In this new memo: "The CEO Pay Ratio: How Should Compensation Committees Evaluate Their Ratios?," using the heavily-scrutinized S&P 500 as its study population, Pay Governance demonstrates that median employee pay - which varies considerably across companies based on, e.g., company industry, business model, geographic employee distribution, and employee skill level - has a stronger correlation with the CEO pay ratio than CEO pay, which is more homogeneous across industries and company size.
Among other key observations and findings: Although company-specific, CEO pay is tied to the CEO role, which is associated with a fairly consistent set of responsibilities and expectations, whereas the position, role and responsibilities of the median employee identified for CEO pay ratio purposes vary considerably by company. Further, the firm's evaluation of Bureau of Labor Statistics (BLS) data on average employee pay by industry counters the misperception that high CEO pay ratio companies underpay their employees relative to the relevant labor market by demonstrating that industries with lower market pay levels by BLS standards ($40,739.00) are associated with companies that disclosed higher CEO pay ratios, and industries with higher market pay levels by BLS standards ($102,242) are associated with companies that disclosed lower CEO pay ratios. The data also shows that companies with higher profits per employee (net income/employee) paid their employees more than those with lower profits per employee, which makes sense.
More generally, Pay Governance's analysis supports why CEO pay ratio comparisons across companies are impracticable and inappropriate, and recommends instead that companies focus on their pay governance practices and fairness based on the market for like levels of skill, experience, etc., based on these principles:
- Compensation practices and levels for both executives and employees consistent with the company's business strategy and philosophy. The firm notes: "While some stakeholders may second-guess a company's compensation program (i.e., a high level of CEO pay and low level of employee pay), an economically successful company will create productive jobs with competitive pay over the long term."
- Executive compensation-setting processes and disclosures that are exhaustive and consistent with good governance standards
- Broad-based pay levels that are fair and competitive for the level of skill, experience, and hours of employment, and confirmed with market data
- Broad-based pay structures that represent a competitive wage for full-time employees in the local economy
- Evaluate whether and to what extent recent company-wide surveys have identified pay as a concern on a stand-alone basis, and in relation to other concerns.
In the event companies still feel compelled to try to compare ratios notwithstanding the multiple impediments, the firm suggests structuring a 5 - 10 company pay ratio peer group based on companies with similar broad-based employee demographics (e.g., similar headcounts, geographic distribution of employees, employee skill level and staffing models), if feasible.