On January 31, the California State Senate will vote on SB 37, also known as “Corporate Fair Share for California and Californians.” Under the bill, corporations earning $10 million or more in the state would face progressive tax increases based on the pay gap between CEOs and their average workers.
“The bigger the gap, the higher the tax,” explained Senator Nancy Skinner, SB 37’s author, in a statement on her site. The bill has attracted the attention of national media, drawing criticism from the California Business Roundtable and other business groups, and support from Abigail Disney, the entertainment heiress who has become a vocal opponent of income inequality.
“It is absolutely ridiculous for corporations to be making record profits while many of their employees are in working poverty,” Disney said. “This is an issue close to my heart, and one I feel a duty to speak out on simply because it doesn’t appear that these corporations will do anything to fix the problem themselves.”
Disney’s concerns are legitimate: Since 1978, CEO compensation has grown 940%, whereas typical worker compensation has only risen 12%. The average CEO at an S&P 500 company makes 287 times more than the average employee. While those are troubling figures, the good news is that corporations need not wait for lawmakers to force them into action; they can begin paying attention to the CEO-worker pay gap today. Here are three reasons why they should.
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It Affects Business Performance
Some data suggests that large disparities between CEO and worker pay are bad for business. One study conducted at UC Berkeley found that consumers were less interested in buying from or working for companies with wide gaps. Another study described in the Wall Street Journal, wherein participants could choose gift cards from companies with small or large pay gaps, also indicated that consumers find the latter unappealing.
The greatest harm to businesses, however, comes from the workers themselves. “Academic research indicates that extreme compensation gaps sap worker morale,” wrote the authors of an Institute for Policy Studies report. “Lower morale, in turn, reduces productivity and increases turnover.” Peter Drucker, the management guru, warned against this backlash. He believed the proper CEO-to-worker pay ratio was approximately 20:1, as it was in 1965; any higher, and companies would suffer. A recent Harvard Business School study affirmed Drucker’s prediction, finding that “firms with an abnormally high unexplained pay ratio saw their performance drop by as much as half” when compared to those with low levels of unexplained pay disparities, potentially due to weak corporate governance, lower sales, and higher employee turnover.
“In many respects, extremely large CEO compensation packages are problematic,” wrote Manfred Kets de Vries, a distinguished professor of leadership development and organisational change at INSEAD. “The practice over-emphasises the impact of a single individual and undervalues the contributions of other employees to the success of a company.” As a result, studies have found that companies with high CEO-to-worker pay ratios have lower shareholder returns than those with lower ratios.
It Is Stirring Dissent
Back in 2016, a Stanford study found that 74% of Americans believe CEOs are paid too much. As Nick Donatiello, one of the study’s authors, told Marketplace: “It is remarkable when 74% of Americans agree about anything in today’s environment — particularly something as politically charged as CEO pay. This is a warning that companies need to do a better job of justifying CEO pay levels.”
That need for justification has grown even deeper since 2017, when the SEC began requiring companies to disclose median worker pay and the CEO pay ratio. As the American public learned the ratio was far greater than they had imagined, dissent has only grown louder. The topic of executive pay, for example, added fuel to the fire in both the Fight for $15 and General Motors strikes. “There is a clear sense among the American public that CEOs are taking home much more in compensation than they deserve,” said David F. Larcker, another author of the Stanford study. “[T]here is a general sense of outrage.”
This dissent has begun affecting politics, as well. In 2018, the city of Portland passed a progressive tax on companies with large pay gaps, like SB 37, and as part of his platform, presidential candidate Bernie Sanders has proposed a similar tax nationwide. In Bloomberg, Nir Kaissar warned companies that if they do not fix wage inequality, somebody will do it for them. “For now, companies and their shareholders are free to address that [pay gap] failure as they choose,” he wrote, “but that freedom will evaporate if they continue to leave workers behind.”
It Contributes to Inequality
Three decades ago, the average CEO earned 58 times what the average worker did; today, they earn 200 times what their workers do. At the average company in the S&P 500, therefore, employees would have to work multiple lifetimes to earn what their CEO brings home in a single year. At the 50 publicly traded companies with the widest pay gaps, they would have to work for an entire millenium. While, as outlined above, this is damaging to worker morale and public perception of corporate America, it is perhaps most damaging to society as a whole.
As CEO pay has grown, so has income inequality — in 2019, it reached a 50-year high. “[E]xcessive CEO pay matters for inequality, not only because it means a large amount of money is going to a very small group of individuals, but also because it affects pay structures throughout the corporation and the economy as a whole,” stated the authors of an Economic Policy Institute (EPI) report. “If a CEO is earning $20 million, then it is likely many other high-level executives are also being paid in the millions.”
Though many business leaders might argue otherwise, this does not have to be the case. In the United Kingdom, the average CEO earns $7.95 million; in Sweden, $2.79 million; and in Japan, $1 million. Compare that to the United States, where the average CEO earns $14.25 million. “I think you could cut the pay of CEOs in half, and the economy would be the same size as it was last year,” Larry Mishel, former president of the EPI, told CNN. “I don’t think we have to argue that workers will be more productive, we just have to say that they’re going to be better off, and it’s hard to see that the firm will be worse off.”
Leaders should consider that — and all of the aforementioned factors — when examining their executive compensation packages. As Abigail Disney pointedly said to Congress last year: “This is not just a question of what is moral or what is right. There’s an important economic case to be made for addressing inequality across the spectrum. In tolerating such extreme unfairness, we have begun to cannibalize the very people that make this economy thrive.”
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