The Advisors' Blog

– Paul Hodgson, The Corporate Library

As I recently blogged on The Corporate Library’s Blog, Jesse Brill has been trumpeting this cause for at least the last six years: CEO pay differentials. Not differentials between CEOs, but differentials between CEOs and the executives who report directly to them. Not just Jesse, though. Mark Van Clieaf has been discussing and researching this issue since at least 2006. In fact, since 2007, when he published a paper that included statistics on the issue, he has been warning that some 40 percent of the Russell 3000 had pay differentials between the CEO and the median named executive officer pay of greater than 3X. 3X, according to Mark, is the danger point. And he’s got a point. Why would a CEO’s contribution be worth more than three times the next most important executive officer? Exceed that and, whoa, differentials in the rest of the firm are going to be completely outrageous, with CEOs earning three to five hundred times more than average employees.

Oh, no, wait a minute, they do, don’t they?

Despite this, Josh Martin in Agenda reports that only a handful of companies even pay lip service to internal pay equity. And many of these pay this lip service because they have been forced to by a campaign run by the Connecticut Office of State Treasurer.

Of course, some companies – DuPont (since 1990 apparently) and Intel – got there on their own. And the other 60 percent of the Russell 3000 are doing the right thing, but that’s still a lot of companies where the CEO is paid so significantly more than the other executive officers (and it gets worse when you use option profits and real equity values, rather than notional costs and grant date values) that you might be forgiven for thinking that the company could not be run without the CEO, in fact that the company could be run JUST WITH THEM and no one else.

Of course, this is complete nonsense. No company can be run just by the CEO. But some companies have been moving farther and farther away from the theory that a CEO is simply part of an executive team and is useless without his or her direct reports, their reports, theirs, in fact without all employees. Those that have moved the furthest – the Oracles, the Nabors Industries, Occidental Petroleums of this world – from this executive team concept are at the greatest risk from:

1. poor morale, not just in the executive team who feel undervalued, but throughout the entire company – employees read the newspapers!

2. succession planning problems. If the CEO is paid 10 times more than anyone else, who could possibly take his or her place?

But is it just activist investors and corporate governance gurus who care about this kind of thing? Well, no. Moody’s thinks it’s a credit risk, never mind an investment risk. And, let me tell you, any investor looking at a superstar CEO is thinking, “What happens if they walk under a bus?” That means short, not long. Risk, not risk free. Who needs that?

Now, the SEC is not going to do anything about this in terms of requiring specific disclosures. It’s not part of any of the compensation legislation making its way through congress at the moment. So it’s up to companies and directors to fix this one themselves… as I was quoted in Agenda Opinion saying so myself. Either reduce the differential or have a really good excuse for it.

Broc’s note: You should check out Paul’s recent blog entry entitled “Banks ASKING Government to Help Them Curb Pay and Bonuses: Now THAT’S News.”