In an effort to improve income inequality in the U.S., Portland, Oregon, will tax publicly traded companies with high CEO pay for tax years starting January 2017 and later.
The ordinance states that there will be surtax to the city’s business license tax for publicly traded companies where the CEO earns at least 100 times more than the firm’s median worker. Proceeds from the tax will help the Portland Housing Bureau fund homeless services. The city is still working through the specifics of the arrangement.
As executive compensation continues to be a hot-button issue amid growing concern with income inequality across the globe, Portland’s example serves as yet another marker in the debate. Two questions in particular arise: Is executive pay too high? And what is the best way to go about stemming the slide in income inequality?
“Yes, CEOs are being overpaid,” said Anup Srivastava, assistant professor of business administration at Tuck School of Business at Dartmouth College. “We all know that. There’s no study that has yet shown that larger pays are justified.”
Of the largest firms in the U.S., CEOs earn an average of about 300 times more than their workers, according to the Economic Policy Institute. This is much different than 50 years ago, when the ratio was closer to 20-to-1. However, the story of wage inequality isn’t that simple. Rather than a huge paycheck, CEO pay is typically broken up into other forms of compensation. In 2014, CEO pay was made up of 37 percent cash, and 54 percent stock and stock options, according to a Hay Group survey profiled by CNBC.
There is great incentive in having most of CEO compensation tied up in stocks, Srivastava said. The primary driver is to have CEOs focused on driving growth in the firms they lead. Having most of their compensation in stock therefore motivates them to work toward increasing the company’s stock market value. The benefits of this practice aren’t limited to just the CEO. “The positive aspects are that the best interest of an average employee is in continuation of the company,” Srivastava said. And employees can carry stock options as well, so their assets also rely on the CEO’s ability to drive success.
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The public sector might not be fond of a high CEO-to-median-worker pay ratio, but those who make money off of company success — such as investors — will likely be fine with it. “They’re OK turning a blind eye to excessive pay as long as they feel that they’re getting value in return,” said Mark Graham, managing director of CEO Update, an online publication focusing on trade groups, professional organizations and nonprofit organizations based in Washington, D.C.
For the average employee, though, if only the top of the company makes gains from the company’s success, sentiment is likely to fall. “I do think internally for an organization, they need to be cognizant of how the executive pay is going to reflect on the bottom people,” Graham said.
Start at The Bottom?
In late 2013, Switzerland voters went to the polls for a proposal that said executives’ salaries could not be higher than 12 times of the lowest-wage worker at the business. Opponents said it could make competition for talent in Switzerland difficult; voters ultimately rejected it.
Although the proposal in Switzerland was much closer to everyday pay than the 100-to-1 that Portland approved, the question remains of what ratio would be fair to tax, if taxing is the right approach at all. Some argue intervention at the bottom of the wage spectrum is a better approach.
“I don’t think any ratio is fair,” Graham said, referring to the gap between CEO and median worker pay. Market forces are going to drive CEO compensation much more than anything else, and if CEO pay starts going in a downward direction, the leader might just leave for another company, Graham said. Instead, he thinks Portland should refocus its efforts on lower-paid workers. “If you want to work on ratios, I think we should start lifting up the bottom, lifting up the minimum wage.”
Others agree. “To bring it to the local municipal level from a business tax standpoint seems like a good headline for articles, but in the end, it’s not actually going to address pay inequality,” said Randy Knaflic, vice president of people and internal operations for Jawbone, a wearable technology company based in San Francisco. “If you’re going to get into penalizing companies, focus instead on rewarding companies that are leading the way with closing the gap that has a broader impact on an employee base than strictly the CEO.”
Lauren Dixon is an associate editor at Talent Economy.