Commentary by David F. Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.
The financial reform bill that recently passed the Senate Finance Committee would require among other things that companies report the ratio of their CEO’s pay to that of the average employee. Advocates argue that such disclosure will help to rein in executive compensation by allowing for a more direct comparison across companies and industries.
We disagree. The ratio of CEO to average employee pay is a statistic that gets much media attention but has little practical value. It is likely to raise far more questions than it answers.
Take for example, H. Lee Scott, former CEO of Wal-Mart. According to the company’s most recent proxy, Scott was awarded $30 million in total compensation for 2009. Assuming that the average Wal-Mart employee makes something like $40,000 in salary and benefits, Scott can be said to make 750 times more than the average Wal-Mart employee.
Is this too much? By some measures, yes. Recent studies estimate that the average CEO of a U.S. corporation earns somewhere between 180 and 530 times more than the average employee (measurement and sampling differences account for the extreme discrepancy among results). The ratio at Wal-Mart exceeds all of these. Even Lloyd Blankfein, CEO of Goldman Sachs, makes “only” 140 times his average employee ($70 million versus $500,000). By comparison, Scott looks grossly overpaid.
By other measures, however, Scott’s pay looks much more reasonable. Does Scott create 750 times more in corporate value than the average employee? Probably. Does oversight responsibility for 2.1 million workers and $400 billion in revenue merit 750 times more compensation than the oversight responsibility of the average Wal-Mart associate? Perhaps. Would the company rather eliminate the CEO position or 750 other positions selected at random? We’re guessing the latter.
The problem with all of these comparisons is that they are highly arbitrary and do not contribute to a meaningful discussion about compensation.
From our perspective, the “right” amount to pay a CEO is the lowest amount that it takes to attract, retain, and motivate a qualified executive to lead the corporation. This is the same calculation that is made in setting the compensation of all other employees. From there, a ratio between the two will emerge, and it would be hard to argue that it’s irrational.
The focus should be on these issues, and not on a summary statistic that has no logical point of reference and is likely to stir up more controversy than it settles.