they bring home the bacon.

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Gail Gardner November 16, 2011 at 00:23

Hi Joe,

We probably come from different sides of the track so our belief systems are going to be different on this to start with. There is a very obvious (to me and some others) reason why economies around the world are crashing. It is being done intentionally by the bankers who control the money supply.

There is an excellent graph clearly showing why we have a failing economy over on Brian Rogel’s blog (first link in my post attached to this comment).

What happens at one multi-national publicly traded corporation happens at just about all of them at just about the same time. I can tell you that because whatever new program IBM introduced was being introduced at our client’s businesses, too – places like EDS, HP, Dell, Lockheed, etc.

As I mentioned, over 200 corporations illegally converted real pensions to cash pensions back when I was still at IBM and there is a video somewhere of the favorite accounting firm of the multi-nationals bragging during a presentation about how perfect their plan was because “the employees won’t know what has been done to them until it is too late”. (They didn’t count on IBM employees being able to figure it out and starting the largest group on YAHOO and putting up Web sites to share with others what was going on.)

Companies are downsizing because that is how CEOs and other executives can drive the price of the stock up and cash in on stock options. I forgot to mention that when CEOS are total failures they get paid millions or even billions to leave = thanks to their Golden Parachutes.

The bottom line is GREED – pure and simple. Corporations are vehicles for greed that is way out of control, If we don’t reign them in America will have shanty towns like the ones I saw in Cape Town and the ones we see in movies about India and other countries. People who were not born into at least the upper middle class have already realized that, but people who comfortable now won’t know what hit them until it is too late. That is what the protests are about.

I for one would revoke the Corporate charter of every Corporation that does evil and let the chips fall where they may – YES I know what chaos that would cause – but small businesses could then step in and right our economy. Small business is the solution – multi-national corporations, global bankers and the governments they have bought and paid for are the problem.

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Gail Gardner November 16, 2011 at 00:27

P.S. Saving money when they’re printing it as fast as they can and the dollar is sliding is a fool’s errand. Why save worthless pieces of fiat currency? It will take a wheel barrow full of them to buy a loaf of bread and we’ll be using them to insulate our shanty shacks or to burn to stay warm if we don’t manage to turn this Titanic around in time.

Anyone who has money should be putting it into things the mega-wealthy will still buy when no one else has any money or things everyone will be needing when the economy gets even worse – like food, toilet paper, generators, batteries, etc.

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TekGems January 17, 2012 at 13:13

CEO pay and benefit is set by the board of directors (friends of the CEO). When the board of directors vote for a pay and benefits hike, they essentially are voting for a pay hike for themselves. When the CEO leaves the company for another, the “market rate” for the CEO has increased. Its not based on performance nor productivity. It is based on corporate cronyism.

If CEO pay was actually based on performance, how do you explain Léo Apotheker who walked out the door with $10 million cash in severance and bonuses. He performed terribly for HP and lost billions for HP on the webOS.

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RJ Miller January 19, 2012 at 20:48

That is one example out of several thousand, but at any rate leaving with ten million is worse than staying at the company and remaining a CEO at various firms for life.

If anything, I think if the laws in the US were limited to protecting life, property, and human discretion, most large corporations would disperse into small businesses overnight.

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TekGems January 20, 2012 at 10:39

All you need is one example to disprove that CEO pay is somehow based on merit versus cronyism. Want me to find you another example? It won’t take long…

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Kate October 16, 2014 at 22:12

By dismissing the “should” and “could” angles of this discussion, the core of the issue is dismissed. What will result if such a huge division of wealth continues to grow?
Of course, we all know what will happen. If there are no stepping stones to riches, if the balance of power is such that the stones connecting the rich and poor have evaporated, then there is only one place we will end up: in a class war that will not fare well for anyone.
So – is it worth it? To the CEO who makes $13 million annually? You KNOW 80% of your workers make less than $60,000 per year; you KNOW you aren’t giving anyone full time hours anymore so you don’t have to pay benefits; you KNOW you are discouraging unions in order to minimize revolt; you KNOW the majority of your employees have worked at your company for DECADES longer than you have. You know all this, yet you ….what? need another jet? I mean, seriously, what can $13 million buy you that $10 million can’t??
Is it worth it??

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