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Aug 21, 2015

The Securities and Exchange Commission approved a rule this month that will require publicly traded companies to disclose the ratio of CEO pay to the average employee pay.

This rule has been pending approval since Dodd-Frank legislation in 2010, and has been a source of continuing conflict and controversy.

Now, I’m not generally on the political side that opts for income equality because I believe that people should be rewarded based on their hard work and that in reality, you can never truly have income equality when jobs and work are not equal.

But this rule makes great sense to me. It might be because I’ve seen corporate compensation rationalization at work for too long. I have vented about executive pay before, and so I must again.

A New York Times article, reporting on the approval of this ratio rule, says that “50 years ago, chief executives were paid roughly 20 times as much as their employees, compared to nearly 300 times in 2013.” It quotes Sen. Robert Menendez, a New Jersey Democrat, reminding us that most working people have gone without any salary increase for years.

I thought that was a pretty darned good argument, and even if not factually absolute (and really, we can only grab a sampling), it is a solid perception among those working hard for a living.

I decided to do a little research of my own. I selected a Fortune 100 company that employed everyday workers – not technology gurus, or scientists who command higher pay. I found Target and CVS, but Target’s proxy was too complicated, so I opted for a beautifully simple proxy filed with the Securities and Exchange Commission by CVS. (My heartfelt apologies to CVS and Mr. Larry Merlo, but I had to start somewhere and his pay is justified by current standards using peer group CEO pay as a benchmark. He’s not alone.)

Digging into one’s company’s pay ratio

Larry Merlo is President and CEO of CVS. In 2014, his base salary was $1,350,000 and he did not receive a raise from the prior year. I will make an educated guess at an average employee salary around $65,000.  The ratio of Mr. Merlo’s pay to the average employee then would be about 21:1.

But wait, there’s more: Mr. Merlo has the opportunity to earn an additional 200-500 percent of his base salary through an executive incentive plan which pays based on corporate performance.

If you add his base to the minimum incentive, the ratio climbs to 42:1, or 42 times the pay of the average employee. If he maxed out at 500 percent of his salary, the ratio is a whopping 104:1. His 2014 incentive award was actually 340 percent, putting his cash pay at 91 times the average employee pay.

Is $65,000 a realistic average pay for all 200,000 employees at this organization? It seems a bit high, based on the nature of their workforce. So rather than guessing, let’s see what I can figure out. Based on their 2014 annual report, their total 2014 operating expense was $16,568 billion.

The rule of thumb I learned about service-based companies was approximately 50 percent of operating expense was attributed to personnel expense (salaries and benefits). That puts their personnel expense at $8,284 billion, and 70 percent of that (removing 30 percent for benefits) would be $5,799 billion in salary expense.

But the highly compensated individuals push that number up, so I removed $17,215 million in cash pay to the five (5) highest paid individuals (as declared in the proxy), the 2014 salaries expense was somewhere around $5,782 billion. So far so good?

Dividing that salary expense by 200,000 employees yields an average salary of $29,000. Eek. That would make Mr. Merlo’s ratio at 158 times the average employee pay.

Is this a fair way to look at executive pay?

But wait, there’s more: Mr. Merlo is also is entitled to long term incentive compensation in the form of stock awards. For the three-year performance cycle 2014-2106, he can earn an additional $5.5 million.

So when you look at his “total” compensation package, his potential annual compensation is well over 158 times the average salary/pay of his employees which is a stunning pay disparity. It’s right to ask if it’s fair.

Here’s the thing. Those who oppose this rule do so because:

  • a.) The data will be misleading;
  • b.) The data will be costly to collect; and,
  • c.) It will shame companies into paying executives less, per The New York Times article.

Shaming companies? Probably. Not too sure if that is a bad thing. At least it is a countermeasure to the “peer group” comparison that they use to determine executive salaries. That process is a juicy bit of rationalization for increasing executive pay, because they must “remain competitive.”

So let’s look at the data issues. They’re squabbling over which employees to include in the “average employee pay” analysis. Does it include foreign workers? How about adjusting for cost-of-living  Must they use all employees’ pay, or a statistical sampling, and if a sample will it negatively impact the ratio? What about seasonal workers if the snapshot in time is taken in the last quarter of the year when there are many lower paid seasonal workers?

Yes, it IS out of control

Oh come on, folks. This nit-picking is nothing other than a safeguard for the continued practices in executive pay which are, in fact, creating severe income equality in our country. How much money and how many toys do executives need?

And in reality, when you’re talking millions and billions, how much difference will the cost-of-living really make in the end result?

I’m on the side that says Executive Compensation is out of control and it needs to be reined in. Hopefully the rule the SEC approved will be the needed catalyst for change, but I’m sure they’ll find some loophole before implementation in 2018.

Executive compensation consultants (and corporate lawyers) live to justify exorbitant executive pay, and they’ll probably continue to do so. But Boards and shareholders really need to take this matter seriously and do something about it.

This originally appeared on Carol Anderson’s blog @the intersection of learning & performance