The (4x) CEO Salary Cap problem

By | 2014/09/18

Every now and then I see a petition or article floating around about how CEO salaries should be capped at 4x the salary of the lowest paid employee.

I think it’s one of those ideas that sounds so utterly charming and simple that it gets a lot of people on the bandwagon. Unfortunately, that simplicity is somewhat marred by gross impracticality and utter ridiculousness.

It’s fair to say that there are many CEOs who are paid too much. But what is too much? How much a salary should be paid is not the point of this article. Whether it’s 4x the salary of the lowest paid employee is.

Consider risk – for most companies, the lowest paid person in any company has little to no risk burden. Or rather, his or her burden is almost an entirely person-centric one: a sudden lack of income would result in personal financial hardship. But that’s not the risk shouldered by someone in a more senior position in the company. Seniority comes with legal and regulatory responsibility, and equally, legal and regulatory risk. A lower paid employee might be fired for making a bad mistake; the accountable manager for an entire vertical of operations might be fire and personally fined for the scenario happening. (Or even sentenced.) Members of the board and the CEO wear considerably more risk than 4x the risk shouldered by the lowest paid employee.

Movies, TV and some exceptional cases would also have us believe that CEOs mainly exist to have five star lunches, play golf, and visit dens of iniquity all while filing it as a miscellaneous expense item (or having their PA do so, at least). It would be foolish to say that no CEO ever does that – but it would be equally foolish to suggest that by and large, CEOs work normal hours – or get into their positions by working normal hours. (And it would be especially foolish so suggest that all CEOs exist merely to have five star lunches, play golf, and visit dens of iniquity all while filing it as a miscellaneous expense item.) Because of that risk, of their accountability and responsibility, these are often people who work long hours as a matter of course. Not because there’s a big project on, but because it’s their job to.

(Of course, on that front, there’s many people who are paid a lot less to work long hours, too. But the burden of risk is not the same in those circumstances.)

Then there’s the naivety of the entire salary statement and the comparison against an entire company structure – sometimes comprising tens of thousands of employees, or more. It implies one of two utterly ridiculous scenarios, viz.:

  • A complete flattening in the salary structure for all individuals such that if the CEO is paid at 4x the base salary of the lowest paid employee, that’s the cap for everyone else in the company too. So you might get an annual review and find your salary going up $3. Per annum. (That’s assuming excellent performance.)
  • Becoming a CEO is akin to falling off a financial cliff – one minute you’re earning a few hundred thousand dollars a year as a senior level manager, or maybe even a million dollars a year as a board member, then in stepping up to the CEO, you’re offered a pay decrease to something you perhaps haven’t earned in two or three decades.

The first sounds like some Socialist wet dream, forcing pay equality through to the masses. In reality it would be more like some Dickensian nightmare, providing little-to-no wage growth or scope for career advancement.

In the second scenario, given so much legal responsibility does fall onto senior management, the board of directors and the CEO (and forget those instances where slippery buggers have got out of their legal obligations – that’s a legal, not a fiscal issue), why would anyone take up a job with substantially higher risks in return for considerably lower pay? Perhaps someone nearing retirement who wants a cushy final few years with all decisions handed over to subordinates, maybe. Altruism only stretches so far when accompanied by strong risk.

The next time you see that proposal floating around, have a bit more of a think about the real world implications of such a goal.