In this edition of HR News You Can Use we focus on CEO/Senior Management compensation. There are two great articles that cover the topic well.
First, there is a great WSJ article that discusses the corrosive effects of high comp packages that do not correlate to results.
Second, there is an interesting article regarding pay transparency in the world of sports.
Much has been said about building a winning culture, improving employee engagement, and making your organization a magent for top talent.
My belief is that all of the strategies for improving these key areas can be undermined by the corrosive effects of excessive CEO and senior leadership compensation.
People still highly value meritocracy and do not begrudge high performers or owners from earning high compensation. There are limits though – especially with the pay packages for non founder/owners,
Here are two curated recent articles that analyze the persistent problems that are tied when pay does not equal performacne
Concerns About CEO Compensation Still Exist As Results Show That High Pay Does Not Equal High Performance
From The Wall Street Journal July 25, 2016, article “Best-Paid CEOs Run Some of the Worst-Performing Companies” by Theo Francis reported:
The best-paid CEOs tend to run some of the worst-performing companies and vice versa—even when pay and performance are measured over the course of many years, according to a new study. The analysis, from corporate-governance research firm MSCI, examined the pay of some 800 CEOs at 429 large and midsize U.S. companies during the decade ending in 2014, and also looked at the total shareholder return of the companies during the same period. MSCI found that $100 invested in the 20% of companies with the highest-paid CEOs would have grown to $265 over 10 years.
The same amount invested in the companies with the lowest paid CEOs would have grown to $367. The report is expected to be released as early as Monday. The results call into question a fundamental tenet of modern CEO pay: the idea that significant slugs of stock options or restricted stock, especially when the size of the award is also tied to company performance in other ways, helps drive better company performance, which in turn will improve results for shareholders. Equity incentive awards now make up 70% of CEO pay in the U.S. “The highest paid had the worst performance by a significant margin,” said Ric Marshall, a senior corporate governance researcher at MSCI. “It just argues for the equity portion of CEO pay to be more conservative.”
Executive-pay critics have long said pay and performance could be better aligned, and in June, The Wall Street Journal reported the little relationship between one-year pay and performance figures for the S&P 500. Most longer-term analyses have used considered three or five years at a time. The MSCI study compared 10-year total shareholder return—stock appreciation plus dividends—and cumulative total CEO pay as reported in proxy-filing summary compensation tables. The study also examined pay and performance among companies within the same broad economic sectors and found similar results:
The top-paid half of CEOs in a sector tended to run companies that performed worse than their peers, while the lower-paid half tended to outperform. “Whether you look at the entire group or adjust by market cap and sector, you really get very similar results,” Mr. Marshall said. One possible factor driving the results, the researchers concluded:
Annual pay reviews and proxy disclosures, which discourage boards and executives from focusing on longer-term results. The report recommended that the Securities and Exchange Commission require disclosure of cumulative incentive pay over long periods, to help illustrate a CEO’s pay relative to longer-term performance.
Pay Transparency Can Backfire
From the Harvard Business Review post “10 Years of Data on Baseball Teams Shows When Pay Transparency Backfires” written by Aaron D. Hill, Federico Aime and Jason W. Ridge
You’ve probably taken a guess as to how much money your coworkers and others make, compared with you. Evidence suggests you probably aren’t very accurate. In one PayScale survey of 71,000 people, for example, 64% of those paid the average market rate thought they were paid less than average. At the same time, 35% who were paid above market rates also thought they were paid less than average.
Because our perceptions about pay are often wrong, pay transparency has started to gain popularity. Why not simply inform workers of what everyone in the organization makes, in order to stave off speculation?
There are pros and cons to this line of thinking. On one hand, such a policy can guard against discriminating along racial, ethnic, or gender lines while giving people a firm grasp of where they stand in an organization. On the other, firms naturally have differences in pay in some form. When people are made aware of pay inequality (or “dispersion”), it can lead to feelings of inequity that affect satisfaction and motivation, increasing the likelihood that people will quit. Because of this, some question the wisdom of openly informing people that pay differences do exist.
We agree with both arguments. Pay transparency can be a good thing, but it can also be a bad thing if executed poorly. So how does a firm correctly execute a pay transparency plan? By making sure the inherent differences in pay are justified by differences in workers’ performance on the job. Our research, appearing in Strategic Management Journal, shows that if people know how much they make relative to others, and if differences in pay can be clearly tied to how their performance stacks up against coworkers’, harmful effects of differences in compensation can be negated. Pay transparency must go hand-in-hand with performance transparency — something that may seem obvious but, at least in our experience, is lacking in most organizations.
To analyze this, we used data from an industry where individuals’ pay and performance are quite transparent across firms and also, at least for some, are quite unequal: Major League Baseball. We tested how differences in pay and in players’ performance affected the winning percentages of MLB teams from 1990 to 2000, controlling for a host of factors including how much teams spend on players’ salaries, relative to other teams; the ability of the manager; and the overall team talent, which we measured using a comprehensive and comparative player performance metric created by noted baseball statistician Bill James. (While sports are different from other industries in many respects, baseball makes a good test case for this kind of study for several reasons. First, there’s lots of transparency about individual performance and compensation. Second, the format of the game makes it possible to separate, to a higher degree than in other contexts, individual performance from team performance. And third, MLB players’ compensation is less regulated than in other sports, so we can more readily observe the impact of pay dispersion.)
We first show that, as in prior studies, pay dispersion is negatively related to winning performance above and beyond the effects of the other factors. In other words, the greater the inequality in pay, the worse the performance.
But when we looked more closely at performance, we found that teams actually perform better (that is, they have a higher winning percentage) when there is a matchbetween pay and performance. In essence, a team could have a high dispersion in pay between players, but if the pay corresponds with their performance, the negative aspects of inequality go away, at least in the form of a team’s winning percentage.
Consider the Oakland A’s as an example. In the late 1980s and early 1990s, they were one of the top-spending and most successful teams, playing in three straight World Series, from 1988 to 1990, and winning nearly 60% of their games in 1992. New owners took over in 1995 and changed strategies, slashing payroll and shifting their emphasis to using younger, cheaper players (as opposed to a roster of expensive veterans), while also focusing their smaller payroll on rewarding a handful of key performers. This approach, famously described in Michael Lewis’s book Moneyball, took time, as the team cycled out existing contracts, so that by 1997 the A’s had a very low match between pay and individual performance.
But then things began to change: The match improved to about league average in 1998, and increased further in 1999. Most important, the winning percentage of the A’s improved along with the improved match in pay and individual performance; the team went from winning 40% of games in 1997, to 46% in 1998, to 54% in 1999. In 2000 they won 57% of their games and were back in the playoffs, with a high match between their dispersion in pay and players’ performance.
There are also examples of pay and performance mismatches, either by having highly dispersed pay or highly similar pay (low dispersion) that is not justified by performance. In 1998, just a year after winning the World Series, ownership of the Florida Marlins (now named the Miami Marlins) engaged in a fire sale, cutting the payroll to one-quarter of its previous total. As with the A’s, certain players and contracts were hard to trade, and the result was that the Marlins had a highly dispersed payroll — the highest in the league, in fact. That same year, the Montreal Expos (now the Washington Nationals), which had been cutting payroll for the previous few years, had a roster full of inexpensive players all paid relatively the same, resulting in the lowest pay dispersion in the league. Yet for both teams, dispersion in individual performance was about average, creating high mismatches for the two teams but in different ways: high dispersion in pay with average dispersion in individual performance for the Marlins, versus low dispersion in pay with average dispersion in individual performance for the Expos. Unsurprisingly, the Marlins won only one-third of their games, while the Expos won 40%.
That same season, however, the New York Yankees set a then-record for wins in a season, and the next winningest team, the Atlanta Braves, won nearly two-thirds of their games. While the former was in the bottom quarter of the league for payroll dispersion and the latter was in the top five, both rated highly in terms of the match between the dispersions of pay and the dispersions of individual performance.
In the end, our analysis points to two general conclusions.
First, the negative impact of high pay dispersion is not about equality but about equity. Or, more specifically, group performance suffers when pay differences or similarities are not justified by individuals’ performance. Relatively high or low dispersion is not in and of itself bad; rather, it is the match (Yankees/Braves) and mismatch (Marlins/Expos) between pay and individual performance that creates problems.
While there are some limitations to the generalizability of our research, including the head-to-head nature of competition in baseball and the openness of pay and performance data, we suspect similar dynamics may be at play in the workplace. Sports data is useful for studying pay and performance since it is widely available, but studies identifying problems associated with pay dispersion appear in diverse contexts, ranging from hospitals to trucking firms and concrete pipe manufacturers, and from administrative professionals to executives in S&P 500 firms.
As such, it is imperative that pay be allocated based on equity, where pay matches performance. If not, firms that pay more or have better overall talent may not perform as well as expected, if high performers are paid the same or less than their lower-performing peers. Similarly, firms with employees who perform similar tasks, and to a similar degree of quality, should all be paid similarly to eliminate any harmful effects of pay dispersion. If not, high performers may lack motivation to continue to outperform their peers who do less but make the same, and low performers may lack motivation to perform better when they can make the same as high performers by doing less work.
Our second conclusion is that it’s important to understand pay transparency as a complex issue. As calls for pay transparency increase, it’s important for companies to understand when it may and may not pay off. Sure, it can be a tool for broader pay equity and for employee motivation. But if pay is transparent and performance does not justify any discrepancies or similarities, pay transparency can have disastrous effects.
Consider the infamous case of Seattle credit card processer Gravity Payments, which, in 2015, set a minimum salary of $70,000 for all employees. Two employees interviewed by the New York Times ultimately quit. One was frustrated with “people who were just clocking in and clocking out” earning the same as he was. Another was upset by the lack of fairness, noting the company “gave raises to people who have the least skills and are the least equipped to do the job, and the ones who were taking on the most didn’t get much of a bump.”
The bottom line for companies is that people are going to make comparisons about pay and, more often than not, will make them inaccurately. Rather than hiding pay information or making it accessible without context, organizations would be better off forming transparent performance metrics, matching pay to those metrics, and having open conversations with employees about where they stack up. That, more than anything, is what a truly transparent compensation program would look like.
