CEO Salaries: Bloated or Justified?

salaryAccording to the Economic Policy Institute, a Washington-based research group, in 2005, the average CEO in the United States earned 262 times the pay of the average worker, the second-highest level in the 40 years for which data exist. In 2005, a CEO earned more in one workday (there are 260 in a year) than an average worker earned in 52 weeks, the EPI says. Though it seems unfair, many would argue that a good CEO is worth the price tag. Take John A. Thain, the CEO of Merrill Lynch. Thain was offered a $50 million paycheck with pay options worth up to $120 million to revive the ailing Wall Street firm, 'The New York Times' reported last fall. The story dubbed him "Wall Street's richest mop-up man, at least for now."

Thain isn't the only chief reaping robust compensation. The gap between stagnant wages for workers and soaring pay for leadership has prompted great debate and much scrutiny. While some companies do abuse compensation practices and pay CEOs too much, experts say, in many cases the hefty salaries are justified.

Does a CEO deserve to make 262 times more than the average worker?

The salary gap between employees and lower-level executives can also be significant. It varies by industry, but in most companies, the salary gap becomes explicit at the vice-president level, says Todd Milbourn, finance professor at the Olin Business School at Washington University in St. Louis. "This is when you start moving into a new pay echelon, but there's still a pretty significant gap between, say, a senior vice president and a CEO," he says.

The average worker can easily be frustrated by bloated CEO pay, not understanding the chasm between his earnings and those of the man at the top. One possible driver of the gap, says Dan Moynihan, principal of Compensation Resources, an executive compensation consulting firm in Upper Saddle River, N.J., is that today's CEOs have shorter tenures than in years past. "I think there's a capitalistic model that says 'get as much as you can while it lasts because you don't know how long it'll last,'" he says. "I don't think CEOs are doing more or less than they were 20 years ago. And I don't think line workers are either. Should [the gap] be rectified? Yes. Will it be? Probably not."

If a company is losing market share but the CEO continues getting bonuses and pay increases, worker satisfaction will likely wane. "When you have a thousand people who are unhappy and feel unfairly compensated, everyone's going to be a little less efficient, and it'll start impacting the bottom line," Milbourn says.

Brent Longnecker, president of Longnecker & Associates, an executive compensation and corporate governance consulting firm, says companies do abuse the system. But in most cases, the salary gap is reasonable and justified, he says. "A top-level executive is probably worth his or her weight in gold as far as what they do for the economy," Longnecker says. "They create jobs. They increase the tax base with which the United States can grow. They give us a competitive edge in the world markets. They do a lot of things with a lot of pressure on them that we really never talk about."

Milbourn agrees and stresses the importance of paying top executives a fair market value. If they're wooed with higher pay from a competing company, everyone is likely to feel the effects. The good news for everyone below the CEO, Longnecker says, is the salary gap has closed slightly since 2000. The not-so-good news is the salary gap is never going to be as small as some would like.

Do You Know What Your CEO Earns?

Concern about the salary gap can partly be attributed to the generation gap in today's workforce, Longnecker says. In generations past, salary was often a taboo topic, but the 20- and 30-somethings of today want to understand the why behind company decisions. "Once they understand it," Longnecker says, "they say, 'okay, thanks.' That's all they need." Some experts say the best move a company can make is toward fair, honest, and transparent compensation. Internally, Milbourn says, companies should be clear about executive performance targets and how they translate to bonuses, stock grants, and pay increases.

Longnecker even suggests the story of a company's executive officer be told as part of orientation. 'People need to understand what the CEO does, what he or she represents, what they value, and what they've done for the company so far," he says. A clear view of the how, when, why, and what behind compensation is not only good for morale and company confidence; it can even provide those on the low end of the scale a roadmap to higher pay.

According to Moynihan, as companies shine a light on compensation, people can see more opportunities. "With this transparency," he says, "employees can start to understand what it would take for them to become an executive and potentially reap some of the benefits."

Did You Know...
  • Some CEOs, such as Steve Jobs of Apple Computer, cap their own pay but still get rich on stock options, bonuses and other forms of compensation. Steve Jobs' actual salary is $1.
  • Companies with voluntary CEO pay caps include Whole Foods Markets (19x average worker pay) and formerly Ben & Jerry's Ice Cream. Ben & Jerry's Ice Cream capped executive pay at seven times the salary of the lowest-paid worker for a decade, but dropped the provision in 1994 when it sought a CEO to replace co-founder Ben Cohen, according to an article in Time Magazine.
  • In 2006, the U.S. Securities and Exchange Commission updated its rules for executive compensation disclosure. The rules line up several requirements:
  • 1. Executive pay must be explained in terms that are easy to understand.

    2. One number must be provided for total annual compensation for each executive.

    3. Reports need to include detailed information on pension and estimated severance packages.

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Research from Kevin J. Murphy @ University of Southern California:

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