Monday, April 9, 2012

The Executive Pay myth

I'm going to revisit something because I think it is important to do so. A recent article in the New York Times discusses the pay levels of various CEOs and offers quite a bit of data worth looking into. The article starts by looking at Steve Cook and his compensation as the new CEO of Apple. Mr. Cook received a salary of $900k in 2011, but was also given a one-time award of Apple stock:
It was initially worth a staggering $376.2 million. As of the end of last week, it was valued at roughly $634 million, reflecting Apple’s soaring share price.
Did he really earn that money? Is he worth it to Apple as a company? It's a tough question to fully answer. Apple is a huge company with close to a billion shares outstanding. The stock award Cook received is for a ten year period (and was approved very easily by shareholders, by the way) and doesn't vest until 2016 and 2021. So, the goal for Cook is to make Apple stock worth as a much as possible by the end of those ten years. Suppose--under his leadership--stock prices for Apple double by 2012. His package would be worth around $750 million dollars. But...shareholders (many of whom are Apple employees) would see their investment double as well, to the total tune of over $700 billion. For all intents and purposes, stockholders are paying Mr. Cook a less than one percent or so commission on the growth of their stock. If he delivers, I have to think the stockholders will think it was more than worth it.

Still, the numbers are staggering. And as the article points out, so are the numbers for other CEO's compensation levels. Here's one of the article's bullet points of data:
The median chief executive in this group [100 most highly compensated CEOs]  took home $14.4 million — compared with the average annual American salary of $45,230.

The 14.4 million figure is all inclusive of salary, benefits, and bonuses, as is the 45,230 figure. With this in mind, how many remember that viral e-mail/posting from some time back about CEO pay compared to average worker pay in the United States? Here it is at Daily Kos:

Remember it now? I can't even begin to list the number of times I heard this factoid cited--especially the 475:1 ratio--by people, online and in real life. But my question always was, what's it based on? Politifact took a look at the chart and declared it to be false (as I noted in my previous bit), but at the same time citing other studies that still offered up huge ratios:
The most recent chart from the Economic Policy Institute shows a ratio of 185 to 1 for 2009. According to the group’s calculations, the peak since the mid 1960s was almost 299 to 1. But it was never as high as high as 475 to 1.
Meanwhile, the most recent ratio from the Institute for Policy Studies is also smaller -- for 2010, it was 325 to 1. In previous years the ratio on two occasions has exceeded 475 to 1 -- to be specific, 516 to 1 in 1999 and 525 to 1 in 2000.
In other words, it's not 475:1 but may be anywhere from 185:1 to 325:1. But guess what? Politifact blows it, too. The 325:1 number comes from the Institute for Policy Studies, who derive it by looking at the pay for the 100 highest paid CEOs, not all CEOs or even most CEOs. The source for the 185:1 ratio--the Economic Policy Institute--looks only at direct compensation and does not specify how the group is limited, at all. Thus, it's useless.

Looking back at the numbers from the article, quoted above, we can easily find the ratio of the top 100 highest paid CEOs to the average annual salary in the U.S.: 318:1. That's in line with the ratio for the previous year from the Institute for Policy Studies, and it should be since it's based on the same group.

But the chart that went viral and became a talking point for most of the left suggests the 475:1 ratio is for all CEOs, not just the top 100. That's how it was presented, that's how it was received. And we now know it overstates the case for even just the top 100. How many CEOs are there in total in the U.S.?

Well, according to the BLS--which we know likes to spin things to benefit the government and the left--there were over 2 million such jobs in 2010. With a--wait for it--median income of $165,080 per year. That's a staggering small--in comparison--ratio of less than 4:1. Allowing that the poorly defined "average worker" means something like a typical hourly employee, perhaps the ration could be posited as 8:1 or even 10:1.

Obviously, that includes CEOs who are companies of one, who maybe just incorporated for specific tax benefits or the like. It includes CEOs of very small companies--including start-ups--who may actually not be drawing a salary at all. The real number--the one the chart falsely claims to show--is based on CEO salary from all medium to large companies, or something along those lines. Unfortunately, I don't have that data; not all of it is public.

But what I can say--with absolute certainty--is that the vaunted 475:1 ratio for CEO pay to worker pay is complete nonsense; that the actual ratio is far below 300:1, likely below 100:1, and possibly below 50:1, depending on how many CEOs are considered.

Cheers, all.


  1. Wow, I had no idea. That's just highway robbery there. WTH??

  2. Rob, using a sample (or even the population) of medium to large companies would still be problematic because you have to define what constitutes "medium". This is a very important determination since smaller companies are so much more prevalent than larger ones, and so there is plenty of maneuver room to skew the result one way or the other. In my opinion, a more fair analysis might use a weighted average of all CEO's salaries (perhaps even "companies of 1") with the weights being the number of people employed by those CEOs. You have until Friday to complete your assignment.

  3. I agree, Pete, that the terminology makes the measurement problematic. But you know, when someone says "the average salary of a CEO," I think the typical person gets a general idea in their head, one that can't be exactly pinned down and thus can never be exactly measured.

    But those outrageous ratios (300/400+ to 1) were just to appealing to far too many people; they just sounded so right, I think.

    I know CEOs of smaller companies, usually companies they built. And frankly, a couple hundred grand a year is about right for many of them because they're pumping profits back into the business. They're hoping--and working their asses off towards--that million dollar salary down the road, after they go public. That's the real model right there. But since it doesn't involve a lazy, greedy CEO playing golf all day and firing people to increase the stock price, no one wants to hear it.