Whose Idea Was It To Adjust CEO Pay—Investors, The Board Or The CEO?

Findings of a new study give supporters of stakeholder capitalism ammunition to question the motives of corporate boards that favor CEO pay increases. Three things directors should consider.

A new report by the Institute for Policy Studies accusing companies of adjusting performance goals and compensation metrics for their CEOs during the pandemic is bringing even greater attention to the high number of chief executives whose salaries have skyrocketed in a year when many companies suffered losses. As more information about CEO salaries is reported, one question is starting to be asked more often in governance circles: whose idea was it to adjust the metrics regarding CEO pay—the CEO or the board?

The report by the Institute for Policy Studies focused on the 100 largest U.S. companies that employ mostly low-wage workers and found that “of the 100 S&P 500 firms with the lowest median worker wages, 51 bent their own rules in 2020 to pump up executive paychecks.” The report also stated that of the 51 companies that adjusted their compensation metrics, “CEO compensation averaged $15.3 million, up 29% from 2019,” and 16 of those firms ended 2020 in the red, yet “this group of profit-losing, rule-bending corporations had the highest average CEO pay at $17.5 million.”

Added to concerns about overpaying CEOs who, it could be argued, “underperformed” was the report’s findings on the impact corporate decisions during the pandemic had on low wage workers. The 51 companies that adjusted their compensation goals to pump up CEO salaries awarded typical low-wage workers smaller paychecks than their counterparts at other similar companies.

According to the report, “The 100 S&P 500 corporations we analyzed all paid median compensation under $50,000 in 2020. Some did offer frontline employees paid leave and small pay increases during the pandemic, usually around $2 per hour, but in nearly all cases this modest extra Covid-19 support was only temporary.”

These findings give supporters of stakeholder capitalism ammunition to question the motives of corporate boards that adjust their pay plans to favor CEO pay increases. Is the trend of never-ending pay raises for CEOs in the best interest of shareholders? And who actually makes the final decision on CEO pay—the board, the CEO or the shareholders? Some things for corporate directors to consider:

• CEO pay is the board’s decision, but explaining compensation plan adjustments will be critical going forward. With so many companies adjusting their pay plans in favor of CEO pay raises, every corporate board will need to be prepared to explain why an adjustment was needed and why each specific change was made. Explaining the reasons why is relevant because investors don’t want to feel like their corporate board is obligated to make sure the CEO takes home higher and higher pay. For investors, guaranteeing CEOs substantial salary increases no matter what they do doesn’t seem like the best way to motivate an executive to do their best work. Guaranteeing CEOs raises can also serve as a morale-buster for regular employees who often have salaries frozen or cut when companies experience bad times. If the explanations for making pay plan adjustments that result in higher CEO pay don’t correlate with improvements in long-term shareholder value, the board leaves itself open to criticism regarding its decision making. The perception of poor decision making leads to challenges for director seats.

• High compensation can’t be the only way to retain a CEO. News reports suggest that many companies are saying they’ve relaxed pay metrics because they want to make sure they retain top talent, including their CEO. Retaining a CEO who is not preventing losses doesn’t seem like a cost-effective move. Boards must make sure that a CEOs performance is the reason he or she is retained, and that their performance is the key reason for any pay raises – even during a pandemic.

Are boards really afraid that a CEO will quit their job because he or she didn’t get a raise in one specific year? That’s unacceptable. It gives the impression that the CEO is dictating salary considerations to the board, which is not in the best interest of shareholders. If the board trusts its ability to develop a fair compensation plan, then stick with it. Examine the pay plans of other companies that did not make adjustments and consider why they didn’t.

Also, boards must always plan for CEO exits. If the board is doing its job in terms of succession planning there should be no worries about a CEO who wants to leave. The board should ensure the company has several capable replacements waiting in the wings in its executive ranks and they should identify one or two possible successors at other companies that they would approach if their CEO quit.

• If boards don’t address escalating CEO pay regulators and investors will. Right now it doesn’t appear that boards are making the best decisions regarding CEO pay. With discontent growing over escalating CEO pay, there will likely be more shareholder actions against boards in the coming years. In addition to more companies failing their say-on-pay votes like we’ve seen in the first half of this year already, expect investors to file more proposals seeking disclosure of the CEO-to-worker pay ratio. These types of actions will place more pressure on directors sitting on compensation committees to lower CEO pay. If large shareholders like BlackRock and large pension funds get involved, the result might be some board members losing their seats.

The Institute for Policy Studies report also suggests that legislation such as the Tax Excessive CEO Pay Act may actually gain traction nationally. Legislation that would provide tax incentives for corporations to narrow the margin between the company’s highest paid executive and its media workers and tax increases for those that don’t may be enacted in the future.