“Surprising Findings” on Relationship Between Pay Ratio and Corporate Effectiveness

A recent Wall Street Journal article authored by two researchers at the Drucker Institute report that, much to their surprise, companies with a high ratio of CEO pay to that of the median employee score better on the Drucker Institute measure of management effectiveness.   The Drucker Institute measure of company effectiveness is a composite of ratings in five areas (customer satisfaction, employee engagement and development, innovation, social responsibility, and financial strength) and is an attempt to assess company performance from multiple perspectives.   

The study analyzed 482 large companies over the period 2019 to 2021 to assess the relationship of CEO pay ratio and company effectiveness.  The companies were divided into four quartiles based on their pay ratio (481:1, 243:1, 154:1, and 85:1) and the authors found that companies in the top quartile of pay ratios scored highest on each of the five measures of company effectiveness, while companies in the lowest pay ratio quadrant consistently ranked lowest on each measure of effectiveness.  The authors speculate that this unexpected result is attributable to the fact that “the majority of CEO pay comes in the form of stock and stock options, and the most effectively managed companies in our rankings have, by and large, watched their shares perform very well in recent years.” 

However, the authors’ rationale for the high pay ratio/high effectiveness relationship points to their lack of understanding of the Summary Compensation Table measure of CEO pay, which, as the numerator in the pay ratio calculation, is not impacted by the change in stock price but is based on the grant date value of the equity award.  The Institute for Policy Studies conducted an analysis attempting to replicate the results of the Drucker Institute study using a broader list of companies, but found the opposite relationship between CEO pay ratio and company effectiveness.  

Despite being widely reported due to the high-profile nature of the Wall Street Journal as a publication, the findings of the Drucker Institute research are by no means determinative. The contradictory findings by the Institute for Policy Studies demonstrate that any purported “insights” based on the mandated CEO pay ratio disclosure should be taken with a very large grain of salt.