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Can CEO Pay be limited through a formula?

CEO pay has become a very controversial topic in recent times. The reason for this is that the wage gap of CEOs relative to the general worker has grown every year for the past 20 years.

The wage gap is the number of times that a CEO earns what a  general worker earns. If we consider the Total Earnings of CEOs (guaranteed pay plus variable pay) the wage gap of the largest organisations is around 93 in South Africa which means that the CEO earns 93 times the general worker. According to Forbes, CEOs in America earned 335 times more than the typical employee. This ratio is much worse in large economies like America where the company size is much larger than in South Africa.

 

The Wall Street Journal has an article by Will Harmon (2017) punting a formula for CEO Total Earnings which uses combinations of the Net income that the company made as well as the market cap of the company. This intuitively has some logic behind it in that first amount of money that the company made is used to base the CEO pay and then it is adjusted up for the company size. Harmon (2017) believes that the formula he uses is a good indicator for the USA market:

 

Maximum CEO Comp = (0.5% * Net Income + 0.03% * Market Cap)

 

We have tested this formula on our South African Executive Salary database (https://www.21century.co.za/salary-surveys-and-salary-benchmarking/#national-salary-survey-rewardonline) with some interesting results. We tested it on both the Top 40 listed companies and the Top 100 listed companies with the following results:

 

This means that at the median (or 50th percentile) South Africa pays its CEOs 35% less than the formula maximum for Top 40 companies and 9% more than the formula maximum for Top 100 companies. This calculated figure is meant to be a maximum which indicates that a large percentage of CEOs earn above this maximum (as can be seen by the compa ratios at the 50th and 75th percentiles).

 

This appears to fly in the face of our more conservative wage gap relative to the USA and we posit that CEO pay is far too complex to ascribe to 2 financial factors.

 

There are many other elements to CEO performativity that contribute to the levels of pay.

 

CEO pay can be influenced by the following list of factors, amongst others:

  • Size of the organisation – turnover and market cap are usually good indicators of size, whilst Net Income is not a good indicator as it does not cater for public sector organisations whose mandate is service delivery
  • Strategic level that the CEO operates in – this could be Global (eg. Apple), International, Multi-country or single country)
  • Complexity of the organisation – structure, value chain, etc
  • Industry
  • Regulation
  • Capital or people intensive
  • Societal needs
  • Environmental considerations
  • Competitiveness
  • Shareholder structure

 

The world is moving away from mere financial measures to measure both sustainable performance of organisations and CEO pay.

 

It makes sense that CEO pay should be linked to truly sustainable organisation performance that is based on the 3 pillars of economics (including financial results), social and environmental measures.

 

This includes the wider stakeholders that have an interest in or are affected by the organisation and include employees, customers, suppliers, financiers, media, communities, government, world citizens and of course shareholders. Stakeholders are learning to be vocal about non-sustainable organisations and practices and CEOs have to take the brunt of this not only in their level of pay but also in their continued employment as CEO. Recent examples of this have been the resignation of the CEO of KPMG South Africa as well as the departure of the CEO of Uber.

 

We may not be able to design a pragmatic formula to limit CEO pay sensibly but the stakeholders certainly know intuitively when pay is out of line with sustainable performance. Stakeholders will continue to use social media and other channels to influence pay practices so that Remuneration Committees and Boards cannot ignore the societal pressures bearing down on them.

Written by:

 

Bryden Morton
Data Manager
B.Com (Hons) Economics
bmorton@21century.co.za

 

Chris Blair
CEO
B.Sc Chem. Eng., MBA – Leadership & Sustainability
cblair@21century.co.za

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2018-04-09T07:42:00+00:00