In recent years, an increasing emphasis has been placed on the idea that executives of major companies make an incredible amount of money each year. In the U.S., it is not uncommon to see executives making over 100 times more per year than their entry-level employees, with some firms paying their top-level management over 1000 times more.
Worryingly, this trend has continued and expanded over the past 10 years. Even during part of the time since the Great Recession, executive pay grew while wages for the average worker stayed flat. According to a study by the Economic Policy Institute in 2012, chief executives were paid 231 times as much as, not the lowest-paid workers, but the average American worker. While this number was down from the peak of 383 in 2000, it still was significantly higher than the 1990 number of 53.
On a global scale, surprisingly, the same situation is not found everywhere. Specifically, executive compensation in Europe has historically not matched the trends in the U.S. Numerous studies over the years have identified the ratio of executive-to-worker pay as being much lower in Europe than in the United States. As an example, a 2013 study found that the ratio of CEO-to-worker pay in the U.S. in 2012 was 354-1, while in Norway, Portugal and Germany, the ratios were 53-1, 58-1 and 147-1, respectively.
One contributing factor to this is the use of compensation consultants. Much more often in the U.S. than in Europe, compensation consultants advise the board of directors. These advisers are tasked with crunching the numbers and coming back with an appropriate payment schedule for the executives. Unfortunately, consultants ultimately answer to boards that usually make efforts to retain the executives and keep them happy rather than simply paying average amounts. This leads to an almost guaranteed raise for the executive in question and a handsome payday for the consultant.
However, compensation data is notoriously difficult to find and report on accurately. For example, despite focusing on relatively recent data, the two studies cited previously report dramatically different numbers for the year 2012.
In an effort to remedy this, a recent paper by authors from the University of Virginia and University of Southern California gathered a dataset on executive pay, taking advantage of recent changes in disclosure rules. To their surprise, they found that pay in Europe has steadily been moving toward U.S. levels. Controlling for firm size, industry, board composition and ownership structure, U.S. CEOs make only 26 percent more than their European counterparts. While still significant, this is much less than conventional wisdom had assumed in the past.
The real conundrum in these numbers is that there is often only a small link between company performance and compensation. Whether the company is in the United States or in Europe, salary and bonuses too seldom reflect company earnings. Efforts are being made in France and in Britain to curb this trend where so-called “say on pay” laws give shareholders more input on executive pay. Other newer packages tie future compensation to long-term performance, opening the door to significant reductions in payouts should the company fall on hard times.
In the end, the questions around executive pay are difficult and complicated. But the discussions about compensation need to happen. Whether the conversation focuses on inequality between continents or gaps between workers and executives, there is a great deal of work to be done. Our current structure is unsustainable in the long run; the time to start making necessary adjustments is now.
John Hoffmire is director of the Impact Bond Fund at Saïd Business School at Oxford University and directs the Center on Business and Poverty at the Wisconsin School of Business at UW-Madison. He runs Progress Through Business, a nonprofit group promoting economic development.
Ben Young, Hoffmire’s colleague at Progress Through Business, did the research for this article.