- Warren Buffett, CEO of Berkshire Hathaway, believes that CEO salaries are too high and should be no more than 20 times the salary of the average worker. But why do CEOs earn so much money? Let’s explore the complex factors that influence CEO compensation and why it is such a controversial topic.
Posted on Oct 07, 2023Oct 05, 2023 by Priyansha
In the world of corporate powerhouses and industry giants, it’s no secret that CEOs earn astronomical salaries. But have you ever wondered why CEOs earn so much money? Is it simply because they’re the leaders of their organizations, or is there more to the story? A report from the Economic Policy Institute (EPI) in 1965 revealed that the salaries of CEOs were 20 times more than the average worker in their industry. This figure, however, increased significantly in the 1980s and 1990s, when CEOs were held in high esteem and a major portion of their salary was linked to the stock performance of their company. In the past 30 years, the S&P 500 has increased by more than 1000%, while wages of employees, after allowing for inflation, have remained stagnant. In 2021, according to the EPI report, the ratio of a CEO’s salary to that of an average worker was 399:1. “It goes without saying that a CEO should be the highest-paid employee in any organization,” said EPI Chief Economist Josh Bivens, who co-authored the report. “But the real question is, how much higher should they be?”
To understand the current state of CEO compensation, we need to take a trip down memory lane. Back in the early days of capitalism, CEOs were not the well-paid titans we see today. In fact, their salaries were relatively modest compared to their counterparts in the modern era. So, how did we get from there to here?
Why are CEOs paid high salaries?
One key factor that fueled the surge in CEO salaries is the shift towards shareholder capitalism. In the late 20th century, there was a growing emphasis on maximizing shareholder value, which led to a change in the way CEOs were compensated.
As companies started linking executive pay to stock performance, CEOs had a powerful incentive to drive up share prices, resulting in hefty paychecks when they succeeded.
- The Celebrity CEO Phenomenon: Another factor that contributed to the rise in CEO salaries is the emergence of the celebrity CEO phenomenon. In the 1980s and 1990s, high-profile leaders like Jack Welch of General Electric and Lee Iacocca of Chrysler became household names. Their success stories and charismatic personalities elevated the role of the CEO to that of a superstar, deserving of superstar compensation.
- The War for Talent: As the business landscape became increasingly competitive, companies realized the importance of attracting top talent to lead their organizations. The demand for exceptional CEOs skyrocketed, leading to intense competition and bidding wars for the best executives. This fierce battle for talent drove up CEO salaries as companies were willing to pay a premium to secure the services of the most sought-after leaders.
Drivers of CEO Pay Trends
Now that we have a historical context, let’s dig deeper into the factors that influence CEO compensation. It’s not just one thing that determines their sky-high salaries; rather, it’s a combination of various elements that make us question ‘Why CEOs earn so much money?’.
- Company Performance: One of the most significant factors impacting CEO pay is company performance. CEOs are often rewarded handsomely when their companies achieve exceptional financial results and outperform their competitors. After all, if a CEO can deliver impressive returns to shareholders, it’s only fair that they reap the rewards of their success.
- Industry Norms and Peer Comparisons: CEO salaries are also influenced by industry norms and peer comparisons. Companies want to ensure that their executives are competitively compensated compared to their counterparts in similar positions and industries. Benchmarking against industry standards helps companies attract and retain top talent by offering salaries that are in line with market expectations.
- Complexity and Scope of the Role: Being a CEO is no walk in the park. The complexity and scope of the role often justify the hefty paychecks that CEOs receive. They are responsible for making critical strategic decisions, managing large teams, and navigating complex regulatory environments. The level of responsibility and accountability that comes with the position warrants a commensurate level of compensation.
- Supply and Demand Dynamics: As mentioned earlier, the war for talent plays a significant role in determining CEO salaries. The scarcity of qualified individuals who possess the necessary skills, experience, and track record to lead large organizations drives up their market value. When the supply of exceptional CEOs is limited, companies are willing to pay a premium to secure their services.
- The Controversy Surrounding CEO Salaries: Given the staggering disparity between CEO salaries and those of average workers, it’s no surprise that CEO pay has been a topic of intense debate and controversy. Critics argue that the exorbitant compensation of CEOs contributes to income inequality and widens the wealth gap. They question whether CEOs truly deserve such astronomical salaries and whether their pay is proportionate to their contributions.
- CEO-Worker Pay Ratio: One metric that highlights the disparity between CEO and worker pay is the CEO-worker pay ratio. This ratio represents the difference between the average compensation of CEOs and the average compensation of a company’s workers. In recent years, the CEO-worker pay ratio has been a focal point of discussions on income inequality, with some ratios reaching hundreds or even thousands to one.
- Shareholder Activism and Say-on-Pay: To address concerns about excessive CEO pay, shareholder activism has gained momentum. Shareholders now have the opportunity to voice their opinions on executive compensation through say-on-pay votes. These votes allow shareholders to approve or reject a company’s executive pay packages, creating a mechanism for accountability and transparency.
- Calls for Reform and Regulation: The controversy surrounding CEO salaries has prompted calls for reform and increased regulation. Some argue for stricter oversight and transparency in executive compensation, insisting that boards of directors should be more accountable to shareholders. Others advocate for changes to tax policies or the implementation of caps on executive pay to address income inequality.
CEO salaries have become emblematic of the wealth disparities in modern society. While the factors influencing CEO compensation are complex and multifaceted, it’s clear that a combination of company performance, industry norms, talent scarcity, and market dynamics is the answer to why CEOs get paid so much money. The controversy surrounding CEO compensation underscores the need for a broader discussion on income inequality and the role of executive compensation in shaping our economic landscape. As the debate continues, it remains to be seen whether changes will be made to address the perceived inequities in CEO salaries and bridge the wealth gap.
So, the next time you hear about a CEO earning a mind-boggling salary, remember that their compensation is a result of a complex interplay of factors and market dynamics. Whether you view it as a necessary reward for exceptional leadership or an egregious example of income inequality, CEO pay will continue to be a topic of intrigue and debate for years to come.
