Are CEOs overpaid? is arguably the most difficult question in executive compensation. That’s because there is no one metric that answers it.
Overpaid with respect to what – CEO compensation in other companies? Size of business managed? Compensation of other employees? The answers are not straightforward. Remuneration committees, while evaluating CEO pay decisions, typically focus on the first two dimensions. However, larger public perception on whether CEOs are overpaid is also influenced by trends in CEO pay ratios — CEO Pay to Median Remuneration of Employees (MRE). Debates in the media on whether CEO pay is excessive also rise when layoffs feature too often in headlines.
Listed companies across many jurisdictions (including India) publish CEO pay ratios. Our analysis shows that over the last five years, CEO pay ratio has risen from 153 to 222 in India and from 218 to 263 in US. CEO pay ratio increased in two out of every three companies in India and for every second company in the US. The challenge is that there is no rule to determine what the ideal CEO pay ratio should be.
Literature suggests that this ratio was as low as 20 in the 1960s in US. This difference in the rate of increase of CEO pay vis-à-vis that of other employees is at times the source of controversy.
What does data say?
The popular belief is that CEO pay, particularly in India, is growing at 200–300 bps slower than other employees. This is not borne out by the data. CEO pay in India has risen 11 per cent annually over the last five years while MRE has risen at only 4 per cent.
If we adjust for CPI inflation, CEO pay has grown 5 per cent annually whereas MRE has fallen by 1 per cent. Also, while increments impact a larger proportion of total compensation for the junior employee, most of the CEO pay is at-risk and delivered via commissions or incentives that are delinked from fixed pay increments.
As per our analysis, CEOs of some of the largest companies in the US earn $24 million compared to $2 million in India. MRE stacks at $90,000 in US compared to $9,000 in India. The pertinent question therefore is not whether CEO pay is too high but whether median pay is too low. MRE reflects both the nature of role as well as talent market dynamics.
One way to increase MRE is to develop higher value-adding skills that enhance productivity. Technological enhancements and digitisation will lead to long-term cost savings which can partly be used to bring up the living standards of all employees and increase employment via new ventures.
Remuneration committees in India are rightfully concerned about taking socially responsible executive pay decisions. In our view, they should do three things. Firstly, they must ensure that the level and the composition of CEO pay drives sustainable value and performance. Secondly, they must ensure that CEO pay decisions are contextual, independent, and backed by the right benchmarks.
Finally, they should pay close attention to CEO pay ratios and their rate of increase as part of the compensation decision making process. The CEO role comes with great responsibility. And great responsibility comes with high remuneration in the corporate world. We just need to reinforce a culture of collective success.
The writer is Director, Deloitte India Consulting