Our opinion: Debunking the myths of CEO salaries
While politicians at the state and national level debate the pros and cons of increasing the minimum wage it is worthwhile to take another look at the other end of the pay scale spectrum -- inflated salaries for CEOs.
In 1960, the top 10 percent of earners in the United States took in 33.5 percent of all income, which includes wages and investment returns, according French economist Thomas Piketty. By 2010, that share had risen to 47.9 percent. Another report shows that CEOs of S&P 500 companies earned, on average, 204 times the salary of rank-and-file employees in 2013.
These exorbitant salaries and compensation packages are based on two basic assumptions: You need to offer higher salaries to attract and retain the best talent, and you need to compensate company leaders for good performance. However, a number of recent studies and news analyses debunk those myths.
The argument that higher salaries enable firms to hire the best candidates is undermined by the prevalence of poor recruiting practices, according to J. Scott Armstrong, professor of marketing at the Wharton School of the University of Pennsylvania, and Philippe Jacquart, assistant professor of leadership at France's Emlyon Business School. Both argue in a recent Fox News article that high CEO pay hurts American companies and stockholders.
Armstrong and Jacquart note that executive recruiters are seldom aware of evidence-based procedures for selecting managers. Instead, executives are typically selected based on their performance in unstructured interviews, which are prone to biases from irrelevant characteristics such as age, gender, looks, voice, weight, height, and race.
There is no evidence that higher pay produces better executive performance. Instead, there is evidence that higher compensation undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore some stakeholders, and discourages them from considering the long-term effects of their decisions. In some cases, Armstrong and Jacquart say, incentives are likely to encourage unethical behavior.
"Stock options became infamous when the public discovered that grant dates of CEO options were being manipulated to increase the personal benefits of CEOs at the expense of the firms' owners," they wrote.
The website Gothamist.com notes that many of the metrics used to measure performance are skewed, and yet CEO pay keeps rising. A study of 195 companies shows that tying a CEO's pay to total shareholder return usually means the company underperforms. Those companies' shares had an average loss of 0.18 percent, annualized, over the five-year period. That compares with an average gain of 1.15 percent among all 195 stocks, regardless of the benchmark they used. Even more striking, stocks of companies that did not use total shareholder return as a measure gained an annualized average of 2.67 percent, according to Gothamist.com.
Crain's Chicago Business attacks another common myth fueling CEO pay inflation -- the widespread belief that every one of these chiefs is a superstar wooed day and night by headhunters bearing lucrative offers to run other companies. This is what drives the common practice of "benchmarking" CEO pay to the compensation of counterparts at companies deemed comparable in some way, according to Joe Cahill, who writes a business blog for Crain's.
"Pay less than average, and a rival will spirit away your superstar. Or so the thinking goes," Cahill wrote. "I've always thought this notion was patently false, given the inability of so many CEOs to produce extraordinary results for shareholders. Yet it persists among the people who determine CEO pay."
On the contrary, Cahill notes, Professor Charles Elson of the University of Delaware has produced a study showing that companies rarely recruit sitting CEOs. Elson and his research colleagues found that 72.9 percent of CEO vacancies in 2012 were filled from within. And the vast majority of outside hires were lower-level executives moving up to their first CEO job.
Elson says most CEOs aren't qualified to run any company other than the one they're running now. Conversely, most companies find better-qualified CEO candidates within their own ranks, not outside. That's because deep familiarity with a company's operations, accumulated over many years with the organization, is more likely to foster success in the CEO role than the general management skills an outsider can bring. And the specific expertise so vital to running one company rarely is transferable to another.
"There's this idea that the skills of top CEOs are transferable, and they'll jump ship and take them somewhere else if you don't pay them enough," Elson said at a recent corporate governance forum in Chicago. "We've demonstrated they can't jump, won't jump and don't jump."
Based on that evidence, Cahill has a message that corporate directors should heed: "You can stop worrying about losing your CEOs. Nobody's calling them. More important, you can stop paying them as if they were the subject of a nonstop bidding war."
We would also add that if CEO salaries weren't so outrageously high then more companies like Walmart and McDonald's could afford to pay their employees a livable wage that would reduce their dependence on government subsidies, help lift them out of poverty and possibly end this class warfare that the 1 percent keep complaining about.
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