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WORKSPAN DAILY |

Rethinking Fairness in Exec Comp Amid a Changing World

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Editor’s Note: This is part of an ongoing series in Workspan Daily produced by Korn Ferry for the benefit of our readers and to encourage further discourse on topics vital to compensation professionals. Each article addresses Korn Ferry’s “Top 10 Questions for Compensation Committees in 2021,” a publication produced at the beginning of the year.  

A frequent criticism leveled against executive compensation is that “it’s just not fair.” If looking purely at the statistics, one may draw a similar conclusion.

The average annual pay for United States workers in 2020 according to Bureau of Labor Statistics was $52,168, while the average CEO/median worker pay ratio disclosed by the S&P 500 was 299:1. The total pay for CEOs in the 300 largest US companies reviewed by Korn Ferry increased by approximately 7% annually over the last decade, while that for the average worker went up only 3%.  

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While statistics can be misleading, what is unassailably true from all of this is that top executives are very rich, and they have gotten richer at a much faster pace in recent years than everyone else. Is something askew?

No, not really. 

There are compensation committees of the boards of directors of both public and private organizations that oversee executive pay. And with as much disclosure and as much attention as has been devoted to executive compensation for decades — especially in the most recent one — they have taken their jobs very seriously. Many have added new members, and they have spent more time scrutinizing and carefully assessing more comprehensive sets of relevant pay and performance data. Statistics tied to the voices of shareholders bear this out.

Indeed, among the Russell 3000 companies in 2020, the average say-on-pay vote was 90.5% approval, and only 2.3% of companies failed. And the average director vote support was nearly 95%. Shareholders seem to be pleased with executive pay oversight and the outcomes produced.  And why wouldn’t they be?  Executive pay has grown at a pace that tracks very closely with the pace at which company value, as measured by total shareholder return (TSR), has increased over the last decade. The executives charged with stewarding shareholder value have delivered for shareholders, and the board members charged with overseeing executive rewards have done so responsibly.

How do we square all of this? How can executives be paid almost 300 times as much as the average worker, and yet their pay seems reasonable in light of what they delivered?

The answer is simple. The attention on executive pay is usually focused on the top five or so executives in the company, and CEO pay gets all the media attention. And those top executives typically receive 60% or more of their total pay through long-term incentives, which are often denominated in company equity or tied to financial metrics closely tied to TSR; the average worker almost never gets any of their pay in company stock. And another 25% of executive total pay is delivered through annual bonuses (while the average worker only has about 5-10% of their pay in bonus). With strong performance, these variable pay elements (unavailable to the average worker) can generate significant upside — and they have.

Is anything broken?  Not really.  Is executive pay “fair?”  Yes, in most respects — but that also depends on your vantage point and your frame of reference. Should we consider making changes? Almost certainly, and here’s why.

We are in a rapidly evolving world.

 “Company purpose” for many is now taking on meaning that goes beyond marketing and public relations hyperbole. ESG (environment, social and governance) is no longer a misunderstood step-cousin of CSR (corporate social responsibility), and companies, the executives who lead them and the boards who govern them are operating with a different set of values, priorities and principles than prior generations.

This is partly due to the fact that companies recognize the economic case for considering the interests of a broad array of stakeholders beyond their shareholders — employees, customers, suppliers, prospective investors, communities as well as the planet. 

Pay equity is being looked at in many different dimensions, and the notion of a company’s responsibility to provide a living wage to its most vulnerable employees and suppliers is gaining serious attention.  The unprecedented talent market we now face, with shortages of skilled (or willing) workers driving up the spot market for worker compensation, has shifted the economic dynamics for many companies. 

As a result of the above factors, the scope of compensation committee charters continues to expand and evolve, and reward strategies are evolving at a faster rate than we’ve seen in generations.

Here is where things could be headed:

1. Executive pay is going to be looked at in a broader light by company boards. They won’t toss out the traditional peer group competitive pay analyses and pay-for-performance assessments, but they will supplement them with a richer discussion of how executive total pay is increasing relative to pay for everyone else in the organization and additional external norms.

2. Companies will start to evaluate sharing ratios of company profit — company employees vs. shareholders, executives vs. non-executives, CEOs vs other senior executives, as well as relevant external comparisons — and will consider shifting more to the broader-based employee population if the talent crunch continues or worsens.  

3. Senior executive teams will be more accountable for reporting on what they are doing to hire, develop and retain the top talent needed for the future throughout the organization, which will likely result in developing new approaches for broad-based rewards (and possibly broader use of company equity, along with profit redistribution).

4. With a greater focus on non-financial performance metrics, ESG metrics will be used more broadly in company annual and long-term incentive plans, and TSR will receive less emphasis in driving executive pay (and this could have a dampening impact on overall executive variable compensation).

5. Many companies will revisit their fundamental executive pay strategies as they reconsider their overall company total reward strategies. And many of these will “zero-base” their approaches and consider what will be needed to transform their companies to a new generation of senior leadership and differently skilled talent. Expect program simplification, shifts to more fixed pay for many and broader use of company equity.

The world of executive pay has always received a lot of negative attention, and it is often not well understood by many of its harshest critics. While the system is not fundamentally broken, and executives have not been systematically overpaid, the world is changing, and company priorities are evolving. 

In the context of those changes, compensation committees should evolve their approaches to reviewing and managing executive pay to incorporate a broader view of fairness.

About the Author

Don Lowman_150px.jpg Don Lowman is a global leader of total rewards at Korn Ferry.


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