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Is the Gap Between Executive and Employee Compensation Ethical?

Median Pay was $14.2 million in 2021 for CEOs

A few days ago, I read that pay increases for U.S. CEOs are on the rise in the post-pandemic period. Median pay rose to $14.2 million last year for the leaders of S&P 500 companies, up from a record $13.4 million for the same companies a year earlier, according to a Wall Street Journal analysis of pay data for more than half the index from MyLogIQ LLC. Most CEOs received a pay increase of 11% or more and pay rose by at least 25% for nearly one-third of them.

Pay for rank-and-file employees rose, too, last year but more slowly, as measured by the compensation figures the companies report for their median employee. Half the companies said pay for their median worker increased by 3.1% or less in 2021, and at one-third of companies, median employee pay declined year over year—broadly similar to pre-pandemic rates of change.

CEOs at roughly half the companies were paid at least 186 times what their median worker made in 2021, according to the Journal analysis. That is up from 166 times in the year before the pandemic and 156 times in 2018, the first year that nearly all S&P 500 companies reported median employee pay. CEO pay

Companies dismiss such pay ratios in part because businesses have a range of operational structures. Outsourcing low-wage work, for instance, can lift the employee median pay and make a company’s ratio lower. In addition, the SEC’s executive compensation disclosure rule gives companies wide leeway in identifying median workers, making comparisons between companies more difficult. Executive pay also can be highly variable, with some companies making multiyear grants, leading to periodic spikes in the pay ratio.

The CEO compensation figures reported by companies include the value of stock awards at the time of grant, along with salary, cash bonuses, perks and some retirement-benefit increases. Equity awards, the value of which can rise or fall significantly after grant, accounted for the bulk of pay for the highest-paid CEOs in the Journal’s analysis. These awards typically vest, or become fully the executive’s, over several years and can be tied to performance targets.

Discovery Inc.'s David Zaslav, at $247 million, had the highest 2021 pay disclosed so far among the CEOs of S&P 500 companies who served the full year. Mr. Zaslav’s pay was 3,000 times the $82,964 that the company reported paying its median worker last year, up from a multiple of 1,511 in 2018.

The second-highest paid CEO so far in the S&P 500 was Amazon.com Inc.’s Andy Jassy, who took over for Jeff Bezos, and who was awarded compensation valued at $213 million, nearly all in restricted stock. That was 6,500 times the median Amazon worker, who made $32,855 in 2021.

From an ethical perspective, the question is whether it is fair and just that CEOs make so much more than the average worker? Can it be justified by any ethical rationale? To answer this question, we need to examine how CEO pay is determined.

In the U.S., corporate governance is based on Agency Theory. That is, the top managers (i.e., CEO and CFO) are the agents of shareholders who are the principals because of their stock investment. Managers are supposed to make decisions that are in the best interests of the entity and, therefore, the shareholders and not their own self-interests. The idea is by providing incentive compensation in the form of bonuses and stock options (nearly two-thirds of CEO pay packages are tied to performance), top management will work hard to improve the results for the entity thereby leading to higher stock prices that helps to maximize shareholder wealth. Of course, the higher results should come from improved operations and not from manipulating the financial statements as occurred at Enron and WorldCom.

The checks and balances in the system come from the board of directors that makes the final decision on CEO compensation. If the board approves a specific pay package, then regardless of the (excessive) amount of compensation, the pay packages meet corporate governance standards.

Shareholder skepticism for executive pay packages reflects an ethic of fairness. How can CEOs make so much when the average employee makes so little – and the disparity shows no sign of decreasing any time soon. Book cover

Blog posted by Dr. Steven Mintz, The Ethics Sage, on April 7, 2022. Steve is the author of an accounting ethics textbook, Ethical and Professional Obligations and Decision Making in Accounting: Text and Cases, 6th edition. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/. Follow him on Facebook at: https://www.facebook.com/StevenMintzEthics and on Twitter at: https://twitter.com/ethicssage.

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