What the Presidential Candidates Are Failing to Address About CEO Pay

This article originally appeared in Fortune on Nov. 11, 2015

By Philip Kotler

In Tuesday night’s Republican TV debate, Wall Street Journal editor-in-chief, Gerald Baker, put the following question to presidential candidate Rand Paul: “Income inequality has been rising in the United States. Fifty years ago, for example, the average CEO of a big corporation in this country earned 20 times the average salary of one of his or her workers. Today, that CEO earns about 300 times the average salary of a worker. Does it matter at all that the gap between the rich and everyone else is widening?”

Presidential hopeful Rand Paul accepted this but said that the cause lies with the Federal Reserve keeping interest rates low; therefore, offering no direct answer about the growing income equality, even while many CEOs pulled in a much higher pay ratio in 2014:

• The CEO of Discovery Communications was paid $156 million or 1,951 times the median worker pay of $80,000.
• The CEO of Chipotle was paid $28.9 million or 1,522 times the median worker pay of $19,000.
• The CEO of CVS was paid $32.4 million or 1,192 times the median worker pay of $27,139.
• The CEO of Walmart was paid $25.6 million or 1,133 times the median worker pay of $22,591.
• The CEO of McDonald’s was paid $7,29 million or 644 times the media worker pay of $11,324.

These pay ratios are massive. Companies with these pay ratios will have to do a lot of explaining. Even if the average pay ratio of major Fortune 500 companies is 300-to-1, the question is: are our CEOs overpaid or our workers underpaid?

This is news because the U.S. Securities and Exchange Commission (SEC) just approved by a 3 to 2 vote along party lines that public companies will have to disclose these pay ratios. Five years earlier under the Dodd-Frank law, the S.E.C. was asked to come up with this measure. Now that it is official and beginning in 2017, public companies will be required to post these numbers.

Not surprisingly, the U.S. Chamber of Commerce is expected to sue over this rule and get the courts to deny the SEC’s right to require these numbers.

Many companies had been resisting supplying this information, arguing that the two numbers are difficult and costly to estimate: (a) a CEO’s pay includes salary, bonuses, stock options, restricted stock grants, and long-term incentive payouts, not to mention that a CEO’s pay varies every year, and (b) the median workers’ pay in a multinational corporation differs in different countries and the resulting median number is almost meaningless.

Probably what is really on their mind is that it will create bad publicity for their company and for capitalism itself. It could make combatants out of their employees, consumers, investor groups and even state governments.

• Employees may see competitive companies paying a higher median worker pay than they are receiving, and this can get them to start or join a union.
• Unions are in favor of pay transparency because it will help them bargain better for wage increases.
• Consumers may conclude that a company’s prices are too high partly because of high executive pay and decide not to buy from companies that pay very high CEO pay ratios.
• The company’s shareholders might be upset with the negative publicity and reconsider whether they are paying their CEO too much.
• Investor groups may use pay transparency information in making decisions on which companies to invest in.
• CEOs at other companies who are only paid 100 times the median worker pay may either complain that they are underpaid or join the chorus of consumers and charge that most CEOs are overpaid. 

Yet high CEO paying companies will counter that they have scientifically determined the correct CEO pay offer. They want to attract the most competent CEO. His or her pay needs to be as high or higher than the pay of the competing CEOs in that industry. Companies should be free to pay whatever they need to get the most desirable CEO.

Many Americans believe that the CEO pay process is not scientific but a rigged system where compensation consulting firms have an interest in recommending high pay levels because this increases their pay commission in pursuing a CEO candidate.

The problem of high CEO pay creates another problem. Senior vice presidents have to be paid at a level related to the CEO’s pay. As a result, the total senior pay package in large corporations is top heavy in relation to the pay packages of competitors from other countries. So American companies have to charge higher prices for their export goods and services than foreign companies to cover the higher American pay packages. This dampens our export-winning rate and is a factor contributing to our high annual deficits on foreign trade.

We need more debate on what is fair pay for senior managers and what is fair pay for ordinary workers. Senators Bernie Sanders and Elizabeth Warren have been brave enough to highlight this question in this heated election period when it really matters. It’s not a bad question to ask each political candidate where he or she stands.

-- Philip Kotler is a professor at Kellogg School of Management at Northwestern University and author of 55 marketing books including Confronting Capitalism: Real Solutions for a Troubled Economic System.