Former MGM Resorts Chairman and CEO Jim Murren (Photo by Larry French/Getty Images for MGM National ... [+] Harbor)
GettyOver 40 million Americans have lost their jobs since the start of the Covid-19 pandemic. Meanwhile, corporate CEOs are doing just fine. The average compensation of CEOs at companies in the United States is over $12.3 million. CEO compensation has grown 940% since 1978. It would take several lifetimes for an employee to earn as much as their CEOs.
In late August 2019, I wrote about the Business Roundtable, an association of over 180 chief executive officers of America’s leading companies, releasing a progressive statement meant to radically change the mission of corporations and the lives of their employees. The top executives pledged that they will alter the way they operate and focus on their employees to ensure that everyone is treated fairly. This aspirational goal didn’t last too long.
In my initial coverage of the pledge, I predicted, “It's easier to portray themselves as caring individuals fighting against income inequality in an environment with record-high employment and a roaring stock market. At the first decline in the economy or a recession, the companies will most likely retract their offerings in an effort to save resources.” That’s exactly what happened.
While millions of Americans lost their jobs, had their hours cut, were forced to take positions beneath their experience and educational levels or labored in essential jobs risking their health and safety, corporate industry titans were well-compensated.
Companies cut jobs, but CEOs continued to receive lush pay packages. Iconic brand-name corporations filed for bankruptcy protection causing massive layoffs and the CEOs and top-echelon executives were richly rewarded with generous million-dollar bonuses.
The Wall Street Journal previously reported that then-CEO of AT&T Randall Stephenson received roughly $32 million in compensation last year, while about 20,000 AT&T workers lost their jobs. A company spokesperson disputes the numbers, as well as claims that thousands of jobs weren’t offshored after U.S. workers trained them.
The oil and shale sectors were hit hard, in large part, by the Covid-19 crisis, as people stopped traveling. Bloomberg reported that roughly 35 executives at Whiting Petroleum, Chesapeake Energy and Diamond Offshore Drilling may receive about $50 million after their respective companies declared bankruptcy—or edging close to it. The board at Whiting filed for Chapter 11 in April and the board of directors approved a $6.4 million bonus for CEO Brad Holly.
After 100 years in business, the once-beloved retailer, J.C. Penney, filed for bankruptcy protection and paid out millions of dollars to top executives right before it happened. In a regulatory filing, it was disclosed that J.C. Penney CEO Jill Soltau received a $4.5 million bonus. Three top executives, including chief financial officer Bill Wafford, chief merchant officer Michelle Wlazlo and chief human resources officer Brynn Evanson each received a $1 million payout.
Hertz, the well-known car rental company that’s been an American fixture at airports, handed out over $16 million in bonuses days before filing for bankruptcy. Hertz paid a $700,000 bonus to chief executive Paul Stone. Chief financial officer Jamere Jackson was awarded $600,000 and chief marketing officer Jodi Allen received $189,633, according to the Wall Street Journal.
The common claim from companies defending the largess is that they need to retain the top talent to guide them through this tumultuous time. This flies in the face of reason given that the very same people led their companies off a cliff to financial ruin, causing thousands of workers to lose their jobs and be thrown into one of the worst job markets since the Great Depression.
Tenet Healthcare furloughed thousands of workers in the wake of the coronavirus. CEO Ronald Rittenmeyer pledged to relinquish about three months’ pay to help out his employees. It's a noble statement; however, it falls flat. Rittenmeyer will still take home about $1 million in salary, an $875,000 bonus and stock awards worth $11.3 million through 2022, along with a contract worth millions more.
Kroger, the ubiquitous grocery store chain, discontinued its extra $2-per-hour hazard pay. Meanwhile, CEO Rodney McMullen made $21.1 million in compensation for 2019. This is in stark contrast to the average worker who gets under $27,000 in pay and benefits.
Hotel and gambling empire MGM Resorts furloughed tens of thousands of workers and began layoffs. That didn’t stop the company from giving its departing CEO, Jim Murren, a $32 million golden-parachute package.
It was reported by the Financial Times that Disney furloughed roughly 100,000 employees (this was disputed by the company’s spokesperson) to deal with a sharp decline in revenue in its core business lines. Some Disney executives have made it known that they’ve taken salary cuts or elected to reject their salary for certain defined periods of time. Disney Chairman Bob Iger (who up until recently was the CEO) will forgo his $3 million salary for this year. Back in May 2019, Forbes estimated Iger’s net worth to be at about $690 million. Disney CEO Bob Chapek said he would forfeit half of his $2.5 million base salary.
The salary declination is somewhat disingenuous and conveniently leaves out an important fact—the two executives will still accept massive bonuses and long-term incentives that dwarf their salaries. Iger earned about $65.6 million in 2018 and $47 million last year. To put this number into perspective, it's 900 times higher than the median Disney worker’s earnings. Chapek should earn an annual bonus of “not less than 300%” of salary, along with an incentive award of “not less than $15 million.” According to a Disney spokesperson, executive bonuses are not determined until the end of the year, based on performance and are said to not be guaranteed. Disney claims that reports stating executives will still receive bonuses and other incentives are based on what has happened in the past.
United Airlines chief executive Oscar Munoz announced he will waive 100% of his base salary until—at least—the end of June. For 2019, his wages were $1.25 million, but this was only 10% of his total remuneration package. United Airlines received approximately $5 billion from the federal government through the Payroll Support Program under the Coronavirus Aid, Relief, and Economic Security (CARES) Act. These funds secured from the U.S. Treasury Department need to be used to pay for the salaries of its thousands of employees.
The airline said that it will cut thousands of jobs starting on Oct. 1. The date is important in that, by accepting the money from the stimulus plan via the CARES Act, companies are required to retain employees for a specified time period and can’t fire workers until after Sept. 30. It shows that the company is gaming the system by waiting for its very first window of opportunity to downsize thousands of employees.
Aircraft manufacturer Boeing was accused of selling its 737 Max jets with faulty software, failing to provide adequate training to pilots and maintaining a too-cozy relationship with the regulator that oversees the company, which may have led to the crash of two planes that killed hundreds of passengers. Boeing also spent over $11 billion to buyback stock. Boeing’s CEO at the time, Dennis Muilenburg, was fired and walked away with about $58.5 million.
There’s no accountability for mistakes made under the watch of the CEOs. Last year, former Equifax CEO Richard Smith, received roughly $19.6 million in stock bonuses and a $24 million pension. This was subsequent to the credit agency’s disastrous data breach. Similarly, back in 2014, Target paid ex-CEO Gregg Steinhafel over $30 million in the wake of a major hack of its customers’ data.
When the stock options don't work to the benefit of CEOs and executives, the companies change the game. They then change their executives’ pay packages to make up for it. U.S. car dealership, Sonic Automotive, laid off and furloughed a third of its employees due to deteriorating business conditions.The company’s senior executives received new stock options to replace the prior performance-based share awards. Chief executive David Smith’s new awards are worth about $5.16 million. This is greater than four times the value of the performance-based stock awards. Sonic isn't the only company doing this. Reuters reported that an array of other companies have also changed—or plan to improve—their executives’ incentive compensation.
It's fair to appropriately award CEOs when they add value to their companies. It's tone-deaf and inappropriate to reward executives who preside over companies that fail and seek bankruptcy protection due to mismanagement or layoff thousands of workers, while simultaneously receiving lush compensation packages.
It’s no surprise that business executives make more money than lower-level employees. But when that pay disparity between a CEO and the average worker is perceived as unfair, the result may be more than unhappy workers: A firm’s performance can deteriorate.
The gap between the large sums that CEOs take home versus average employee pay is taking on added importance in 2018, as public companies in the United States are mandated for the first time to disclose pay ratios between the CEO and employees. Harvard Business School Assistant Professor Ethan Rouen warns that if those disclosures are not made with proper context, they could ignite worker backlash and harm productivity.
“When you hear the amount that a CEO makes, it is going to seem outrageous. People are going to react with passion,” Rouen says. “So, it’s going to fall on every company that has to disclose these figures to provide some explanation and give a measured response justifying the pay disparity.”
Connections between wage disparity and company performance are detailed in Rouen’s recent working paper, Rethinking Measurement of Pay Disparity and its Relation to Firm Performance.
In essence, firms can flourish when they pay their workers fairly—and struggle when they don’t, the research suggests.
Resentment leads to employee backlash
Rouen’s research findings add a layer of understanding to previous studies on the effects of pay disparity on company performance, which produced mixed outcomes.
Some studies support an economic idea known as Tournament Theory, which says that as pay differences between job levels increase, the value of receiving a promotion also rises—spurring employees to put in more effort.
“People make work decisions based on what they’re being paid and what others around them are being paid,” Rouen says. “If the person above me is making a lot more money than I am, but I feel like I could work harder and get promoted to get the same salary, I will be motivated to do that.”
Other researchers backed the concept of Equity Theory, which says that pay disparity generates feelings of unfairness—leading lower-paid employees to shrug off their responsibilities or leave their jobs. In other words, Rouen explains, if employees feel their hard work isn’t being rewarded, “this pay disparity will create resentment.”
“People make work decisions based on what they’re being paid and what others around them are being paid”
Rouen believes the results of these earlier studies fall short because they don’t take into account how CEO and employee compensation are determined. In essence, they ignore the reasons for the pay disparity, which can make a difference in how the gap is perceived by workers.
Rouen set out to explore the factors at play. He obtained data from the US Bureau of Labor Statistics for 931 firms in the S&P 1500 between 2006 and 2013, including total employee compensation and the composition of the workforce.
He found that CEOs in the study took home an average annual paycheck of $5.8 million while the average employee earned $42,000, and determined the ratio of CEO compensation to mean employee compensation. He also figured out what he calls the “economic pay ratio” you might expect to see based on economic factors influencing both CEO pay and employee pay (such as worker performance and labor market characteristics), as well as the “unexplained pay ratio”—the portion of pay disparity not driven by economic factors.
Rouen then studied how these measures of pay disparity affected future firm performance. He found that firms with an abnormally high unexplained pay ratio saw their performance drop by as much as half, compared to their industry competitors that had low levels of unexplained pay disparity.
In the most glaring cases—about a fifth of the companies studied—not only was the CEO overpaid, but the employees were underpaid, as well. “When both occur—the CEO is overpaid and the employee is underpaid—that’s when you really see the firm performance suffer,” Rouen says.
These firms can feel the backlash in a variety of ways: They may suffer weak corporate governance, lower sales, and higher employee turnover.
“You have this high turnover, and that is incredibly costly because you have to search for new people and train them, plus you have a short-term decline in productivity,” Rouen says. “And then you have the people who stay but are dissatisfied and won’t work as hard. If you’re not making your employees happy and creating an environment where they’re doing their best work, your firm is not going to succeed.”
The research found that as compensation at a firm moved closer to the expected levels based on economic factors, firm performance increased.
Pay ratios need explanation
Rouen was particularly motivated to study the issue because the US Securities and Exchange Commission in September 2017 adopted a rule stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule mandates that companies disclose the ratio of the CEO’s compensation to median employee pay starting in the 2018 proxy season.
Rouen is concerned those pay ratios may appear misleading to both employees and investors because, in some cases, economic factors that drive those earnings differences won’t be apparent. For instance, Apple is likely to have a CEO-to-employee pay ratio that is much higher than other firms in its industry. That’s because the company employs a large number of retail workers who earn less than, say, engineers, and that lower pay grade will skew the average employee pay figure lower.
“You may say the pay ratio at Apple looks outrageous because it might be 200 to one. This is a number people will latch onto, but at the same time, it’s not really fair, and it won’t capture what regulators are hoping to capture,” Rouen says.
Once the new SEC disclosure rule comes into play, firms should brace for some worker disgruntlement.
“When you disclose compensation, you wind up losing talent”
“When you disclose compensation, you wind up losing talent,” Rouen says. “[Many companies] will see this negative reaction from employees, who know how much people at other companies are making, and that can change their expectations about what they should be making.”
Companies should offer detailed information to investors and employees outlining the economic justifications for their pay ratios, Rouen says. For example, firms can spell out whether a simple factor like geography is creating pay diversity; clearly, an employee in New York City will be paid significantly more than a worker in rural Alabama due to huge differences in the cost of living.
Corporate culture creates large impact
In addition to providing a clearer explanation of pay disparity effects, the study also spotlights the importance of corporate culture in creating value for employees.
“The evidence more and more suggests that corporate culture is a first-order driver of company performance,” Rouen says. “It’s something that can differentiate one company from another in a competitive industry.”
Companies can boost workplace culture in ways beyond compensation, particularly by providing promising career opportunities and allowing workers to pursue personal interests at work, Rouen says.
“Yes, people work for money, but they also work for other things. Firms should think creatively about how to retain their top talent,” he says. “Executives need to determine not just how to pay their employees better, but how to make their employees’ lives better in some way.”
Related Reading:
Why a Federal Rule on CEO Pay Disclosure May Get You In Trouble With Customers
Will Transparency in CEO Compensation Have Unintended Consequences?
Rising CEO Pay: What Directors Should Do
What do you think about this research?
Does your CEO's paycheck influence how you do your job?