On Wednesday, the Securities and Exchange Commission voted to propose a rule requiring companies to disclose the ratio of CEO pay to the average worker’s pay within their company. Big business has been fighting the Dodd-Frank rule for years, arguing that the number is either impossible to calculate or irrelevant to investors, while unions and other supporters of the rule think it will be invaluable for shaming companies into lowering their executives’ big paychecks.
But now that the rule has been approved, if not finalized, we’re left with the question: What ratio is the right one?
Is it 147-to-1, the reported ratio in Germany, the economic powerhouse of the European Union? Is it 58-to-1, the ratio from the late 1980s, according to the Economic Policy Institute, before the stock options craze of the 1990s really got going? Or to be purely arbitrary (if more realistic), should it be 100-to-1?
No doubt what’s deemed acceptable once these ratios start coming out will be just that: arbitrary. Whatever the median ratio is–however inflated that may be in today’s world of executive compensation–will by default become the new yardstick. I’m skeptical these new disclosures will bring about much change, and they may even have the unintended consequence of previous disclosure rules–higher pay. I hope to be proven wrong.
Of course, there is one ratio that’s been suggested by a management expert whom most CEOs and corporate directors admire and–whether they know it or not–already emulate. Peter Drucker is widely credited as the father of modern management who predicted the importance of decentralization and marketing to the modern corporation, as well as articulated the concept of the knowledge worker on which our economy is largely built today.
He believed that the pay ratio should be 20-to-1. “I have often advised managers that a 20-to-one salary ratio is the limit beyond which they cannot go if they don’t want resentment and falling morale to hit their companies,” the Drucker Institute at Claremont Graduate University quotes him as saying in a letter it wrote to the SEC back in 2011 commenting on the new rule. Drucker scaled back from his more generous suggestion in 1977, when he put the ratio at 25-to-1.
Even by that more generous figure, the “right” amount of executive pay today, according to Drucker, would be about $1.3 million (and that’s using a worker pay figure calculated by the Economic Policy Institute that it says “clearly overstates” typical worker pay). Not bad for a year’s work, but also highly unlikely. For perspective, Bloomberg reported earlier this year that the average multiple of CEO pay to workers’ pay is 204, eight times the ratio Drucker suggested.
Jena McGregor is a columnist for On Leadership.