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The Space Between Us: The Evolution of Executive Compensation

Executive compensation is a hot topic in 2014; not just in the United States, but globally. The commonly held belief that redistributing top executive pay to the average worker would result in increased compensation for the lower to middle class does not seem to pan out. Despite this, a look at top executive pay and the percentage of wealth that the top one-percent is in possession of, reveals critical lessons for managers who are seeking to effectively implement strategic management plans and increase employee buy-in levels.

The middle class is dying off, slowly but surely. Many things are blamed for this widening of the gap between the rich and the poor: the changing economics of a global economy, generational work ethic, mechanization of the factory floor, and unionization are just some of the scapegoats. Is there evidence that a much more primal human trait is the main culprit and trait is greed? Is executive compensation a microcosm of the expanding gap between the “haves” and the “have nots”? Does excessive executive pay drag the poor deeper into poverty and the rich into more prosperity?

This widening gap does not exist across the globe, some countries have laws that limit executive compensation and those countries have a prospering middle class. For instance, Switzerland, who recently enacted such a law which limited executive compensation (Minder, 2013). The public sphere is filled with propaganda, lobbyist, headlines, and more, all providing conflicting information. On one hand, there are pundits stating that the shrinking of the middle class is a myth (Haskins & Winship, 2012), and on the other hand we have experts stating that there is a dire situation (Kearney, Harris, Jacome, & Parker, 2013). It is the raw facts of the situation which need to be looked at and evaluated, not the anecdotal observations that cloud reality. Projections such as those stated by Rhode, “European and American middle classes will shrink from 50 percent of the total to just 22 percent” (2012) are alarming. It was unintentionally suspected that the evidence would demonstrate a correlation between the skyrocketing incomes of top executives in comparison to the rest of the population. Surprisingly, the available evidence pushes the conclusion in a different direction, calls for more research, and shows that numerically, it is probably irrelevant. It is the dramatic accumulation of wealth by the top one-percent, the public perception of that inequality, and the backlash against it that creates the challenge for managers in the future.

There is absolutely no question that there are some staggering numbers in modern economics. Numbers that seem especially grotesque while many workers are feeling the strain of a poor global economy. A few examples of statements that grab the attention of the population and have unexpected implications later in the analysis are:

    • Make no mistake about it. Executive pay is a prime reason why in 2005-2008 the top 0.1 percent captured a record 11.4 percent of all household income (including capital gains) in the U.S., compared with 2.6 percent three decades earlier. In 2010 (the latest Internal Revenue Service data available), this number was 9.5 percent. The income threshold among taxpayers for being included in the 0.1 percent in 2010 was $1,492,175. Of the executives named in proxy statements in 2010, 4,743 had total compensation greater than this threshold amount, with a mean income of $5,034,000 and gains from exercising stock options representing 26 percent of their combined compensation. (Lazonick, 2012)
    • The world’s top 100 billionaires now hold so much wealth, says a new Oxfam report, that just the increase in their net worth last year would be “enough to make extreme poverty history four times over.” (Pizzigati, 2013)
    • Last year [2006], the average American worker had to toil for an entire year to make what the majority of Fortune 500 CEOs made in one day. Moreover, the gap between what the lowest and the highest paid employees is widening. (Rheannon, 2007)
    • Wages for the top one percent spiked 131 percent between 1979 and 2010, while wages for the bottom 90 percent of workers rose just 15 percent over that same period, according to the Economic Policy Institute. (Associated Press, 2012)

This is the information that struggling employees are inundated with and are talking about around the water cooler. The logical sentiment is to draw the conclusions, if this top one-percent were not so greedy then the lower class would not be sinking lower while th6e middle class evaporates, and that if these CEOs were not so greedy then the average worker could be paid much more and save the middle class and the economy in general.

It is reasonable to infer that across the globe, economies which have placed limitations on top executive pay or have social restrictions on the top one-percent and CEOs, would see a more prosperous middle class and an ascending lower class. The data for this endeavor of truth is incredibly sparse and calls for much more detailed research. Each year the fluctuation of population numbers, currency exchange rates, buying power, income levels, inflation, et cetera make direct comparisons extremely difficult. There is a significant margin of error in the researched data in figure 1, but it is sufficient to drawn general conclusions. As can be clearly seen in figure 1, there is no direct conclusion that can be made as to the relation to CEO pay and poverty levels.

It is hypothesized that some level of correlation could be discovered if the various factors of the subject economies were thoroughly evaluated, but that would be quite an endeavor, and economics is an unclear science with variables that have little to do with economics as a principal. 1Variables such as culture, social norms, environmental policies, import/export policies, and more. The only conclusion that can be drawn from the raw data is that there is insufficient evidence to believe that excessive top executive pay correlates to an increase in the poverty level and/or a dwindling middle class from a global perspective. This is, admittedly, surprising and goes against assumed logic.

Being that the evidence studied does not show that the growth of CEO pay affects the global economy, the fact persists that the CEO pay is way out of line with history and with timeframes which, especially in the United States, had much stronger economies and less offensive pay gaps. Times in United States history when everyone was doing better than they are now. The common worker takes no less offense to the idea that he or she has to work astronomically harder and longer while seeing that in reality their pay continues to be much lower and insultingly outpaced by inflation. They continue to see news articles in which charts like figure 3, point out in dramatic fashion, just how much their bosses take home in comparison to them, the ones doing the vast majority of the actual work, the ones who sweat to make the operation run. 7

It is fair to argue that it is not the comparison between the sweat that the worker puts in for a year with dwindling compensation versus the compensation awarded to top executives within that year that is the snapshot of the problem, rather that it is the cumulative effect of that disparity. It is the reality of the quickly expanding disparity between CEOs and the average worker that started in the early 1970s and quickly grew from there. “Over the course of the 1970s and ’80s, the real after-tax earnings of the average manufacturing worker had decline2d by about 13 percent” (Lazonick, 2012). Beginning in 1979 the disparity exploded. Factoring in inflation, the poorest Americans are earning less than they did in 1979, despite political, educational, and technological advances that should drive the poor to continuously climb. It may seem like the poorest Americans are a small group, but it is “Americans in the bottom tenth of the wage distribution [who] earned less [in 2011] than the lowest earners did in 1979, accounting for inflation, according to the Economic Policy Institute. Meanwhile, the real wages of the median worker rose only 6 percent between 1979 and 2011” (Associated Press, 2012). With approximately 150 million workers in the United States, that is an estimated 15 million workers who have regressed due to inflation alone.

Inflation is no3t the only factor that should be considered when calculating fair wages. There is also productivity. In this time span between 1979 and 2013, worker productivity increased by 69 percent while compensation increased by just 6.5 percent. With inflation factored in, effective wages have decreased. The minimum wage in the United States in 2011 was $7.25 per hour. Simply factoring in the increase in productivity the minimum wage should be $18.30 per hour. This lack of reward for increased productivity is quite the opposite on the other side of the income spectrum, in fact if the minimum wage reflected the income gains of the top 1%, it would be a staggering $31.45 per hour (Associated Press, 2012). This disparity is glaring and understandably headline grabbing for the news.

What does this mean for business management and governments? It means that a breaking point has been reached and the people and workers are fighting back. The workforce is tired of seeing executives with salaries plus bonuses which total $1 million or more continually increase, 529 in 1992, 703 in 1993, and 922 in 1994 (Lazonick, 2012). While they see the reduction of their households as reflected i4n figure 6. The backlash is no longer in words, there is action taking place. In the United Kingdom a publically traded gambling company, paid CEO Richard Glynn £4.7m (7.89 million USD) for the 2013, an 85% increase from 2012.  Outrage and investor backlash ensued because during this period the company had a 32.8% drop in profits, which fell from £200.7m (337 million USD) to £138.2m (232 million USD) (Rab, 2014). The outrage is sure to result in action, like it did with Gold Field Ltd.

A similar situation happened in 2012 at Gold Fields Ltd., resulting in Chief Executive Officer Nick Holland’s pay being dropped by 45% and the company’s share price fell by two-thirds (Crowley, 2014). A two-thirds share price drop is a serious loss for investors and company potential. The tide of disparity rebellion went even further in Maryland:

About a dozen faculty members and 30 students at St. Mary’s College, a public school in Maryland, have proposed a plan to limit the salary of the highest-paid employee to 10 times that of the lowest-paid employee. At St. Mary’s, the total salaries of the president and vice 5presidents have risen 91 percent since 2000, according to the pay cap campaign. And student tuition has risen about 60 percent since 2000. In contrast, St. Mary’s lowest-paid employees have had their salaries increase 56 percent over the same time period, the activists say, and associate and full professor pay has actually increased at rates that are lower than inflation – 29 and 22 percent, respectively. (Miles, 2014)

The situation at St. Mary’s is evolving, but the push and public sentiment is for a school policy to be established that forces equality for the future and brings the current situation up to appropriate levels. This demonstrates the flow of the workforce mentality that contains the true lesson for management. When the workforce sees increasing profits, such as with Walmart who had $22 billion of annual pre-tax income which would equate to a $10,000 a year raise for each of its 2.1 million [global] employees (Blodget, 2010), motivation dips, investors become outraged, and the all-important buy-in of employees to the company’s mission is almost impossible. It is all about perception and often perception becomes reality.

There are plenty of criticisms to the idea that something should be down to bring down top executive pay and put a dent in the exponential growth of the top 1% at the expense of the average worker. Many believe that the government has no business regulating top executive pay, even President G.W. Bush stated as such, “Government should not decide the compensation for America’s corporate executives.” The flaw in this thinking is that government regulates, pollution, distribution, stock market rules, occupational safety, et cetera at the very same time. The government regulates the bottom end, setting a ridiculously low minimum wage, there is no logical reason that the maximum cannot also be regulated.

Another justification is that the demand for CEOs is so high that those high salaries are a result of supply and demand. Anecdotally, this can be immediately seen as absurd. The business world is full of extremely high paid CEOs who lost millions, billions, in company value, some even needed the federal government to bail them out. There is the belief that the stockholders of publically traded companies can also regulate the pay through their board votes. While this seems logical, who has enough stock in a company to be a board member? It is other members of the top 1% who control these board and you cannot expect that the club will vote to hurt the club because that goes against everything known about human behavior. Sports stars and other celebrities make tons of money, but no one complains about them. While this objection is true, it does not mean that it is a rational comparison. They train their whole lives for a short window of pay, injury can stop everything, and if they don’t perform, they don’t get that high pay. Although the aforementioned justifications are easily dismissed, there is one objection to top-executive pay affecting the global economy which has some merit.

How much is this money really? There are those who dismiss the entire situation of high CEO pay by stating that even though the money going to one person is large, the redistribution of that amount has no significant impact on the economy or employees of a company. Using Walmart as an example, the half-truth of this is easy to see. Walmart CEO, Mike Duke, made a staggering $23.15 million, an embarrassing 1,033 times the $22,400 salary of the average “associate” of Walmart. If it were regulated back to 1979 levels and CEOs could only make 35 times as much. Spread out over Walmart’s 1.4 million U.S. workers the average “associate” salary would only increase by $16 per year. From a purely numerical standpoint, this objection is true. The bottom line is that under this regulation, Mike Duke would make $784,559, almost twice as much as the President of the United States and he would still live quite prosperously. Companies are also stock piling profits though; as mentioned previously, if Walmart distributed their profits to the employees, then the increase would be $10,000 per year, a number sure to have an impact on the entire economy especially considering that Walmart employs 1% of the U.S. workforce. The key lesson is in perception, the cumulative increase of the top 1% and stockpiling of profits, hurts the buy-in of workers, creates an us vs. them mentality, and affects employee morale.


Recommendation for Managers:

Perception goes a long way. The result of this research is that the workplace issue on the horizon is the rebellion against the one percent. The truth of the one percent is almost irrelevant because of the perception of the one percent and the implications on the goals for mangers, investors, and top executives. The backlash has already begun, those that combat the backlash and face it head on are the managers that will succeed in the future.

Management guru Peter Drucker, echoing the view of finance magnate J.P. Morgan, believed that the ratio of pay between worker and executive could be no higher than 20-to-1 without damaging company morale. Several studies have supported this belief. A poll of Industry Week subscribers, the majority of whom are managers themselves, revealed that over half felt that soaring salaries at the top had a depressing effect on their morale and productivity. Another study published in the Journal of Organizational Behavior found that high levels of executive compensation generated cynicism in white-collar workers. The research further found a correlation between cynicism and tendencies toward unethical behavior. (Anderson, The CEO Pay Debate: Myths v Facts, 2009, p. 1)

There is an undefinable moral objection to the astronomical disparity and the solution lies right here in the United States. Hardly anyone ever complains that the U.S. President makes too much money.

The U.S. President’s salary is $400,000. “Peter Drucker, the founder of modern management science, considered twenty-five to one an appropriate ratio for the private sector as well. Larger gaps, he argued before his death four years ago, undermine enterprise effectiveness and efficiency” (Anderson & Pizzigati, 2009). The biggest push in modern management is increasing efficiency through intelligent resource management and employee investment in the goals and missions of the employer. There are always exceptions to the rules in economics, but there is a rising theme in the business world that inflated top executive pay has a negative effect on sustainability in the long run; for example:

Japanese and German companies have won world market dominance led by executives who earn a fraction of what American CEOs are paid, CEOs and their boards of directors have together unlocked CEO pay from company performance, and in some cases disguised the true extent of CEO compensation from the company’s shareholders. He further points to the damaging effects of inflated CEO pay on company morale and productivity and on the national work ethic, as the disparity between the incomes of middle-class Americans and the pay of American CEOs grows even greater. (Butts, 2003, p. 60)

There is a growing global trend towards the recognition of this fact, it is those that are recognizing this trend who will prosper in the decades to come.

Managers may not be able to have direct impact on this, but they can influence the decisions of top executives by understanding the situation, presenting valid arguments, and making the changes once they ascend to the top executive ranks. Some facts that managers, executives, and the voting public need to be aware of are:

  • German law states that paying a worker an immoral wage is illegal.
  • Denmark negotiates a minimum wage that applies to all public and private sectors, currently the equivalent of $20 per hour.
  • Sweden minimum wages are collectively bargained annually.
  • Many countries set the minimum wage through collectively bargained agreements which automatically extend to everyone else.

There is no doubt that the moral implications of the disparity in pay is difficult to define. It will be challenge for management, but ultimately management will be ineffective and fail as its mission if it cannot stem back the tide of public dissent towards the executives running the company and the rest of the top one percent.

In conclusion, the direct correlation of excessive top executive pay in comparison to the average worker and its effect on the increasing lower income group cannot currently be made, but the cumulative effect of wealth being concentrated in this top one percent and oven more so in the top .1 percent is making daily headlines and causing a growing level of discontent among not just the workforce, but the populous as a whole. A rapid movement towards more realistic CEO compensation is a necessary element for managers to succeed in the current environment and a recognition of the current environment is a key element to effective strategic management. Managers are only going to be able to do this through articulate policy development, influence on top executives, and by making the changes (at a personal income loss) when they fill the top executive positions in the future.























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