The Advisors' Blog

In a recent WSJ article, Rick Wartzman & Kelly Tang of the Drucker Institute analyzed whether high pay ratios drag down the health of businesses, as Peter Drucker, “the man who invented management,” had predicted. Using the Drucker Institute’s measure of management effectiveness (which looks at 34 indicators of customer satisfaction, employee engagement & development, innovation, social responsibility, and financial strength), they arrived at this result:

The pattern that emerged was clear and consistent: The higher the pay ratio, the higher the average scores in our rankings. This was true for overall effectiveness, as well as for every one of the five areas we gauge.

Wartzman & Tang were surprised by this result: Drucker himself had said that resentment & falling morale would set in for ratios above 20:1, but the most “effective” companies in this analysis clocked in with a median pay ratio of 481:1. They note:

A key reason, we suspect, is that the majority of CEO pay comes in the form of stock and stock options, and the most effectively managed companies in our rankings have, by and large, watched their shares perform very well in recent years, easily outpacing the benchmark Dow Jones U.S. Total Stock Market Index.

To be sure, when exploring different variables than we do, other experts have produced evidence more in line with Mr. Drucker’s thinking. For example, a 2016 study by MSCI Inc. indicates that when pay imbalances between the CEO and everybody else are greater, labor productivity is lower. And a 2017 study by Harvard University’s Ethan Rouen found that “pay disparity matters to employee satisfaction, with consequences for firm performance”—specifically, year-ahead, industry-adjusted return on net operating assets.

Notwithstanding the correlation here, the authors aren’t advocating for higher CEO pay. They caution that the resulting income inequality risks tearing society apart, which would probably wipe out most of those market gains.

– Liz Dunshee