How justifiable is high CEO pay in the United States?

Kotsch, Christoph

Leseprobe

1 Table of Content

Table of Content ... 2

Index of Abbreviations ... 3

Table of Figures ... 5

Introduction... 6

Executive vs. Employee Compensation... 7

The Wealth of CEOs... 10

Trends of CEO Pay in Recent Time ... 13

General Issues Regarding CEO Pay ... 16

CEO pay in the US... 18

9.1

US CEOs compared to German CEOs ... 19

9.2

Referendum in Switzerland ... 20

Discussion in the Media ... 21

10.1

Arguments for CEO Pay Being Excessive... 21

10.2

Arguments for CEO Pay Not Being Excessive... 22

10.3

The Public Opinion ... 23

Conclusion... 26

References ... 27

2 Index of Abbreviations

AFL-CIO

American Federation of Labor and Congress of Industrial

Organizations

CEO

Chief Executive Officer

CFO

Chief Financial Officer

e.g.

for example (exempli gratia)

etc.

and so on (et cetera)

GfK

German institute for market research (Gesellschaft für

Konsumforschung)

KPI

Key Performance Indicators

million

NYSE

New York Stock Exchange

OECD

Organization for Economic Co-operation and

Development

p.a.

per year (per annum)

United States

USD

US- Dollar

3 Table of Figures

Figure 1: CEO compensation compared to top wages and income (1947 - 2012) ... 9

Figure 2: CEO pay in regards to company size ... 10

Figure 3: CEO pay in regards to type of ownership ... 12

Figure 4: CEO pay in regards to industry ... 12

Figure 5: Trends in CEO pay (1965 - 2013) ... 13

Figure 6: Average CEO pay (2007 - 2015) ... 15

4 Introduction

The high compensation for executives and in particular for CEOs has been a topic of debate

for many years. Increasing salaries and bonuses for leaders of companies have mostly been

criticized and even pointed out as a key factor for a rising wealth distribution inequality.

Especially in the United States, where CEO pay is most extreme, the public as well as the

media ask for new regulations and political intervention. But are these high compensations

really undeserved and unfair? How much do top managers actually earn and why do

businesses support it?

This academic paper will first give an overview of some important numbers and statistics in

order to have an idea of how high a CEO's income is compared to an average employee. It

will also explain how to properly interpret these data and how much an executive's income

can vary depending on different factors.

After analyzing the recent history and developments in CEO pay, chapter 8 will provide the

necessary economic background to help understand companies' decisions and see high wages

from a business point of view.

Although the paper will focus on CEO earnings in the US, it will give examples of differences

in other countries and systems. Due to a distinct set of labor regulations, we will draw a

comparison to CEO pay in Germany and furthermore illustrate the event of a political

referendum in Switzerland.

Finally, we will pick on various arguments by media, the public, as well as renowned

economists, listing a series of pros and cons for excessive CEO pay. An insightful survey,

conducted in the US, will then close the debate and leave the reader with the final thoughts of

the conclusion.

5 Executive vs. Employee Compensation

The topic of high compensation for executive managers and CEOs has been widely covered

by global media and especially in the United States of America. It has not only been

criticized, it also has been pointed out as one of the main reasons for the rising income

inequality.

But how significant are the differences between an executive's pay and a common worker's

pay? And who can actually call themselves an executive?

An executive may be any high-level manager within a business enterprise, e.g. a chief

financial officer or a chief operations officer. However, the discussion focuses mainly on the

president of a company, the so called chief executive officer (CEO). This person is running

the entire company as well as leading it by making important decisions. His rank is higher

than that of any other executive. Though, the CEO is not to be confused with the owner.

Unlike an owner or shareholders, the CEO does not possess any equity in the company per se.

Having an executive pay usually means there are at least a few additional components other

than the base salary. Those can be in the form of short-term or long-term incentive pays, an

enhanced benefits package including a Supplemental Executive Retirement Plan (SERP),

extras such as cars or club memberships, as well as deferred compensation earnings. One of

the reasons for all these benefits and extras is minimization of tax, government rules and

financial reporting. These payment plans are taking current tax laws into consideration, trying

to get the greatest benefit while maintaining a certain competitive wage for the executive.

To answer the question of how big the gap between an executive's and a worker's pay is, it is

important to look at some numbers. In 2013 the average worker in the US earned USD 35,239

throughout the year

, whereas the average CEO earned USD 11,664,109 that is 331 times as

much.

If we look at the federal minimum wage in 2013, a full-time worker earned only USD 15,080.

That means 774 workers on minimum wage would have the same amount in earnings as one

company's CEO.

John Cassidy (2014/03/31).

PayScale (2011/02/28).

According to the Bureau of Labor Statistics data for production and nonsupervisory workers.

2013 CEO to average worker pay ratio calculated based on AFL-CIO (American Federation of Labor and

Congress of Industrial Organizations) analysis of 350 available companies in the S&P 500.

It is important to keep in mind that these calculations were made using data of 350 companies

in the S&P 500 which includes only the 500 wealthiest companies in the US. So we have to

consider, that, when we talk about enormously high CEO salaries, we mainly focus on a small

minority of companies. CEOs of small and medium enterprises most certainly do not earn

millions of dollars.

Nevertheless, taking an average of 350 CEO salaries means, there is also a number of people

who earn more than his fellow CEO colleagues. And when we take a look at some specific

salaries, we'll find out the gap between average and highest is huge.

For instance, J. Michael Pearson, CEO of Valeant Pharmaceuticals International, made the top

of the list for highest paid CEO in 2015. Throughout the year and including a variety of

bonuses, he earned USD 143,077,442. Going further down the ranking to the third place we

can see Lyndon R. Rive who is CEO of the SolarCity Corporation, getting paid `only' around

half that amount at a total of USD 77,318,016.

When analyzing data from different years, it has to be pointed out that the CEO pay has been

significantly increased over the past years. As it has been mentioned earlier, the ratio of CEO

earnings to average worker earnings in 2013 was 331:1, meaning that 331 workers earn the

same amount of money within a year as one CEO (of the S&P 500 companies). Only one year

later, in 2014, the ratio has increased to 373:1, meaning that one single CEO now earns the

equivalent of a 373 workers' salary.

CNBC calculated that from 2013 to 2014, the 200 highest-paid CEOs in the US received a

9.1% increase in their total compensation. At the same time, the increase in the average

worker's salary only came down to 2.2%.

When we discuss the gap between an executive and the average worker, we also have to

consider the income inequality between labor force and skilled workers. Most people would

agree this gap is completely fair regarding different education and qualifications. But how

large can this gap be without being unfair?

In the past years, not only CEOs were able to earn more, skilled workers have increased their

wages, too. Some analysts suggest, that the high demand for skills and professionals is driving

According to the American Federation of Labor and Congress of Industrial Organizations.

Tim Mullaney (2015/05/18).

According to the unemployment report from the Labor Department.

the rise in CEO compensation. Other groups with high income (excluding managers) have had

a similar growth in earnings. This is due to the competitive market for talents.

Figure 1: CEO compensation compared to top wages and income (1947 - 2012)

Source: Economic Policy Institute (2014)

In order to see the development of CEO compensation ratios to the top earners and incomes,

we compare data from 1947 to 2012. The diagram illustrates how much more a CEO earns in

relation to the highest-earning 0.1% individuals (dark blue curve) as well as in relation to the

top 0.1% household income (light blue curve).

CEO compensation in 2012 was 1.85 times higher than the top household income. The same

ratio as an average of the years from 1947 to 1979 was 1.11, which means two-thirds less.

CEO pay relative to the highest wage earners was 4.75 times higher in 2012, while the

average ratio from 1947 to 1979 was at 3.25 (meaning in 2012 the ratio was 1.5 times higher

than historically).

As CEO compensations rose again after 2012, we can expect even higher ratios today.

What we can also see from the graph is that CEO pay, in comparison to the top earners, has

been relatively constant over most of the time. It only began in the 1990s when CEOs started

Alyssa Davis, Lawrence Mishel (2014/06/12).