The great overpaid CEO debate

Are CEOs overpaid? Many people think so.

Many potential causes of overpayment have been identified: CEOs with too much power, inattentive boards of directors, conflicts of interest by compensation consultants, the use of stock options--the list goes on.

Some studies show the average CEO was paid $10 million to $15 million in 2005. This includes their salary, bonus, stock option gains, stock grants, and various executive benefits and perquisites. Are rank-and-file workers underpaid? Everyone, I suppose, feels a little underpaid. Some data sources indicate the average American worker was paid about $40,000 in 2005. Anyone working in the technology sector knows this average pay level would barely hire a below-average administrative assistant in any of the technology hot spots in the U.S. And the average CEO pay has been earned by more than a few average technology company workers who had stock options in the right company at the right time.

So, are CEOs overpaid compared to rank-and-file workers? If you read the media stories this year, and in previous years, you might conclude that they are. Some interest groups have determined that the ratio of CEO pay to average worker pay is an appropriate measure of this problem. Some Web sites allow you to calculate how underpaid you are compared with your CEO. According to these sources, chief executive pay is between 250 and 500 times that of the average worker.

If there is an excessive CEO pay problem, we won't fix the problem by measuring the wrong things and then misinterpreting flawed calculations.

Who are these CEOs who are purportedly paid hundreds of times more than the average worker? In most analyses, they are CEOs managing the largest public companies in America--usually the top 200 to 500. These are largest of the thousands of public corporations in the country. Given that executives typically earn more pay for managing larger organizations, we might expect these individuals to be at the top of the pay hierarchy.

It's more difficult to determine the relative value of the individuals in a job. Most CEOs I've dealt with are highly intelligent, have advanced degrees--often from one of the top universities in this country or elsewhere in the world--and have worked 70 or more hours per week for most of their career. Even if they weren't CEO of a public company, people with a background like that get paid much more than the average person.

Measuring worker pay
If we want to understand the pay level of the average worker in America, we would have to ensure we included all forms of their pay--wage or salary, shift differential, overtime pay, bonuses, tips, commission, stock-based compensation, hiring bonuses, retention bonuses, and so forth. Without digressing into which data sources do and do not capture all of this (hint: none do), this would provide a good portrayal of how much the average worker is paid for his work. We would assume that this data reflects average performers with average levels of education, and so forth. But that's not the data that's being used in these comparisons.

I can't recall seeing a comparison of how much software engineers are paid compared with postal workers, or database administrators compared with bank tellers. This might mean that no one believes these would be relevant comparisons, because different jobs with different educational requirements and different levels of responsibility should be paid differently. We don't always know or agree how differently, but differently.

It still would be completely meaningless, however--just like comparing CEO pay to average worker pay.

I am in no way trying to serve as an apologist for high executive pay levels. After more than 20 years in the field of executive compensation, I have seen numerous examples of inappropriate pay for executives--not only in amount, but in reason and in form. Billions of dollars have been paid to thousands of executives who have destroyed companies and ruined workers' lives. I have seen executives join a company shortly before a takeover and get millions in "change in control" payments.

I also have seen numerous examples of inappropriate pay for nonexecutives--the so-called average worker. I have seen software sales representatives who made far too much commission due to a flawed incentive plan; a receptionist earning more than double the market rate because she had been with the company for decades, and there was no pay cap for any position; software engineers who joined a company at just the right time, and cashed out their stock options just before the stock price crashed and the company went out of business, due to a poorly developed software product.

Fixing the right problem
If there is an excessive CEO pay problem, we won't fix the problem by measuring the wrong things and then misinterpreting flawed calculations. That only will encourage misguided legislation, and we've had plenty of that. It also might encourage big shareholders and their advisors to begin bullying companies into change using arbitrary standards, and we've had plenty of that, too.

Disclosure and publicity of pay allows us to identify the egregious situations and apply pressure to fix them, but only when the data seem accurate to reasonable people.

I just read that U2 made $260 million in gross receipts on their 2005 tour. That's $3 million per show (about $1 million per hour)--far above Motley Crue's $33 million for a similar number of shows (a paltry $400,000 per show, well under $200,000 per hour). I don't think most Americans want to impose an arbitrary cap on CEO pay any more than we want to impose a cap on U2's concert tour receipts because we know U2 would stop touring, and good CEOs would stop CEO-ing, and neither of those is to our benefit.

Let's focus on the real problem and not on concocted metrics rooted in sociopolitical sentiments. There is a lot of fixing needed in executive pay practices, and these average worker pay ratios have the potential to send us in the wrong direction.