March 03, 2017
A recent article in Harvard Business Review argues that disclosure of pay ratios "may have unintended consequences that actually end up hurting workers" and that ratios are misleading "because CEOs and workers operate in very different markets—so there is no reason for their pay to be linked—just as a solo singer's pay bears no relation to a bassist's pay." The article, titled "Why We Need to Stop Obsessing Over CEO Pay Ratios," by Alex Edmans, a professor of finance at London Business School, notes that CEOs may seek to make their ratios look better through outsourcing, investing in automation and similar approaches. He notes that as companies have grown larger, CEO leadership matters more. For example, he states the influence over a $20 billion company (the average Fortune 500 firm size currently) of a CEO contributing 1 percent more to firm value than the next-best CEO is worth $200 million. He also notes that researchers have shown that the "six-fold increase in CEO pay since 1980 can be explained by the six-fold increase in firm size." However, the same argument does not apply to workers because a CEO's actions and decisions are scalable across the firm while other employees' actions are typically not scalable in that way. He also mentions, as our Center On Executive Compensation has argued many times, that the pay ratio is not comparable across industries and the ratio is unduly costly to develop, with first year costs estimated by the SEC at $1.3 billion. Instead of pay ratios, Professor Edmans suggests linking pay to long-run stock price, noting that companies which do so beat peers by 4 percent to 10 percent per year, and it "improves not only profitability and innovation but also the stewardship of customers, the environment, society, and, in particular, employees."