In 2014, 500 of the highest-paid senior executives at U.S. companies made nearly 1,000 times as much money as the average American worker, after taking into account salary, bonuses, and stock-based compensation. That discrepancy is so enormous that it prompts a question: How exactly do companies come up with and calibrate the often-colossal pay packages they give to their leaders?
Through the 1970s—when the ratio of CEOs’ pay to that of the average worker was much lower, at somewhere between 20:1 and 30:1—the lodestar was “internal equity,” or how an executive’s pay compared with that of other employees in the company. A nascent industry, executive-compensation consulting, changed this. Consultants recommended switching to “external equity,” meaning compensation would be based on what other CEOs were paid. This was merely a useful sales tool—even though the consultants didn’t have solid evidence or theoretical justification for this method, they could attract business by vowing to set ambitious goals for their clients. Still, corporations adopted the standard of external equity, and CEOs got a lot richer.
External equity became the foundation of the series of pay practices and procedures that guarantee CEO pay will continue to skyrocket—something that I observed firsthand for over 20 years, as someone who helped companies, such as the ship-repairer Todd Shipyards (which has since been acquired) and the holding company Laird Norton Company, determine how and how much to pay their top leaders. Formally speaking, I was the member of various compensation, or “comp,” committees, which are usually made up of a few members of the company’s board and executives from other firms. (Every time I was on a company’s comp committee, I was serving as one of its board members.) The committee meets annually to recommend compensation packages for a handful of senior executives, including the CEO, and the company’s board virtually always accepts the committee’s recommendations.