If you Google “how much are CEOs paid?” you will get about 6.3 million results. Clearly somebody has been giving this question some thought. But perhaps a better question would be, “compared with what?”. CEO pay gets a lot of attention because of the truly enormous packages awarded to some company leaders. How can organisations strike the right balance?
The press, and some politicians, tend to compare the compensation of corporate chief executives with the pay received by the average worker. Corporate boards and compensation committees typically benchmark “peer group” pay; they compare their CEO’s package with that offered to his or her peers at competing companies. These are easy comparisons to make, and depending on your point of view, satisfying ones as well, but neither provides a meaningful guide to setting CEO pay in a way that is equitable, credible and fair.
CEO pay gets a lot of attention because of the truly enormous packages awarded to some company leaders. Oracle Corporation paid Larry Ellison, who vacated the chief executive post in 2014, $67.3 million for his final full year in the job. Keep in mind that nearly all of Ellison’s compensation consisted of stock options; for the fiscal year 2014, his salary remained $1. But Oracle has done well, and so has Larry Ellison, as his purchase of a Hawaiian island and sponsoring of the most costly America’s Cup campaign in history attest.
Pay and performance
More irksome are big pay packages for the chief executives of companies that underperform. Marissa Mayer of Yahoo is the highest-paid female CEO at $42.1 million, but the company has continued its decline since she came on board in 2012. Forbes magazine described Ms. Mayer’s tenure as “A Case Study in Poor Leadership.” So how does the Yahoo board justify $42.1 million?
Those with outsize income also include many celebrities like the singer Taylor Swift, who earned $80 million in 2015, considerably more than G.E.’s Jeff Immelt, according to Forbes’s annual list. But entertainers and sports stars are less subject to scrutiny than the leaders of publicly held companies. There’s a reason for that. When you shell out big bucks for Taylor Swift tickets, the pay-for-performance equation is pretty clear.
Compensation of CEOs has continued to grow across all indices. According to Equilar, median 2014 compensation in the S&P 500 was $10.3 million, up 2 percent year over year. Median pay in the S&P 1500 increased 7.8 percent in 2014, reaching $5.3 million. When The Wall Street Journal reports that the pay of top CEOs is 373 times that of the average worker’s salary, it gets attention.
But the problem with comparing CEO pay with that of the average or median employee is that the ratio can be distorted by many factors. A multibillion-dollar global corporation may have many employees in developing countries who are paid a competitive wage for that environment, yet very little in absolute terms, driving down the average. The CEO of that company makes decisions that can have nine-figure consequences, dwarfing the size of even the most generous pay package.
Outsize CEO pay is a major contributing factor to the income inequality roiling society. Thomas Piketty of the Paris School of Economics, author of the surprise best seller “Capital in the Twenty-First Century,” shows that two-thirds of the increase in American income inequality over the last four decades can be attributed to a steep rise in wages among the highest earners in society. This, of course, means people like CEOs. “The system is pretty much out of control in many ways,” Piketty told The New York Times.
This is one of the reasons boards are under increasing pressure to make informed CEO pay decisions that are seen as “fair” by an expanding pool of stakeholders—from investors and employees to the CEO and affected communities and the general public. Korn Ferry recommends that board members go beyond benchmarking, and instead use multiple lenses to evaluate compensation via a more complex and rigorous assessment of both internal and external factors. The goal is to establish “internal equity,” or the perception that the organization is paying people according to the relative size and impact of their roles.
The board must determine the goals it has for the CEO and how it will measure and reward that person for achieving those objectives and milestones. It must also factor in any challenges associated with the role and evaluate the differences and expectations of the CEO relative to the market, such as needing to turn around a struggling business. Mapping these answers against the CEO job requirements and expectations will foster a holistic view of pay that is both fair and effective.
This article is an extract of Getting the Right Measure on CEO Comp published in the Korn Ferry Briefings magazine. You can download the six-page article to learn more about the role of the board in setting CEO pay, the growing emphasis of performance and the politics of CEO compensation.