CEO compensation is more than a trendy business topic that surfaces every now and again. It has become, particularly of late, THE reigning business topic. It is a subject dominating headlines and claiming publications’ covers. From mastheads to movements, executive remuneration has been the focus of nearly global attention, with ‘Occupy’ protests occurring in Fleet Street, Wall Street and almost everywhere in between. As a result, CEO salary has become its own, unique brand of business ‘celebrity.’
The spotlight shone on CEO pay has revealed the extent to which the controversial subject has been met with critique and even vitriol. Note, for instance, the outrage with which a recent Forbes piece detailed Jamie Dimon’s latest compensation package: “Although JPMorgan’s board of directors docked Dimon’s bonus by 50%, he still walked away with $11.5 million in compensation for 2012 – a staggering sum in a year when the bank faced months of embarrassing revelations and serious questions about the legality and integrity of its practices.”
It is hard, perhaps impossible, to argue against the Forbes’ perspective on the issue. I, therefore, won’t even attempt it. I will, instead, pose a simple question: beyond its inherent symbolism, is CEO pay even an argument worth having?
I hold the understandably unfashionable view that it’s not. I would argue that CEO pay is less relevant now than ever before. In fact, there may be some instances in which CEOs are actually underpaid.
Before the argument is dismissed outright, let’s take a step back. CEO salary is an emotional subject, I understand that. That emotion has only been heightened over the past few years as the gulf between the ‘haves’ and the ‘have nots’ has grown wider. This divide had helped spawn a movement in Occupy Wall Street that rails against that rarified strata that CEOs inhabit – the infamous 1%. But that visceral response has had another – perhaps unintended, but certainly unwelcome – consequence: it has drowned objective analysis.
Of course it is preferable for shareholders that executives (a) are not paid more than they need to be, (b) are not paid for failure and (c) do not set off wage inflation within their own business because everyone wants to be paid more. But put to objective analysis these arguments are inherently flawed – none more so than the argument suggesting inflated CEO pay is corrosive because of the example set to the rest of the business. The domino theory, as it were, failed us before and here it fails us again.
Shareholders should be less alarmed by the demand for aggregate wage increases than ever before because salaries are less relevant to their business than ever before.
Before we get excited about the salary issue, let’s put it into greater context. Shareholders and institutional investors don’t seem to realize the limited positive impact on business performance that reducing executive pay will produce. Recent research on the FTSE 350 – The £10 billion ($16 billion) profit opportunity – has found that only 12% of revenue is spent on labor (down from 15% three years earlier).
I am not going to argue against the fact that some CEOs are overpaid. But, it’s a side issue at best. Overpaying everyone in the business by 10% will only cause a 7% reduction on EBITDA.
Simply said, reducing senior executive pay, while a nice symbolic gesture, is not going to materially improve profitability. Symbolism won’t pay shareholder dividends, won’t drive revenue and won’t better the bottom line. What will? Recognizing and addressing the egregious inefficiencies in corporate operational costs. That same aforementioned research also found that overpaying suppliers by 10% drops EBIDTA by more than one third.
Indeed, in contrast to the 12% of revenue being spent on labor, a massive 68% is spent on non-labor and supplier related costs. So if a corporation were to reduce labor costs by 1%, it would increase profitability by 0.8%. Yet if that company were to reduce non-labor costs by the same 1%, it would increase profitability by 3.6% – five times greater.
These numbers suggest quite clearly that more attention energy should go into investigating supplier “salary” rather than CEO remuneration, as unglamorous as the former may be.
As for the last part of my argument – suggesting that some CEOs might, in fact, be underpaid – I’m aware that will probably have some readers vexed and choking on their cornflakes. That said, we need to recognize that there are real examples where tinkering with CEO pay should be done with care, if at all.
There are many ways of evaluating a CEO. If we simplify it to a market based approach, it is a question of what would it cost to replace the CEO with someone of equivalent or better talent. Most people’s working assumption is that CEOs are the most expensive talent in a business as they are the top of the tree. This assumption falls over in finance where traders, for example, can see higher remuneration than their bosses and in the area of sales where commissions can be very significant.
The latter point matters when CEOs participate in the sales process. Take a topical example beyond Dimon: I have no doubt that Martin Sorrell of WPP will be one of the CEOs whose compensation will come under scrutiny in 2013.
I cannot think of a better performing global salesman over the last two decades. If he was lost, WPP would lose its greatest salesman. Replacing his sales pazzazz would cost millions in commissions to replacement sales people; possibly significantly more than he is paid. His market value is not just as a CEO but also as a salesman – an ambassador for his organization and industry more generally.
I hope that compensation committees make sure that they understand the reference points upon which they are assessing CEOs and their compensation packages, and they do not throw the baby out with the bath water.
That said, I’m not holding my breath. Celebrities, be they of the Hollywood or Hedge Fund variety, will always attract attention. And in the business world, there is no greater celebrity than CEO salary.
Matthew Eatough is CEO of Proxima, an international procurement outsourcer. Headquartered in the UK with U.S. offices in Chicago and L.A., Proxima manages over $10 billion in operational spend for clients across a broad range of industries including consumer products, healthcare and media and entertainment.