Those ratios differ from those in this report in several ways. The ratios reported to the SEC will reflect compensation of workers in the specific firm. Second, our measure reflects an exclusively domestic workforce; it excludes the compensation of workers in other countries who work for the firm. The ratios reported to the SEC may include workers in other countries.
Third, our metric is based on hourly compensation annualized to reflect a full-time, full-year worker i. In contrast, the measures firms provide to the SEC can be and are sometimes based on the actual annual not annualized wages of part-year seasonal or part-time workers. As a result, comparisons across firms may reflect not only pay differences but also differences in annual or weekly hours worked. Fourth, our metric includes both wages and benefits, whereas the SEC metric solely focuses on wages.
Finally, we use consistent data and methodology to construct our ratios; our ratios are thus comparable across firms and from year to year. The SEC allows firms flexibility in how they construct the CEO-to-median worker pay comparison; this means there is not comparability across firms—and ratios may not even be comparable from year to year for any given firm, if the firm changes the metrics it uses. There is certainly value in the new metrics being provided to the SEC, but the measures we rely on allow us to make appropriate comparisons between firms and across time.
Box A provides more information on the ratios firms are providing to the SEC. As of , all publicly traded companies are required to disclose CEO total compensation alongside the median annual total compensation for all employees other than the CEO in annual proxy statements submitted to the Securities and Exchange Commission. Advocates, investors, and researchers alike have welcomed the disclosure of this information, because these disclosures offer previously unavailable insight into compensation inequality within firms.
Historically, constructing a firm-specific CEO-to-worker pay ratio was impossible without the cooperation of the firm, although sector-specific estimates were possible see Mishel and Schieder The new CEO-to-worker compensation ratios contained in proxies in and in shine a ray of sunlight onto the compensation of the typical worker. According to the authors of a report titled Rewarding or Hoarding? However, fierce business resistance to the mandate to report the CEO-to-worker compensation ratio has watered down their potential use.
Many corporations have implausibly contended that constructing these ratios is too difficult. The SEC has given these claims far too much credence, providing firms tremendous leeway in how to construct the ratios. This SEC capitulation diminished the utility of these new median worker compensation measures for making comparisons across firms and will affect the utility of comparing them over time when additional years of data are available. The data on median compensation are not provided on a per-hour basis or annualized to that of a full-time, full-year worker.
Without such information, or simply the annual hours worked by the median worker, it is not possible to standardize the compensation for comparisons across firms. In addition, firms may not adhere to the same metric each year, limiting the ability to make historical comparisons in the future. Our examination of CEO compensation continues to provide crucial data points for evaluating current CEO compensation trends as well as trends in CEO compensation over time.
Our methodology described in Sabadish and Mishel has a number of advantages over the SEC-prescribed methodology for constructing ratios. It thereby eliminates artificial reductions in a company-reported CEO-to-worker pay ratio that could arise from the extensive use of subcontracting. Second, our worker compensation series reflects annualized compensation multiplying an estimate of hourly compensation by 2, hours , eliminating the ambiguity that arises when weeks worked and hours per week are not specified or when they differ across firms as can be the case for the SEC ratios.
This assumption also likely makes our ratio a more conservative estimate of the true ratio than the ratios reported to the SEC. Third, our analysis captures the ratio of CEO compensation to compensation of U.
Fourth, our series is able to extend back to , allowing us to analyze trends in executive compensation over time. The consistent basis of the measurement of our ratios permits historical comparisons on a year-to-year basis. These and other benefits are why we continue to produce our CEO-to-worker pay series—although it is our hope that with time the ambiguities of the SEC ratio will be addressed and adjusted, to produce a reliable time series for investors and the public to use going forward.
This ratio grew to to-1 in and to-1 by It surged in the s, hitting to-1 in , at the end of the s recovery. The fall in the stock market after reduced CEO stock-related pay e. CEO compensation recovered to a level of times worker pay by , almost back to its level. The financial crisis of and accompanying stock market decline reduced CEO compensation between and , as discussed above, and the CEO-to-worker compensation ratio fell in tandem. By the stock market had recouped all of the value it had lost following the financial crisis, and the CEO-to-worker compensation ratio in had recovered to to The ratio bumped up in and basically was stable in , dipping a bit to to Although the CEO-to-worker compensation ratio remains below the value achieved in , at the peak of the stock market bubble, it is far higher than it was in the s, s, s, and s.
The pattern using the CEO compensation measure that values stock options as they are granted is similar. The CEO-to-worker pay ratio peaked in , at to-1, even higher than the ratio with the stock-options-realized measurement.
The fall from to was steeper than for the other measure, hitting to-1 in The stock market decline during the financial crisis drove the ratio down to to-1 in It recovered to to-1 by and, after dipping a bit over the next three years, ended back up at to-1 in This level is far lower than its peak in but still far greater than the ratio of to-1 or the ratio of to This section reviews competing explanations for the extraordinary rise in CEO compensation over the past several decades.
CEO compensation has grown a great deal since , but so has the pay of other high-wage earners. To some analysts, this suggests that the dramatic rise in CEO compensation has been driven largely by the demand for the skills of CEOs and other highly paid professionals.
Over the last 20 years, then, public company CEO pay relative to the top 0. These patterns are consistent with a competitive market for talent. They are less consistent with managerial power. Other top income groups, not subject to managerial power forces, have seen similar growth in pay. Kaplan a, 4. In a follow-up paper for the Cato Institute, published as a National Bureau of Economic Research working paper, Kaplan expands this point:. The point of these comparisons is to confirm that while public company CEOs earn a great deal, they are not unique.
Other groups with similar backgrounds—private company executives, corporate lawyers, hedge fund investors, private equity investors and others—have seen significant pay increases where there is a competitive market for talent and managerial power problems are absent.
Again, if one uses evidence of higher CEO pay as evidence of managerial power or capture, one must also explain why these professional groups have had a similar or even higher growth in pay. It seems more likely that a meaningful portion of the increase in CEO pay has been driven by market forces as well. Kaplan b, Bivens and Mishel address the larger issue of the role of CEO compensation in generating income gains at the very top and conclude that substantial rents are embedded in executive pay.
According to Bivens and Mishel, CEO pay gains are not the result of a competitive market for talent but rather reflect the power of CEOs to extract concessions. Here we draw on and update the Bivens and Mishel analysis to show that CEO compensation grew far faster than compensation of very highly paid workers over the last few decades, which suggests that the market for skills was not responsible for the rapid growth of CEO compensation.
Table 3 shows the ratio of the average compensation of CEOs of large firms the series developed by Kaplan, incorporating stock options realized to the average annual earnings of the top 0. Both the simple ratios and the log ratios understate the relative pay of CEOs, because CEO pay is a nontrivial share of the denominator, a bias that has probably grown over time as CEO relative pay has grown.
Note: The college-to-high-school wage ratios compare hourly wages of workers who have a college degree with hourly wages of workers who have only a high school diploma. For comparison purposes, Table 3 also shows the changes in the gross not regression-adjusted college-to-high-school wage premium.
The comparisons end in because data for top 0. CEO pay was 5. CEO compensation grew far faster than that of the top 0. CEO compensation relative to the wages of the top 0. Is this increase large? His historical comparisons are inaccurate, however. Figure D compares the ratios of the compensation of CEOs to compensation of the top 0. In this ratio was 5. That CEO compensation grew much faster than the earnings of the top 0. For his part, Immelt says his book gives context to his tenure because the narrative has been unfair and incomplete , he says.
CEO compensation has continued to surge and could rise again despite the pandemic, according to the report. CEO pay for the top firms in the U. Typically, CEOs get a base salary, but most of their compensation comes from performance-related bonuses and stock options that allow executives to buy company shares for a set price.
And CEOs' successful performance makes their company more valuable at the end of the day, according to some experts. We find this result surprising—and symptomatic of the ills afflicting compensation policy. Make real the threat of dismissal. The prospect of being fired as a result of poor performance can provide powerful monetary and nonmonetary incentives for CEOs to maximize company value.
In addition, the public humiliation associated with a high-visibility dismissal should cause managers to carefully weigh the consequences of taking actions that increase the probability of being dismissed. Here too, however, the evidence is clear: the CEO position is not a very risky job.
Sports fans are accustomed to baseball managers being fired after one losing season. Few CEOs experience a similar fate after years of underperformance. There are many reasons why we would expect CEOs to be treated differently from baseball managers. CEOs have greater organization-specific capital; it is harder for an outsider to come in and run a giant company than it is for a new manager to take over a ball club. There are differences in the lag between input and output. For these and other reasons, it is not surprising that turnover rates are lower for CEOs than for baseball managers.
It is surprising that the magnitude of the discrepancy is so large. On average, CEOs in our base sample 2, executives hold their jobs for more than ten years before stepping down, and most give up their title but not their seat on the board only after reaching normal retirement age. Two recent studies, spanning 20 years and more than management changes, found only 20 cases where CEOs left their jobs because of poor performance. But this culture of politeness does not explain why so few underperforming CEOs leave in the first place.
Our own research confirms these and other findings. Then again, perhaps corporate directors are providing CEOs with substantial rewards and penalties based on performance, but they are measuring performance with metrics other than long-run stock market value.
We tested this possibility and reached the same conclusion as in our original analysis. Whatever the metric, CEO compensation is independent of business performance. For example, we tested whether companies rewarded CEOs on the basis of sales growth or accounting profits rather than on direct changes in shareholder wealth. We found that while more of the variation in CEO pay could be explained by changes in accounting profits than stock market value, the pay-for-performance sensitivity was economically just as insignificant as in our original model.
Sales growth had little explanatory power once we controlled for accounting profits. Of course, incentives based on other measures will be captured by our methodology only to the extent that they ultimately correlate with changes in shareholder wealth. Moreover, if directors varied CEO compensation substantially from year to year based on performance measures not observable to us, this policy would show up as high raw variability in CEO compensation. A larger percentage of workers took real pay cuts at some time over this period than did CEOs.
Overall, the standard deviation of annual changes in CEO pay was only slightly greater than for hourly and salaried employees CEO compensation policies look especially unsatisfactory when compared with the situation 50 years ago.
All told, CEO compensation in the s was lower, less variable, and less sensitive to corporate performance than in the s. To compare the current situation with the past, we constructed a longitudinal sample of executives from the s using data collected by the Works Projects Administration. The WPA data, covering fiscal years through , include salary and bonus for the highest paid executive whom we designate as the CEO in large U.
The results are striking. Coupled with the decline in salaries, the ratio of CEO pay to total company value has fallen significantly—from 0. Compensation was more variable in the s as well.
The incentives generated by CEO stock ownership have also declined substantially over the past 50 years. To test this trend, we reviewed stock ownership data for CEOs in the largest companies ranked by market value in , , and The percentage of outstanding shares owned by CEOs including shares held by family members in the top companies fell by a factor of nearly ten from to The trend is unmistakable: as a percentage of total market value, CEO stock ownership has declined substantially over the last 50 years and is continuing to fall.
Note: Median stock ownership for CEOs in largest companies, ranked by market value. Data were obtained from proxy statements and include not only shares held directly but also shares held by family members and related trusts. Government disclosure rules ensure that executive pay remains a visible and controversial topic. The costs of disclosure are less well appreciated but may well exceed the benefits.
Managerial labor contracts are not a private matter between employers and employees. Third parties play an important role in the contracting process, and strong political forces operate inside and outside companies to shape executive pay. Moreover, authority over compensation decisions rests not with the shareholders but with compensation committees generally composed of outside directors. These committees are elected by shareholders but are not perfect agents for them.
Compensation committees typically react to the agitation over pay levels by capping—explicitly or implicitly—the amount of money the CEO earns. How often do shareholder activists or union leaders denounce a corporate board for under paying the CEO? Most critics of executive pay want it both ways. Imposing a ceiling on salaries for outstanding performers inevitably means creating a floor for poor performers.
Over time, by cutting off the upper and lower tails of the distribution, the entire pay-for-performance relation erodes. When mediocre outfielders earn a million dollars a year, and New York law partners earn about the same, influential critics who begrudge comparable salaries to the men and women running billion-dollar enterprises help guarantee that these companies will attract mediocre leaders who turn in mediocre performances.
Admittedly, it is difficult to document the effect of public disclosure on executive pay. Yet there have been a few prominent examples. Bear, Stearns, the successful investment bank, went public in and had to submit to disclosure requirements for the first time. A public outcry ensued. More recently, we interviewed the president of a subsidiary of a thriving publicly traded conglomerate.
For one, because his salary would have to be made public—a disclosure both he and the CEO consider a needless invitation to internal and external criticism. We are not arguing for the elimination of salary disclosure. Indeed, without disclosure we could not have conducted this study. The costs of negative publicity and political criticism are less severe than the costs to shareholder wealth created by misguided compensation systems.
But the level of pay does affect the quality of managers an organization can attract. Companies that are willing to pay more will, in general, attract more highly talented individuals. So if the critics insist on focusing on levels of executive pay, they should at least ask the right question: Are current levels of CEO compensation high enough to attract the best and brightest individuals to careers in corporate management?
The answer is, probably not. This month, Pepper published a paper exploring why the pay gaps have opened up between CEOs and the wider workforce.
But he says the previous system "broke down" when executive pay became connected with share prices, and "asset-based rewards" took off under the prevailing neoliberalism. Pepper says the underlying logic was to pay the CEO according to a company's financial performance, since they were the most important factor of success.
So, on top of basic salaries, CEOs were given performance-related bonuses and stock options allowing them to buy company shares for a set price. Ocado declined request for comment. At the same time, the proportion of UK businesses owned by individuals dropped precipitously. Shareholders grew in power, and their demand for booming stock prices led to booming pay packets for CEOs — in turn signed off by boards of directors eager to please their investors. Robin Ferracone, CEO of Farient Advisors, an international executive-pay consultancy, agrees with these "price-driven" salaries.
However, in reality, the system of calculating CEO remuneration is more complicated. Companies rely on compensation committees, mostly made up of board members and executives from other companies that meet once a year. Besides the more traditional measures of past experience and performance, committees use benchmarking as a key part of the process — working out how the CEO's compensation will compare to those at similar companies, according to Steven Clifford, a former CEO and author of The CEO Pay Machine.
Often the sum will be in the 50th, 75th or 90th percentile, therefore constantly maintaining or increasing pay, he writes. A study in in the Journal of Financial Economics concluded this system of compensation committees is accelerating pay inflation "because such peer companies enable justification of the high level of their CEO pay". Bonuses are then agreed as a way to measure performance, either increasing based on financial measures or provided in sum if specific goals are met. As shareholders have grown in power, their demand for high share prices has nudged up CEO pay Credit: Alamy.
Both the process for base pay and for bonuses are seen by workers' representatives as problematic because boards, not wanting to upset the leader of their company who could leave or fire them, therefore push up pay. Janet Williamson, senior policy officer at the UK's Trades Union Congress, argues the system of compensation committees, who often report directly to the CEO, lacks impartiality and should be reformed.
In fact, Pepper argues the empirical evidence shows the strongest correlation between pay and company financial measures is not financial performance, but rather the size of companies — there is simply more money to spend. Whether CEO pay is justified remains subject to fierce debate.
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