Scrutiny of Pay Gap Between CEO and Direct Reports

The Financial Times reports today that institutional investors and the SEC are taking interest in the difficult-to-justify pay disparities between the CEO and his immediate subordinates at some public companies. And isolated data points, like Sallie Mae, suggest that the ones with the biggest gulf (in its case, ten times) aren’t delivering commensurate performance.

A few corporate leaders recognize that a large gap is demotivating. GE’s Jeff Immelt remarked:

The key relationship is the one between the CEO and the top 25 managers in the company, because that is the key team. Should the CEO make five times, three times or twice what this group makes? That is debatable, but 20 times is lunacy,

However, the facts on the ground indicate that Immelt’s views aren’t widely shared. A lot of CEOs appear to be suffering from what might politely be called acquired situational narcissism, or less politely, a belief in near-royal entitlement. From the Financial Times:

US companies are facing fresh pressure from regulators and shareholders to rein in excessive executive pay as research shows chief executives have been paid up to 10 times more than their top lieutenants.

The average total compensation for a S&P 500 chief executive was about twice as much as the second most highly paid executive last year, according to a study conducted for the Financial Times by the research group,

However, at SLM, the student loan group known as Sallie Mae, the pay of Thomas Fitzpatrick, chief executive, who resigned in May, was more than 10 times that of June McCormack, his executive vice-president.

At more than 30 other companies, the gap ranged from four times to seven times.

The Securities and Exchange Commission is believed to have asked a number of companies to explain the reason for large pay gaps between top executives, as part of a review of corporate pay.

In August, the regulator sent letters to more than 300 companies urging them to be more transparent in their disclosure of executive compensation practices. Several companies received specific questions about the executive pay gap, according to people who have seen the letters.

The Council of Institutional Investors, whose members have more than $3,000bn under management, has also voiced concern at large disparities in pay between executives.

Investors argue a huge pay differential may be a waste of shareholder funds; indicates the board is not an adequate counterbalance to the chief executive’s powers, and could drive away talented young executives.

“[The gap] is a red flag for investors. It is a classic sign that the board may be beholden to the chief executive,” said Christopher Ailman, chief investment officer of the California State Teachers’ Retirement System (Calstrs), the US pension fund.

Genzyme, where Henri Termeer, chief executive, earned more than seven times more than Peter Wirth, chief legal officer, said: “Our compensation structure for executive management is set so that there is a flat tier below Henri. Because there’s not a hierarchical approach here, [there is] a bigger gap between number one and number two.”

Other high-profile companies with above-average executive pay differential include the utility TXU, and the food group Heinz.

A related FT story sees the pay gap as a sign of corporate malaise:

After years spent focusing on the value of the princely pay packages commanded by corporate leaders, shareholders, and to a certain extent regulators, have begun looking at boardroom inequality.

Their argument is that a large differential between those at the top of the ladder and those just below – chief financial officers, division heads, or even superstar sales executives – is a symptom of deeper malaise.

Christopher Ailman, who manages more than $170bn for the California State Teachers’ Retirement System, believes that a yawning gap points to weak corporate controls. “Paying chief executives an excessive amount relative to their number twos is a warning signal that the chief executive may have the compensation committee sewn up and that the board is not doing a good job of the succession plan,” he says.

Others warn that funnelling a large part of the executive compensation pool to the boss can damage shareholders by demoralising senior management and future chief executive candidates.

“A large differential can actually harm performance because it is demotivating for the senior managers,” argues Ann Yerger, executive director of the Council of Institutional Investors,.

Two weeks ago, the Council wrote to the Securities and Exchange Commission, urging the regulator to ensure that “companies… adequately disclose each [executive’s] compensation and explain the reasons for the differences in the amounts awarded to each”.

Mark Van Clieaf, managing director of compensation consultancy MVC Associates International, says directors should police pay equity more strictly: “Large shareholders are asking about it, regulators are asking about it, so directors should take a look at the issue.”

Yet few dare quantify what an “excessive” differential actually is.

It will be revealing to see how much coverage this story gets in the US.

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  1. a

    Wouldn’t the natural reaction of any CEO just be to increase the pay of his 25 lieutenants? Surely the problem is not the ratio between the CEO and them, but the CEO and everyone else, including the workers on the line or in the cubicals.

  2. Yves Smith


    Sincere apologies for the delay in responding. Still having some technical difficulties, and I haven’t been able to diagnose them yet.

    The reason your suggestion wouldn’t work as a fix at many companies is that CEO pay is already a meaningful percentage of corporate profits. So if you take 25 people and, say, given them 1/2 of CEO pay on average when they were formerly getting half that (or even less), that’s the equivalent of the pay of 6.25 CEOs. That would lead to a rebellion among even formerly quiescent institutional investors.

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