CEO Pay - Relative Worth or Entitlement?
How do we determine what any particular function is? Is a nurse more valuable than a sanitation worker, a fireman more than an accountant, a baseball player more than a soldier, or a CEO more valuable than the President of the United States? In industry, worth for the most part is determined by supply and demand, uniqueness of skill sets and value to the organization. During the dot.com boom, the demand for IT professionals was such that salaries and sign-on bonuses increased dramatically. There are many excellent basketball players, but Michael Jordan's unique skills set his value above many of his peers. If there is an individual in your organization who you cannot do without, such as that scientist who is developing new product ideas, his value to the company is greater, and therefore the organization will do more to make sure that they keep him.
There is also an additional intangible that impacts worth, which I'll call celebrity status: the rock star, actress, or athlete whose peers may be equally as skilled or talented, but whose popularity at a given point in time makes them highly sought-after.
So what determines CEO pay? While there is competition to attract the best leaders, there is no shortage of supply, as there are legions of senior executives who would eagerly move into the CEO's office in a heartbeat. Our business schools and corporations are developing legions of would-be leaders who have the skills to run a company. While the CEO is clearly one of the most valuable players in the company, should her compensation be over 300 times what the average worker makes? And what should her value be if the company is not profitable? In a study of 2007 executive pay, total compensation of the highest paid executives grew by 20.8% while revenues grew by just 2.8%. Where's the value?
With Barack Obama recently setting caps on the compensation for CEOs whose companies take government bailout money, there is much discussion about CEO pay. I believe that CEO pay has spiraled out of control. While all of the factors I discussed have had varying levels of influence, executive pay has transcended relative worth. CEOs expect to be paid more each year and their boards of directors and compensation committees react to that level of entitlement. Should we cap CEO pay? My answer is a resounding NO. Let the market continue to establish worth, but several steps should be taken to better manage the process and the spending.
- Create scorecards for CEOs and other top executives that will grade them on both financial performance measures, such as ROI and profit and revenue growth, and other metrics that enhance the long-term growth of the organization. These might include innovation and product development, market share, utilization of technology, geographic expansion, and job growth.
- To create these scorecards, appoint a commission of government, business, and academia to develop the metrics. This might include representation from the Departments of Labor and Commerce, FASB, American Management Association, Society of Human Resource Management, and some of the best academic minds on economics, leadership, and business ethics.
- Recommend that the Fortune 500 adopt these scorecards and publish them on an annual basis. Allow shareholders a non-binding vote based on the scorecards for both the executive team and the board of directors. Consecutive years of both low scores and votes of no confidence would indicate where you need to get new leadership.
- Establish a reasonable multiple of executive to average worker pay and allow incentives to significantly boost executive compensation. Use the metrics in the scorecard to hold CEOs accountable.
- Eliminate "Golden Parachutes." Offer reasonable severance packages that represent enhanced formulas from your standard severance, but eliminate highly rewarding failure.
It will take time to realign the compensation, but making the process more transparent and holding both executives and boards accountable for performance will ultimately achieve that result.