September 24, 2013
Dear Chair White,
What little value the general reporting of a ratio of CEO pay to median employee pay might offer is further diluted by the use of competing methodologies to compete both the numerator and denominator of such a ratio. I question not only the wisdom of offering a firm's investors (and the public, journalists, and others) a ratio difficult to compare between firms, but also the wisdom of Congress and the SEC's decision to implicitly endorse the relevance of such a ratio by forcing its announcement and inclusion in public filings.
While at the University of Chicago, I had the opportunity to study - and write on - CEO pay in some detail. Since then, I've followed the various debates on CEO pay and advised friends and colleagues involved in compensation committee deliberations and decision-making conversations on executive pay.
As you are no doubt aware, there is no empirical evidence that CEO pay relative to median worker pay is an indicator of CEO effectiveness (or, for that matter, a median worker's effectiveness), nor that CEOs that are highly-paid relative to median workers are uniformly more able (or less able) to defend and assert the interests of shareholders. Of the things CEO pay could be compared to, median worker pay within the same firm is perhaps one of the least-useful comparisons. Among the CEOs I know personally, I know none whose compensation was selected because it was a given multiple of median pay - and I know no board member of a publicly-traded firm that would consider this an appropriate way to choose executive compensation levels. The absurdity is easily illustrated by examining the inverse: I also know no firm that tells incoming workers, "Well, even if you're amazing at your job, you could only hope to add 0.1% of the value our great CEO adds, so that's how we've set your pay."
Further, there is no evidence that CEOs that receive pay packages several orders of magnitude less than their marginal product of labor are somehow better, more virtuous, more kind to workers, or - perhaps most importantly - more able to represent the interests of the company's shareholders. Look, for instance, at some recent CEOs who have been paid less than their firms' median workers (for a variety of reasons) are these the world's finest CEOs? A CEO's choice to take a very low salary due to windfalls in prior years or as gesture to disappointed shareholders or in the wake of marrying a wealthy spouse does not make her leadership more effective or her service to shareholders more valuable. If anything, an underpaid CEO may be more difficult for a board (and hence for shareholders) from a governance perspective, as one of the key levers for CEO control (compensation) is removed.
Suppose a firm pays the CEO half of what the median worker earns. Another firm pays the CEO five times what the median worker earns. Another firm pays the CEO five hundred times what the median worker earns. What does this tell you about these firms? It tells me very little and if I were marking a final exam in an economics or public policy course I teach, I would be highly skeptical of a student's answer if he or she claimed these ratios alone were meaningful.
There is no doubt many journalists, bloggers, and noisemakers - many of whom would be qualified to be neither the median worker nor the CEO of the firms on which they comment and were likely too lazy to do the requisite research prior to this publication requirement - will comment on the pay ratio that separates the two. And I'm sure that, in some future course, I'll assign students to research some of these ratios in an illustration that there are plenty of statistics in the world that do little to teach us anything about anything - and that the ratio of median worker pay to CEO pay is, for the vast majority of firms, one of these statistics.
Finally, to illustrate this point, allow me to make an observation about your office. Let's take your annual salary of $165,300 as Chair of the SEC. If the median worker at the SEC makes $50,000 or $75,000, does this change the reasonableness of your compensation? Does it change the reasonableness of that person's compensation (as measured relative to your own)? Or, if one were to view the entirety of the federal government, is it reasonable to compare the $400,000 salary of President Obama to the median federal worker's salary or to your own salary? Is that ratio important in evaluating the performance of any worker? I think not.
With kind regards,
Karl T. Muth
Northwestern University
Note: Opinions and comments and any errors in this letter are my own and may not represent the views or positions of institutions with which I am affiliated.