Bridging pay-gap between CEOs and employees

The controversy over the pay gap between chief executive officers (CEOs) and employees is not new and has a well-traced history. It is often argued that the CEOs are too highly remunerated. Their high remunerations seem to counter the reality since CEOs' remunerations are usually more than 300 times the median remuneration of employees. In the face of such a huge gap, a debate is brewing whether there should be limit on the pay ratio of remunerations of CEOs and employees or not. If there should be a limit, then how the limit should be imposed.
The problem of pay-gap has to be handled from two fronts: First we have to seek what are feasible measures to control pay-gap between CEOs and employees. Second, we have to ascertain the feasibility of each measure in terms of its sustainability and practicability. For example, one can arbitrarily fix the pay ratio at 10. But the problem is how to determine that such a ratio will be sustainable and will lead to a solution while taming pay gap.
Deborah Hargreaves wrote an article in the New Times titled 'Can We Close the Pay Gap'. In that article, she documented the current pay ratio saying that in 2012 compensation of CEOs of S&P 500 Index was 354 times that of rank-and-file staff. This is quite abnormally a huge pay gap. Now the question is why shouldn't there be any law that restricts pay gap between CEOs and employees. Deborah observed that in the USA, Dodd-Frank Act says that American companies should disclose the ratio of compensation of their CEOs to the median compensation of employees. But such a law has hardly seen the implementation due to harsh criticism from the business units. Similar kind of happening occurred in Switzerland when big corporations threatened to leave the country in the face of referendum that would have restricted pay ratio to 12 to 1. Finally, the voters rejected such referendum being threatened by big corporate, added Deborah.
The question is why are corporate so stubborn in cutting down pay-gap between CEOs and employees? What are the reasons behind that? Deborah mentioned several reasons. First, businesses argue that in order to keep them in line with global competition and to attract talent pool, they need to reward CEOs higher. But the appointment of CEOs across the Fortune Global 500 hardly tells this story. She said, "Not one of the chief executives heading up the 142 companies in the Fortune Global 500 at the end of 2012, for example, was hired from overseas." She further concluded that overall overseas CEO appointments in the Fortune Global 500 account 0.8 per cent of total CEO appointments. This is a very small number and doesn't support the above argument regarding CEOs' compensation based on attracting global talent pool.
Second, businesses argue that CEOs need to be rewarded high to give them incentive to drive the business to success. Yet the relation between CEOs' payment and companies' success is not so convincing. Economists say that higher compensation of CEOs is at odds with the long-term success of companies but very much linked to short-term focus.  On the other hand, there is very scarce evidence of strong positive relation between CEOs' pay and companies' success.
Finally, businesses see higher pay gap ratio as a strategy to keep costs of production constant while rewarding CEOs higher and paying employees less. For example, a percentage increase in the pay of a CEO has negligible impact on production costs relative to a percentage increase in wages of employees. Moreover, CEOs' compensation mostly comes from the stock options. This is one of the clever strategies that business units employ to reward CEOs higher.
What is the way-out of the pay-gap problem? We can conceive several measures. The government by legislation can restrict the ratio of pay between CEOs and employees to some fixed value. But as mentioned above, such measures have not seen the hope of implementation, let alone solving the problem.
Another measure can be, as mentioned by Debora, the participation of shareholders and empowering them to decide what should be the compensation through their votes. Such kind of measure has been undertaken in Germany where two-tier board structure for company governance determines the pay for top executives. In this set up, a supervisory board, comprised of half of shareholders and half of employees elected by work force, has the final power to set top pay.
The measure taken in Germany is very much satisfactory and laudable but this measure has inherent deficiency in terms of reducing inequality from the time perspective. Though the ratio of compensation of CEOs to that of employees can be restricted to some manageable range by shareholders and employees' participation and votes in determining CEOs pay, such pay ratio, if it remains constant over time, would keep the degree of inequality between pay of CEOs and employees at least constant while keeping the original degree of inequality unchanged. Moreover, the degree of inequality will also depend on how the pay ratio adjusts over time; whether the pay of CEOs increases more than that of employees. The problem is exactly like the problem associated with reducing inequality through income redistribution policies such as tax measures. To get a satisfactory solution to pay gap problem, we not only need this kind of interventionist measure but also some radical approach to the study and theoretical formulation in economics. Let's turn to the latter approach.
The conventional economic model is built on a rational foundation in which rationality is defined in such narrow concept that each and every economic agent acts as selfish being to maximise his or her utility. Amartya Sen called this rational agent 'Rational Fool'. It seems utter duality from two corners: from one corner, theories tell us individuals are selfish and are only concerned with maximising their own utility. From the reality corner, such theories lead to worse outcome where selfish motive gives rise to big problems such as the pay-gap problem, and the problem of inequality. Theories have given birth to a baby that is too obese to feed. In the end, such baby will die out of starvation since reducing obesity of the baby has become the prime condition to make it alive. Where we study in text books that we are selfish beings, we can only expect to see such theories spreading as much inequality as it can. Therefore, the study of inequality has always been completely separate from the conventional economic theories and these theories hardly seem to be concerned with the degree of inequality that may emerge from these. This kind of apathy has caused us to suffer and will do so more. While the concern of Deborah seems very much justified, such concern will over time be lost with the dominance and flamboyant impression of the conventional theories. The same thing has been happening with the study of inequality. The best example has been the Pareto optimality of competitive equilibrium in judging welfare.
A competitive equilibrium outcome can be a Pareto outcome with one person having the largest fraction of the total income and the rest having the minute fraction.  But the real frustration comes when we see the disinterest of the academics to integrate the concern of inequality with the competitive market equilibrium outcome. In fact, economics as a discipline doesn't restrict us to integrate inequality and competitive market equilibrium to generate a solution that has the smallest degree of inequality. This indicates that the pay-gap problem has much more to do with the teaching of economics in the classrooms and much less to the restrictive measures or legislations to control pay-gap.
The writer is with the University of Denver, the USA. [email protected]