The upward march of chief executive salaries is a sore point in the debate over rising income inequality in America. Forty years ago, chief executives at large companies earned only about 20 times the average worker’s salary. In the 90s, the pay gap widened to ten times that size. Economists like Paul Krugman have argued that this happened in part because social norms changed. Multi-million dollar salaries began to seem, well, less unseemly.
But surveys show that the perceptions of average Americans are stuck in the past. Most still think the CEO pay ratio at large national corporations is around 30-to-1, when it is really closer to 300-to-1. The misunderstandings will soon fade: In August, the Securities and Exchange Commission ordered companies to begin reporting their CEO pay ratios by 2017.
When that information begins to circulate widely, companies may find themselves running afoul of the old-fashioned norms on Main Street -- and losing customers as a result. Recent evidence from researchers at Harvard Business School suggests that customers punish companies that offer lavish CEO salaries.
In a series of experiments, Bhavya Mohan, Michael Norton, and Rohit Deshpandé showed that Americans are deeply concerned about CEO compensation — enough that they will pay up to 50 percent more on average to avoid businesses with egregious CEO pay gaps.
“We do really see that people have a stronger preference for products from companies that pay fair wages,” says Norton, a professor at Harvard Business School. As the researchers dug deeper, they found that this holds particularly true for Democrats and independents — while Republicans didn't seem to care at all.
All this is something of a surprising result. A large pay ratio doesn’t necessarily mean that companies are stiffing their rank-and-file employees. Companies that can afford rock-star executive pay packages might even be seen as particularly competent. High CEO pay could signal that a company offers high-quality goods. (By the same reasoning, customers sometimes shun non-profits, which they perceive to be well-meaning but inferior.)
On the other hand, people do like to feel virtuous about the things that they purchase. Consumers regularly say they’re willing to pay more for goods that are certified fair trade — and of course they do, since sweatshop sneakers and exploited coffee farmers are morally yucky. Apple suffered a PR disaster when Chinese workers began killing themselves at the factories of its suppliers.
The question here is whether outrage over inequality is enough to change people's minds at the checkout counter.
In one set of surveys, the researchers showed people pictures of towels from a national retailer where the median worker earned $22,400 a year. They told half the people that the CEO made $24 million. They told the other half that the CEO made $112,000.
These were carefully chosen ratios, Norton says. Wal-Mart’s CEO pay ratio is believed to be about 1000-to-1, while most Americans believe the ideal CEO pay ratio is around 7:1.
The subjects were asked to what they would be willing to pay for the towels. People who thought the CEO was making $112,000 quoted a price that was 15 percent higher on average than people who thought the CEO was making $24 million.
In another, starker experiment, the researchers asked only if subjects would be willing to buy the towels given a certain price. People were split up into five groups, each shown different combinations of prices and pay ratios. They responded on a 7-point scale (1: Not at all likely, 7: Very likely).
Those who thought they were buying from a company with a high pay ratio were particularly unwilling to buy the towels, even at a discount. The researchers found that a company with a 1000-to-1 CEO pay ratio would have to slash its prices in half to keep up with a company that had a 5-to-1 CEO pay ratio.
It’s important to keep in mind here that consumers weren’t asked to directly compare companies with different pay ratios. The study unearthed something more subconscious about how this information affects people’s decisions.
The researchers saw similar results with lamps and vacuums and books and televisions. Perceptions of quality didn’t seem to have anything to do with how people behaved. Their choices were motivated by a personal sense of fairness.
This became abundantly clear when the researchers asked for people’s political views. It turns out that only people who identify as Democrats and Independents preferred to do business with companies that had low pay ratios. Republicans didn’t care one way or the other.
Of course, people tend to show more moral gumption in surveys than they do in real life. In part this is because we are dealing with hypotheticals (who isn’t against child labor, in principle?). But also, people don't usually ponder issues of inequality while they’re buying their milk and groceries.
“In this study we’re really asking people to pay attention to this specific information about CEO pay,” Norton says. “In the real world, people are considering all kinds of things. Sometimes the effects are smaller in the real world, but typically they’re in the same direction.”
In the real world, people buy stuff from ethically-sketchy companies all the time. This is why the researchers suggest that we should remind people about the principles that they care about by labeling products directly. Experiments show that when coffee is sold with a fair-trade logo, for instance, sales go up by nearly ten percent.
Most people right now have no clue how much CEOs are paid compared to average workers. Corporate America has fought hard to keep them in the dark. When Congress passed a law in 2010 demanding that companies disclose the information, it took five years of squabbling before SEC in August finally ordered firms to comply. Public companies currently report how much their CEOs earn; the new regulation forces them to also publish how much a median employee makes.
Corporate lobbyists complained that that it would be too expensive for companies to review the pay stubs of all their employees. They also argued that the pay ratio is not very meaningful — a company could goose its numbers by firing a lot of low-wage employees and replacing them with off-shore contractors or robots.
But the real concern is that this new rule will draw attention to an unflattering comparison. The left-leaning Economic Policy Institute estimates that among the largest publicly owned U.S. firms, CEOs make over 300 times the salary of a median worker. In 2014, chief executives at these top 350 companies earned 16.3 million on average.
Under the new rule, public companies will report their CEO pay ratios in their filings to the SEC. These filings are usually of interest only to investors. But regulators could require companies to notify consumers about their pay practices. Norton imagines a pay-equity nutrition facts label: How much does the CEOs earn? How much do women earn compared to men? How much family leave is offered?
Corporations have long argued that high executive pay is a competitive necessity. The invisible hand writes the paycheck. “Companies are market takers, not market makers, and the pay ratio is the result of the markets for CEOs and the markets for other workers,” the Center on Executive Compensation wrote to the SEC in 2013.
But there is also the market for customers. The preliminary evidence from Mohan, Norton, and Deshpandé shows that, given adequate information, Americans consumers will reward lower pay ratios. They constitute a market force of their own, and they have the power to demand a return to humbler salaries for chief executives.