Turning Up the Heat on CEO Pay

Posted on Feb 17, 2011 | 21 Comments

The Securities and Exchange Commission is busy writing rules that stem from the Dodd-Frank financial reform bill, which was signed into law last year. Among them is one that would require public companies to disclose the ratio between a CEO’s total compensation and the median total compensation for all other company employees.

Not surprisingly, corporate lobbyists are trying to water down this provision.  But Peter Drucker, we are confident, would have been in favor of the strongest rule possible.

Drucker asserted that the proper ratio between a chief executive’s pay and that of the average worker was around 20-to-1. That’s a far cry from the current ratio of more than 260-to-1 found at major U.S. companies.

“I have often advised managers that a 20-to-1 salary ratio is the limit beyond which they cannot go if they don’t want resentment and falling morale to hit their companies,” Drucker noted.

Today, we submitted our comments on this issue to the SEC.

What do you think: Is it important for companies to disclose the relationship between CEO pay and average worker pay? Why do you think companies are resistant to this? Could more transparency actually change behavior?

21 Comments

  1. Tweets that mention Turning Up the Heat on CEO Pay | The Drucker Exchange -- Topsy.com
    February 17, 2011

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  2. Nicholas Fusso
    February 18, 2011

    In Drucker’s “The Bored Board”, it’s written that “For every large organization is a rumor mill…”. I’ve personally found this to be especially true in the case of corporate compensation gaps. When compensation data is limited to the average employee, they’ll think the worst. It’s most certainly a negative impact on morale, on leadership, and on teamwork.

    Transparency of course opens up the possibility for employees to overly critique salary decisions. But hindering this pressure should be done not through hiding information, but through the explanation of a competent board.

    Reply
  3. Robert Kozlowski
    February 18, 2011

    This is one of the few times I disagree with Dr. Drucker. I have read his comments on this subject before.
    It is not the business of an employee to be concerned with what someone else is paid. If I hire an employee at X dollars to do a job for the company, what business or concern is it, what someone else makes. As long as I pay the person the agreed amount, and they do the agreed job, why should it be of any concern what someone else is paid? If the person hired feels they are not enough then that is negotiable, what is not negotiable is whether that person is paid relative to what someone next to them or the CEO is compensated.

    Reply
    • Jeanne' Moody
      July 27, 2011

      This is not only an urealistic comment, but idiotic in the extreme to think that it doesn’t matter! This kind of attitude is why the US no longer has a middle class. We are either poor or rich. CEOs are making exhorbitant salaries to send companies into bankruptcy while the people who actually have the ability to make the company a success, by making its system work, are making little more than minimum wage. And you think that those minimum wage workers dont have the right to know if they are valued at least 1/20 as much as the CEO? What is wrong with you?!!!?

      Reply
      • Satch
        December 10, 2013

        You’re missing the human factor here. People need to be paid enough to take the concept of money off the table. When CEOs make a grossly over compensated salary – esp. when the company is NOT profitable! (lookin’ at you, HP) – then it puts the “money back on the table” and people feel slighted.

        Reply
    • FredInIT
      November 23, 2013

      Thank you Ayn Rand. NOT!

      Reply
  4. rasih yanardag
    February 19, 2011

    Well, I think we have always to remember what Peter Drucker said: “A manager is nothing else then an employee of the company.”

    The only thing that differentiates the manager from “ordinary employees” is that he/she is much higher in the hierarchie and therefore can do things which “ordinary employees” can’t.

    The only thing a manager can loose in the worst case is his job – often accompanied by a golden parachute. So therefore the risk for failure for managers is quite limited. Meanwhile he/she can “play and fool around” with OPM (other peoples money). While an entrepreneur, who owns the company, always risks his/her own money.

    Do we need a “limit” or a fixed 20-to-1 ratio for pay? Well, I think what we need is a “fair pay” for managers, which follows certain guidelines and are transparent for everyone. People will accept higher pays (even beyond a 20-to-1 ratio) if they can say “yeap, his/her job was worth it). E.g. the former CEO of Porsche, Wendelin Wedekind, earned once +100 million Euro a year. But people said “yes, he deserved it.” Why? Because when Porsche was close to bankruptcy, he invested his own money into the company, turned the company around, made shareholders rich and every single employee got an extra bonus each year. So everybody won.

    My own conclusion: make sure that people concider that the pay for the top-managers are “fair” and transparent. And very close related to “REAL achievements”!
    I think then nobody has a real problem with what the ratio is. Oh yes, and I do think that there should be a maximum limit somwehere. Salarys of +20 million $ per year (or whatever the “exact number should be) are just unethical. Nobodys job (as an employeed manager – not as an entrepreneuer) should be worth that much. And in most cases isn’t at all anyway.

    Reply
  5. Paul Zak
    February 19, 2011

    Legislating CEO pay is worrisome because it lies on the edge of a slippery slope that begs managers to find loopholes (what is pay?, who is a CEO? etc.). A better solution is, I believe, to have truly independent compensation committees and clear objectives for performance. Managers deserve to be paid commensurate for the value they create, but that pay should be set in a fair and competitive market.

    Reply
  6. Alba Patricia Valencia
    February 20, 2011

    First, ethics and morals are the foundation of behavior. Both must be congruent.
    Oddly enough human species is congruent rather than transparent, because there must be coherence and consistency in the implementation of actions. The congruence of our actions depends on the consistency between discourse and action. Transparency is proper only to God. He is life, love, intelligence, substance, omnipotence, omniscience and omnipresence. Transparent action is not supported in human species.

    Second, all, to a greater or lesser extent, by act or omission, we lie. The loss of spontaneity is an evolutionary process whose stages we consume from childhood, as is based on our conviction that honesty is not always possible or desirable because it can cause damage to the receiver of the communication, or the issuer itself.

    There lies more socially positive that certain undeniable truths: there are many situations in which a lie wisely transmitted generates a beneficial effect, or at least palliative to radical moral categories that we set for this apparent dichotomy ethics: truth-lie. If we add that everybody, sooner or later, lie or conceal important truths, might be useful to play down the fact lies well to approach it with more sense and sense of proportion.

    Third, the power (force and intensity) of the reforms, associated with the cultural environment where they evolve, signal a great difficulty for the generation of the desired changes. The resulting scenario shows a critical vision or urgencies together with the uncertainty of decisions and the functional framework of the participants elites, in front of the global expectations of productivity.

    Primero, la ética y la moral son los principios fundamentales del comportamiento. Ambos deben ser congruentes.

    Por extraño que parezca, la especie humana es congruente mas no transparente, porque debe haber coherencia y consistencia en la ejecución de las acciones. La congruencia de nuestros actos depende de la consistencia entre el discurso y la acción. La transparencia le es propia tan solo a Dios. Él es vida, amor, inteligencia, sustancia, omnipotencia, omnisciencia y omnipresencia. La acción transparente no tiene soporte en la especie humana.

    Segundo, todos, en mayor o menor medida, por acción o por omisión, mentimos. La pérdida de la espontaneidad es un proceso evolutivo cuyas etapas vamos consumiendo desde niños, conforme se asienta en nosotros la convicción de que la sinceridad no siempre es posible ni conveniente porque puede causar perjuicios al receptor de la comunicación, o al propio emisor.

    Hay mentiras socialmente más positivas que ciertas verdades incontestables: son muchas las situaciones en que una mentira sabiamente trasmitida genera un efecto beneficioso, o cuando menos paliativo, como para que establezcamos categorías morales radicales sobre esta aparente dicotomía ética: verdad-mentira. Si a esto unimos que todos, antes o después, mentimos u ocultamos verdades relevantes, quizá convendría desdramatizar el hecho de la mentira para poder así abordarlo con más sensatez y sentido de la medida.

    Tercero, la potencia (fuerza e intensidad) de las reformas, asociadas al ambiente cultural en donde se desenvuelven, señala una gran dificultad para generar los cambios anhelados. El panorama resultante muestra una visión crítica de urgencias y apremios, acompañados de la incertidumbre respecto a las decisiones y a las articulaciones con el entramado funcional de las elites participantes, frente a las expectativas globales de la productividad.

    Reply
  7. Rocco DellaNeve
    February 21, 2011

    CEO pay is the most egregious in Wallstreet. Astonishing pay given performance and scandals. As much as I don’t like these ridiculuous salaries, I also don’t like the conversation on CEO pay either. Private firms should be able to pay their execs whatever they want. Let the owners (stockholders or corporate boards) restrain this. Public employees or charities are another option given that they are spending other people’s money. At the worst, this conversation is an extension of the Class Warfare discussion, which is based on the false assumption of a zero sum game on resources. This is false. Capitalism doesn’t move a finite set of resources around, it creates new wealth which creates jobs and in its better examples shares the wealth through stock ownership and dividends (Read Peter’s “The Pension Fund revolution”). President Kennedy stated that ‘rising tides lift all boats”. Peter stated that the world’s richest people are irrelevant compared to the middle class. I would say that American Capitalism has lifted a lot of boats. Our poorest typically have 1 car, a cell phone and cable TV. Not perfect, but compared to what …..Switzerland?

    Reply
  8. Sam Pizzigati
    February 21, 2011

    Peter Drucker’s notion that we need to maintain no higher than a 20:1 pay ratio between top executives and the workers in their corporations needs to be front and center in the ongoing executive pay debate. Our human future, as Drucker so clearly understood, will depend in large part on how effectively our enterprises function. Wide pay gaps undermine that effectiveness.

    Transparency about the current ratio — 263:1, by latest count — would make the logical first step toward restoring some enterprise common sense to corporate pay. Bravo to the Drucker Institute for making this case to the SEC!

    Reply
  9. Sarah Anderson
    February 22, 2011

    Thanks to the Drucker Institute for weighing in on this important issue. Too much of the debate over how to reform our out-of-control executive pay system has focused on the structure of compensation, with the idea that if we can just get the balance right between short- and long-term rewards, we’ll solve the problems. But it’s just as important to bring compensation levels, and the gap between CEO and worker pay, back to the more rational levels of the 1970s to discourage the greed-driven reckless behavior that got us into the current crisis. Asking corporations to report the pay gap between their top executive and their workers is a positive step.

    Reply
  10. World Beaters | The Drucker Exchange
    July 22, 2011

    [...] have closely aligned ourselves with IPS on other issues, such as runaway CEO pay. But Peter Drucker, we think, would have been [...]

    Reply
  11. James
    August 12, 2011

    A company is a team effort, everyone should be rewarded when the team does well. Also, a ratio isn’t a maximum limit or a cap on what the CEO earns. Imagine you are the CEO and want to make more money under this ratio system. By simply raising the pay of the lowest individuals in the company, your maximum earnings for the ratio goes up and you are able pay yourself more. As CEO, this might mean you need to have the company as a whole make more money and increase the pie size so that you can both pay the lower wage earners more and then yourself more.

    I think the spirit of this as a law is a good idea, once there is an agreement on the goal of a having a ratio as a law we can then debate the exact ratio and let the lawyers and courts do their magic with making sure CEO’s don’t find loopholes. Don’t let the difficulty of eventual implementation be a deterrent to the effort and desire to have fair pay.

    The additional money earned by the lowest wage earner has a significant impact on the standard of living of the individual than does 20 times that amount for the highest earner. If you are earning minimum wage, an extra $1000 per year is significant to a persons well being and long term finances. Compare this to if you are earning $260,000 per year, another $20,000 simply buys more luxuries. What portion of Maslow’s hierarchy would you not be able to afford on $260,000 per year? How about with a minimum wage salary?

    This ratio concept is also appealing because instead of the current alternative of taxing the rich and then handing it back out to the people in the form of social welfare programs, we can instead as workers feel as though we are actually earning something. Personally, I am a somewhat proud individual and handouts are unappealing because I should be able to make my own way. I’m certain other people feel this way as well to some degree. However, by forcing the company to pay the employees a fair wage in return for increased executive pay, we avoid the whole ‘embarrassment by handout’ problem.

    The fact that this model has worked in the real world with some companies proves that there is no vast and crippling underlying problem like you have with other economic models that are only good on paper.

    Please excuse the length of my comment but there are several points I wanted to hit.

    Reply
    • Maggi M
      October 18, 2011

      This is a perfect example regarding the social inequity felt deeply by the burgeoning Occupy movement! What a better business model! What a motivating incentive for employees.. to share in the growth of the business they put their blood, sweat and tears into! Producttivity.. up, sick days .. down! A high level of morale and all-encompassing sense of integrity would be the driving force of success. Great foundation to build from. I guess my question would be what happens when something does happen to drive profits down.. in which the natural step would be for everyone to take a decrease in pay.. or the usual lay-offs/benefit slashing would need to occur? How would this work?

      Reply
  12. James
    November 3, 2011

    Maggi,
    You bring up some good questions. Both of those situations occur in companies today, many people take ‘pay freezes’ which is the same as paying them less, having their benefits cut, or are simply laid off as you have said. And it is true, that may not change with the implementation of a fixed ratio for compensation.
    I think the issue you have brought up can be considered a separate problem from the compensation inequality problem and may have it’s own separate solution. I don’t think it is necessary to tackle both of them at once is what I am trying to get at. It’s possible to implement an income inequality solution and independently tackle the problem of how to better gracefully deal with decreased performance of a company no matter what the compensation system looks like.
    Personally, I think it is better to have some positive incremental change now than to wait for all issues to be addressed simultaneously since you might be waiting a while for that. The lower wage earners might as well reap the benefits of an inequality solution while waiting for the long list of other problems that are known to exist to be solved as well.
    I don’t mean to push your concerns aside, but to recognize them as valid and related, but still focus on the issue at hand, namely, income inequality and it’s proposed solution. What do you think?

    Reply
  13. Das Kapital, Via Davos | The Drucker Exchange
    January 27, 2012

    [...] saw many sins in capitalism and deplored things like excessive executive pay and the short-term orientation displayed by many who worship the market. But he tended not to [...]

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  14. Leanpub Podcast on My Book – Management Matters: Building Enterprise Capability » Curious Cat Management Improvement Blog
    January 23, 2013

    [...] Bonuses – Taking What You Don’t Deserve, CEO Style – More on Obscene CEO Pay – Turning Up the Heat on CEO Pay (Drucker Institute): “Drucker asserted that the proper ratio between a chief executive’s [...]

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  15. P N Vasudevan
    March 11, 2013

    There are arguments as to why should private companies’ CEO salaries be subject to discussion by anyone other than its own board/shareholders. however, the point to note is that all companies, whether public or private, do use public resources in some manner or the other. all companies do draw their resources from the pool of common resources available and which, if not drawn by one company, gets drawn by another company. this mindless pursuit of self-deceit that we are a private company and hence should be away from the burden of public scrutiny is what is causing so much wreck all around the corporate world. as the saying goes, there is enough for everyone’s need, not greed. and those managers who are at the top and have an ability to influence their own compensaitons, are the ones who need to set the right example of unselfish behaviour if they want the rest of the organisation to also match their attitudes and actions.

    whether public or private, definitely all companies must have some form of a common method of fixing the pay of their top managers in a fair manner. while the 20:1 cap is a good beginning, it can probably be left in a range of say around 20:1 which gives some flexibility but still reins in extreme behaviours. also the top managers’ salaries must be widely published within their organsiations as well as outside. we, in Equitas, strongly believe that if all corporates only push ‘transparency’ automatically fairness would follow. it is difficult to imagine that one can be unfair and be transparent about it. hence while there may be some leeway given in the ratio cap, there should be no let up on the need to be fully transparent so that it acts as an automatic check on fairness.

    some would, of course, use flowery languages like ‘there is a line between being transparent and nude’ etc to show that some things must be kept confidential in the larger interest. however these are only attempts by people who dont believe in transparency from the bottom of their heart. let such people put their hand over heart and say that transparency in such issues would hurt them?

    regards/vasu

    Reply
  16. The Big Money: Revealing CEO Salaries – Hot Ideas for a Cold Economy – The Frying Pan
    June 24, 2013

    [...] Act mandating that companies disclose the ratio of CEO pay to median company pay. (We even wrote our own letter to the Securities and Exchange Commission about [...]

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  17. What if we knew how much CEOs made vs. their workers?
    August 22, 2013

    […] and execution is suffering at American companies. Employees really do care about this issue.” Peter Drucker famously believed that the proper ratio should be 20-to-1. That sounds pretty fair to […]

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