The truth about executive pay

Measuring executive pay ratios is an enormous waste of time and effort, especially when you consider that we could, instead, decide to measure something much more enlightening such as corporate productivity. Then  at least our metrics would give us something to celebrate. Instead, the equality industry expends a huge amount of energy measuring the multiple by which CEOs earn more than the average worker so that they can regale us with shocking reports about how much other people earn.

​There seems to be a general consensus that corporate executives are paid Too Much, though nobody is quite sure what measure is applied to deciding whether other people are paid too much or how we measure the value of what they have produced - do we simply conclude that if they are paid much more than other people, that is by definition too much? The difficulty then is, that doesn't seem like a very scientific way of measuring things.

Any legal measures designed to bring down rich corporate types are always going to be popular, because why not? Most of us have nothing to lose if the mighty are brought down, and it might be very satisfying to try. Who wouldn't like to see all the greedy bankers squirm in discomfort as they are denounced for being the 1% and excluding the 99% from their fair share of the earth's bounty? This makes it oddly gratifying to see them being denounced by a domestic parliamentary select committee. But entertainment value aside, there's a serious question concerning how executive pay is measured.

​Executives receive compensation in a dizzying array of forms, including base salaries, annual bonuses, long-term incentives, restricted stock, performance shares (i.e. restricted stock with performance-based vesting), stock options, retirement benefits, and perquisites ranging from health benefits to club memberships and personal use of the corporate jet.

In addition, executives routinely receive lump-sum amounts at various points in time, such as signing bonuses when joining their firms, severance payments upon termination, and change-of-control payments when their companies are taken over.

Kevin J. Murphy, ‘Executive Compensation: Where We Are, and How We Got There
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Since equality and fairness are top policy priorities for today's governments, we can see this feeding into the law, with a legal obligation for publicly traded companies to disclose pay ratios. At least this will spare the resources of those who have been working valiantly all these years trying to measure other people's pay, and they will now be able to turn their attentions to other aspects of the inequality parade. These new developments will be reflected in revised corporate governance standards, as reported in the Guardian:

Companies that are publicly listed in the UK will be obliged to publish the pay ratio between their chief executive and their average British worker under government plans.

The requirement will mean that about 900 large listed companies will need to annually publish and justify the ratio of pay between their chief executive and the firm’s average UK worker.

The Guardian, 29th August 2017

This seems to be based on the assumption that it is very important, for purposes of equality, fairness, justice, etc, for you to know exactly how much your boss earns and how that compares mathematically to your own wage. These days people will accept just about any old nonsense if they think it's for equality, justice, fairness, etc, without taking care to examine more closely what these concepts mean and what they require from us.

​The fog surrounding these concepts makes it difficult to ascertain the truth about executive pay, especially when faced with conflicting sums: does the boss earn 350 times your wage, or only 100 times your wage? Even after you’ve decided which mathematical calculations are the most robust what should you do with that information?

• Quit your job because of all the inequality and unfairness?
• Start campaigning for equalisation?
• Lobby the government for more laws to achieve a situation where CEOs are not so shockingly wealthy?
• Go out and riot if it's summertime and the weather is nice?

What is the truth about the various multiples of executive pay, and why should we care?

According to leading think tanks in the equality industry, the average CEO earns 386 times more than minimum wage workers.

The average FTSE chief executive earns 386 times more than a worker on the national living wage, according to an analysis published by the Equality Trust  as it steps up its campaign for new government rules to expose pay gaps.
 
Katie Allen, The Guardian, 22 March 2017
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It is not clear what a minimum wage worker needs to do with this information once it has been 'exposed', but we’ll come that in a minute. 

​The anxiety about pay does not only relate to the disparity between the highest and lowest wage; it is also concerned with the disparity between CEO pay and the average wage.

​Chiming with research by other groups that suggests the squeeze will accentuate inequality, the trust found more than two-thirds (67%) of FTSE 100 CEOs were paid more than 100 times the average UK salary.
 
The Guardian, 22 March 2017
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Now we know that the average CEO earns 386 times the minimum wage, and 100 times the average wage. What should be done? So far the proposals about what the government should do relate to disclosure rules, on the assumption that once the truth is exposed and people can link the headlines about 'fat cats' to individual miscreants those individuals can be shamed into agreeing to a pay cut that will bring them in line with the lower-waged so that it’s fair.

While the equality industry lobbies the government to fix this problem, economics think tanks are questioning the maths. According to the Foundation for Economic Education, the gripping ‘386 times more’ and ‘100 times more’ soundbites are ‘based on pure numerical chicanery’ and ‘flawed statistical assumptions that result in meaningless apples-to-oranges comparison’.
 
It is immediately obvious that in the war between the equality industry and the economists, the equality guys must win the popular vote. Which side do you think has the more compelling arguments: those who say that your boss is overpaid when he doesn't really do any work but just creams off the profits produced by other people like a shameless capitalist parasite; or those who expect you to look closely at the mathematics (yawn) to see whether the calculations stack up?

​I can imagine rioting over ‘fat cat CEOs’ who are causing the rest of us to suffer poverty conditions redolent of the 14th century, but I really can’t imagine anybody mounting the barricades over ‘numerical chicanery’, ‘statistical legerdemain’ and ‘serious mathematical flaws’. The truth about executive pay is that we don't care how the figures are calculated or whether they are accurate. We are just cross that some people are wealthier than others, and that's about the sum of it.
 
The numerical chicanery highlighted by FEE includes making apples-to-oranges comparisons, like this.

​First compute the average CEO pay: 

[They] compare total CEO compensation (base salary plus all additional forms of compensation including cash bonuses, stock awards, option awards, pension benefits, etc.) for executives in their prime earning years managing the world’s largest corporations...

Mark J. Perry, FEE
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Here CEO means CEO in a FTSE 100 (top 100 companies traded on the London stock exchange), not CEO of the butcher shop down the market square who incorporated himself into a one-man-firm and designated himself as its CEO with his wife as the CFO and the two of them are working hard to make ends meet. Not them. 
 
When we worry about executive pay we are obviously focusing on the largest and most profitable publicly-traded firms because if we include the corner shop it will just bring the average CEO income down; also the CEO of the corner store doesn’t have any bonuses or stock options or fancy long-term incentive plans; he barely expects to escape with a pension after his life of hard graft.
 
So to begin our comparison we must first target the richest men [editor: it would be unfair to include women, women have historically suffered enough already] in the largest corporations with the heftiest income packets. We only choose those CEOs in the prime of their careers who are at their highest earning potential; it’s no good including young CEOs who are just starting out on their corporate career and working long hours earning peanuts because when we say 'executive pay' we are only interested in those at the helm of a large and successful company.

​From that starting point, we compare CEO pay to:

Cash-only pay for part-time rank-and-file workers of all ages working for companies of all sizes (including small grocery stores, independent small restaurants, etc).

Mark J Perry, FEE
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In other words, we compare CEO pay to minimum wage and zero-hours workers. You won’t find enough low-wage earners just by focusing on large publicly-traded successful firms – in order to bring in all the poor and exploited you have to look at the corner store and the struggling café in the market square. So you are now basically comparing the part-time 16 year old waitress at the Market Square Café in your town who sometimes waits tables after school, to the CEO of a global corporation like Amazon. Yeah, I guess he probably does earn 386 times her wage. Could even be closer to 1000 times her wage.
 
The next question is, what should you do with this information? For purposes of deciding what to do, it doesn’t really matter if the mathematics is correct. If you try to correct your variables and compare like for like, then according to FEE you end up with a ratio of 177-to-1 or even 104-to-1 based on median pay instead of average pay. That may be slightly less worrying than 386-to-1, but it doesn’t really make any difference to the underlying battle for equality. If you’re going to riot for a CEO who earns 386 times your wage I’m sure you could be persuaded to riot for a CEO who earns 104 times your wage or even 50 or 10 or 5 or 2 times your wage. Who cares? It’s still inequality, and if you’re an Equality Warrior then surely you should never rest until all wages are equal?

You might think that this is a fair price to pay for a 'public' company that enjoys the advantage of offering its shares to the public and thus having access to wider capital markets. But private companies too will be subject to disclosure rules if their shareholders are unhappy about executive pay:

​Listed companies which have faced regular shareholder opposition over top-level pay will also be included on a new public register. There will also be a voluntary set of guidelines for large private companies.

The Guardian, 29th August 2017
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This will work, at least for now, as a voluntary 'name and shame' system on the principle that the highest earners will surely volunteer for paycuts as soon as the disquiet about their wages is exposed to the harsh light of day.

It is not clear whether anybody knows, or cares, what these companies actually do. What do they produce? Are their products good? Are they competitive? Do they create job opportunities? How do the wages they offer compare to the income in comparable jobs at other workplaces? None of these questions has proved to be as attention-grabbing as the urgent matter of discovering what the CEO earns.