Rana Foroohar writes in Newsweek that CEO pay is fair principally because it has risen at the same rate as the market capitalization of large companies. (Market capitalization is the stock price per share times the number of shares of the company that exist. It is a very rough guide to how large the company is.) Assuming CEO compensation grew at the same rate as the market capitalization of the companies they lead, this still has some major problems.
First, why is market capitalization the best measure for the company? Market capitalization is based only on how important it is to investors. Protecting their money is very important, but they are not the only people that are important in the equation. The employees, the suppliers, and the customers of each company are also important. By comparing only market cap to CEO pay, we are only watching the interests of the investors. By looking at a range of metrics, I think it is more likely that inequities will be revealed. For example, the turnover rate at Enron was huge because they had a policy of firing the lowest performers each year – not just 1 or 2 people, but 10% of the workforce. Yes, they fired at least 10% of their employees each year. There need to be other metrics that reflect the how valuable the CEO’s performance is to everyone that is affected.
Second, even if we think that market cap is a good metric to tie CEO compensation to, and we accept that the ratio has stayed the same since 1980, we still don’t know if the ratio needs to be lower. Meaning, just because it has stayed the same, that doesn’t mean that it is fair. It is likely that CEOs were overpaid in 1980 and that the current numbers just make it more obvious to everyone.
Third, when an entire company’s market capitalization improves, why does that mean that the CEO should be compensated and not the rest of the company? In other words, if we want to link CEO pay to market capitalization, then why not link all of the employee’s salary to market cap? We don’t do that because the idea is absurd. The job of the Sr. Widget Engineer is to engineer widgets. The job of the CEO is lead and sustain a healthy company. A company that is a good investment for investors, a productive and safe work environment for employees, a predictable and fair provider for customers, and a polite purchaser for suppliers. The sole job of the CEO is not to simply grow the market capitalization of the company.
Most people are upset that the average CEO made 431 times more than the average working in 2004, and the studies examined in the Newsweek article point out that there are other metrics involved, but there is still massive pay inequity in America.
