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Measuring CEO pay: more than gore

One unusually hot debate simmering during the implementation of the Dodd-Frank Wall Street Reform Act deals with a little provision calling on public companies to publish  the CEO’s pay as a multiple of th"Bart Naylor" "Financial policy"e median-paid employee of the firm.  (For detail mavens, it’s Section 953b.)

Industry claims it’s too difficult to measure (which should alarm shareholders who assumed their companies held some grip on payroll figures), or that there’s no interest in the number (which the hot debate itself contradicts).

Comes now a compelling report by the AFL-CIO Office of Investment with persuasive evidence of the valuable promise of this diminutive addition to shareholder reports:  “Why CEO-to-Worker Pay Ratios Matter for Investors.”

The report demonstrates that the number serves a purpose more than rubbernecking the gore of compensation pile-up.

First, the report notes that excessive CEO pay can’t be dismissed as a minor expense. Top executives at large public companies now keep for themselves an average of 10% of their companies’ net profits; approximately double the rate in the early 1990s, according to the AFL-CIO report.

Second, excessive compensation signals mediocrity. Jim Collins of the Stanford Graduate School of Business found that of the companies that generated cumulative stock returns that exceeded the market by at least three times, not one had a high-paid, celebrity CEO. Such celebrity CEOs turn a company into “one genius with 1,000 helpers,” taking focus away from the motivation and creativity needed from all of a company’s employees, Collins concluded.

Likewise, companies with excessive pay make for a bad investment. In 1998, Fortune Magazine began to publish an annual ranking of the “100 Best Companies to Work for in America.” This list was based on extensive surveys that asked employees about the fairness of their companies’ compensation policies, their attitudes towards management, whether they felt respected at work, and their overall job satisfaction. Starting in 1998, $100,000 invested in a weighted index of the “Best Companies to Work for in America” would have grown to about $240,000 as of 2009, compared with only $150,000 in value for the same money invested in the stock market as a whole.

Finally, let us remember that the idea for this ratio came from the business sector. In 1997, James Cotton, then a law professor at Texas Southern University who previously spent 25 years in IBM’s Corporate Law Department, called for publication of this ratio. He argued it would bring context and a degree of reasonableness to executive pay packages. Now, the Council of Institutional Investors, which is a trade association of the largest investment institutions in the United States,  recommends that corporate compensation committees consider the “the relationship of executive pay to the pay of other employees” as factors in developing their executive pay philosophy.

As Washington weighs the merits of this ratio, let’s continue to listen to this sage counsel, and ignore the obviously self-serving, predictable complaints of the overpaid CEOs.

Bartlett Naylor is Public Citizen’s financial policy analyst

LL: Be sure to read Public Citizen’s latest financial report, “Just Not Us”  and other “Two Cents” series report, “Industry’s Opposition to a Modest Pay Disclosure Rule,” which exposes the financial industry lobbying attempts to derail the aforementioned provision of the Dodd-Frank Wall Street Reform Act.