Are CEOs Worth It?

June 7, 2017

Are CEOs Worth It?

L’Oreal’s legendary marketing slogan “Because I'm Worth It” seems not only timeless in the beauty industry, but also when it comes to CEO compensation. In 2013, Larry Merlo, CEO of CVS Health, earned around 434 times the salary of the median CVS employee. In 2015, U.S. CEOs earned up to 335 times more than the average pay of their employees. Since the 1970s, CEO pay in the United States has risen almost 1,000 percent compared to the rise in worker salaries of roughly 11 percent over the same period (adjusted for inflation.)

The belief that top performers are the most capable is flawed because exceptional success usually occurs in exceptional circumstances.

In his article on the disclosure of pay ratios, London Business School Professor Alex Edmans outlined several arguments that aim to both explain and support these contrasts in income disparity, the first of which proposes that CEOs’ actions are scalable in the sense that any CEO’s improvements of his or her organization’s corporate culture have significant beneficial effects at a firm-wide level. Secondly, there is the argument that high pay ratios could be considered as a significant motivating tool for employees as they indicate great career and promotion opportunities. And lastly, there is the argument that top talent is worth paying top dollar.  

These arguments and assumptions notwithstanding, is important to draw attention to three key facts when considering the magnitude of these ratios. The first of these is that numerous CEOs continue to receive significant payments and financial rewards while at the same time their organizations lay off thousands of employees and staff. This confirms a trend already highlighted in the 2010s, when a report by the Institute for Policy Studies concluded that CEO salaries increase with employee layoffs. While employee layoffs are often a solution, are salary increases for any talent, however top, still justifiable when applying such business-as-usual practices?

The second key factor—as the 2015 Volkswagen emissions scandal and the latest news of Yahoo have shown—is that CEOs who fail or have made decisions which have had severe financial and non-financial implications for their organization, or who cannot turn around a company, can often exit those companies unscathed, often escaping with large golden parachutes. In the case of Volkswagen, the emission scandal cost the company at least $14.7 billion in settlements, and for 30,000 Volkswagen employees, their jobs by 2020. Yet former CEO Martin Winterkorn left the company in 2016, and since receives a pension payment equivalent to nearly 3,500 U.S. dollars per day. In the case of Yahoo, according to the New York Times, outgoing CEO Marissa Mayer will leave the company with a severance package worth $186 million, despite a series of ill-timed purchasing decisions and serious security breaches which left Yahoo to be sold to Verizon for a tenth of what Microsoft offered in 2008.

Thirdly, recent research has confirmed the belief that top performers are the most capable is flawed because exceptional success usually occurs in exceptional circumstances. Studies have shown how top performers are often lucky for having benefited from rich-get-richer dynamics that increased their initial fortunes. These studies also suggest that results and outcomes are somewhat over-credited to the personality, competencies, and skills of a person, rather than to the situational context and to the happenstance of “being in the right place at the right time.”

These arguments could add to the current discussion about how employees might react when in 2018 the CEO pay ratio disclosure rule mandated by the 2010 Dodd-Frank Wall Street reform law is going to be implemented. HR professionals will not only have to think about their role in preparing, presenting and communicating the CEO ratios to their employees. For the future, executive HR leaders will have to review the role they want to play in the making of CEO salaries and the ethics of such lucrative financial packages.  

 

The Authors: 

Stefan Gröschl, Ph.D., is a professor in the Department of Management and the cofounder of the Chair of Leadership and Diversity at the ESSEC Business School, Paris–Singapore. He is widely known for his expertise in responsible leadership, diversity management, international human resources management, and organizational behavior. His research has been published in numerous books, book chapters, and articles in both the international trade and academic press.

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