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:
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:
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:
- 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.
- From 2000 to 2006, online retail sales grew 500%.
- Yum Brands, the owner of the popular KFC restaurant now derives 46% of profits from China, not the US.
- DVDs, popularized in the early 2000s, are now virtually defunct.
- 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.
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.