The Ratio Companies Don't Want You to Know

The P/E ratio. The PEG ratio. The P/S ratio. The debt-to-capital ratio. These are just a few examples of the many ratios investors use when they're researching potential investments. However, there's one telling ratio corporate managements and boards would rather keep hidden, because it has everything to do with their own bottom lines and it could even put their reputations at stake. It's the CEO-to-worker pay ratio.

The odious "too-onerous" argument
Part of the Dodd-Frank Act that hasn't gone live yet is mandatory disclosure of how a corporate CEO's compensation stacks up compared to the pay of the same company's average worker. Such a ratio would likely be quite telling as far as how much one individual is valued related to the rewards given to all the employees who do their parts to fulfill the company's business model and vision.

The Wall Street Journal recently covered this topic, which underlines what we already know: For many companies, revealing this ratio would be embarrassing and could spur outrage and shareholder revolts. Earlier this year, the AFL-CIO revealed that the pay of the average American CEO to the pay of the average U.S. worker was an astounding 380-to-1. In 1980, that ratio was 42-to-1.

The Securities and Exchange Commission is expected to propose the rule regarding this data disclosure by the end of this month and attempt to adopt it by the end of the year. The business community isn't pleased, though. Many companies argue it would be arduous and expensive to figure out their own ratios.

The argument about large workforces that are increasingly global and supposedly difficult to pinpoint may make logical sense on the face of it, but investors shouldn't take those arguments sitting down. Maybe it implies many companies are so big they have no clue as to what's going on. Or maybe it implies that many chief executives are paid massive amounts of money so they can cut corners by laying off American workers and employee people overseas for wages that are so low they could basically be compared to employing slave labor.

Are the right costs being cut? And at what cost to America's investors, workers, and overall economic well-being?

Enquiring minds want to know
Anyone who has followed Whole Foods Market (Nasdaq: WFM  ) knows the organic grocer has long had a policy that caps pay: No one at the company makes any more than 19 times the average worker's wage. A Whole Foods spokesperson told The Wall Street Journal that the company hasn't found this calculation to be onerous or expensive in the least.

A handful of other companies, like MBIA (Nasdaq: MBI  ) , voluntarily disclose figures regarding executive pay and average worker compensation. It's hardly common practice, though.

Long-term shareholders should be relentlessly curious about these data points. Pay policies at many companies would be endlessly interesting when compared to what the average worker bee takes home.

Take Hewlett-Packard (NYSE: HPQ  ) , which has doled out tons of shareholder capital for a string of chief executive officers, as well as handsome golden parachutes for failed or even disgraced executives, all while executing repeated worker layoffs.

It might be interesting to see CEO-pay-to-worker-pay ratios at retailers, since retail work isn't known to generate big bucks for regular workers. A particularly interesting case study might be the ratio at Abercrombie & Fitch (NYSE: ANF  ) . CEO Mike Jeffries has been subject to shareholder scrutiny regarding pay in the past.

Only 56% of Abercrombie's shareholders voted for the company's compensation schemes last year, but the retailer's proxy statement utilizes some fancy footwork to help justify Jeffries' pay. "Although the Company has existed for more than 100 years, Mr. Jeffries' role is more akin to founder than a typical chief executive officer. His vision has transformed the Company into one of the most successful and widely known specialty retailers." Oh, OK.

Although Jeffries' base salary stayed static at $1.5 million, somehow when all was said and done, his total compensation more than doubled on a year-over-year basis to $48.1 million in 2011.

What about compensation at health company McKesson (NYSE: MCK  ) ? CEO John Hammergren raised eyebrows as the highest-paid CEO last year. He's made more than $500 million since he first took the helm at McKesson, according to Equilar. Although a majority of shareholders supported the company's compensation policy last year, the company acknowledged that 30% voted no.

This year, Hammergren and McKesson's board have crafted some changes, such as reducing what he's potentially entitled to in severance pay (this figure was previously $469 million) and relinquishing the right to a golden parachute excise tax gross-up. However, Hammergren's base salary still increased a tad to $1.68 million from $1.67 million last year, and his total compensation was valued at $39.7 million. Granted, that total compensation figure has fallen from $45.7 million last year and $54.3 million the year before that.

This comes at shareholders' expense, too
The CEO pay discussion includes the fact that there's a difference between cash compensation and less concrete incentives like stock options, but the truth is, if moderation's the key, somebody lost it a long time ago. While options can influence chief executives by encouraging long-term stock appreciation, showering executives with them has a dilutive effect on shareholders. Meanwhile, typical workers don't enjoy the same level of incentives in any sense.

CEO pay at most American companies has careened out of control. Shareholders need to raise awareness of what is justifiable and how the best-paid CEOs are creating profits and at whose expense. Disclosing individual companies' CEO-to-worker pay ratio would give some much-needed perspective about corporate priorities.

In particular, it could show the stark reality that at many companies, at the end of the long haul, the only stakeholders truly guaranteed to profit are the managements. That's not what investors are here for. We're here for great, growth-oriented companies that reward all stakeholders and boost the U.S. economy, not just a few overpaid American employees with unjustifiable rewards. No wonder many corporate managers would rather this ratio go uncalculated and undisclosed.

Check back at Fool.com every Wednesday and Friday for Alyce Lomax's column on environmental, social, and governance issues.

Alyce Lomax owns shares of Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Motley Fool newsletter services have recommended buying shares of Whole Foods Market and McKesson. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (21) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 29, 2012, at 6:35 PM, dennyinusa wrote:

    If you truly believe in globalization where general labor jobs are shipped abroad and then products are brought back to USA in shipping lanes protected by US military at a cost to all taxpayers by way of our vary bloated Defense Budget which is another very little talked about hidden subsidy to these companies why not go all the way and outsource management jobs to other countries as Japanese CEOs have proven to be very good at their jobs, when company’s profit plunge they step down and compensation is much lower?

    Top 100 companies by market capitalization in Japan CEOs average $1.5 million compared to USA CEOs average $13.3 million. No designer suits, private jets or multimillion dollar houses, just think how much cheaper product could be if company truly cared about producing product at rock bottom price, not just increasing profits and taking care of over compensated “talent”. You see we could outsource everything to get great prices, but if no one has job, no one can afford anything no matter the price.

    No consumer, no demand equals no company. It is all a matter of balance. Right now there is no balance. Rich get richer; everyone else and I mean everyone else, not just the poor get poorer. Some are still in denial about it, but it’s very real for those without work.

    Source is from article in Bloomberg Businessweek Feb. 10, 2009

  • Report this Comment On June 29, 2012, at 10:16 PM, SuntanIronMan wrote:

    You don't want the Japanese system, dennyinusa. It is just as dysfunctional as anywhere else, just in a different way.

    For one, it is harder to get rid of a Japanese CEO (or other top-level Japanese executives). Pay is lower then that of US executives, but the job offers way more security. You, as a shareholder, just try to get rid of a Japanese CEO who doesn't want to leave. Go ahead. Try. If that's not an exercise in futility, I don't know what it.

    Secondly, pay is rarely tied to performance (which can sometimes be said about US executives, but more so in Japan). Whether the company does amazingly or awfully, pay is the same. Very few incentives.

    Thirdly, pay is less of a meritocracy than it is about seniority (which again, same could be said... but more so in Japan). If you are with the company longer, you're going to get paid more than the guy in the same position who does a better job. 95% of the time. Maybe even higher.

    For fourthly, I say 'guy' because as few women executives as we have heading US companies, Japan has far fewer. If you think US companies are a boy's club, I'm not sure what phrase you'd use to describe Japanese boardrooms.

    Not to mention non-Japanese executives. It was a big deal when Howard Stringer became the President, CEO and Chairman of Sony. Why? Because besides him, there aren't many non-Japanese board members of Japanese firms (much less CEOs). Only other foreign CEO I can think of is the head of Nissan. That's to be expected some, since Japanese is a very homogenous country. But if you are a global company, that's can be an issue. One of the problems with Toyota. Extremely global company, with nearly no foreign executives at the head office. I think they might have had a grand total of one foreign board member over Toyota's entire history. And that person is no longer with the company (after being with the company for only a handful of months).

  • Report this Comment On June 29, 2012, at 10:22 PM, SuntanIronMan wrote:

    And quick clarification. When I said "If you think...", I using the global-you.

  • Report this Comment On June 29, 2012, at 11:11 PM, ilovebatz wrote:

    Excellent article. One of the many problems that plague our economy right now. Get rid of Golden parachutes. If these people making this much money can't save for a rainy day, like us average Americans do, then too bad. The pay ratio has to be reduced so that the average worker feels valued for their contribution to the company.

  • Report this Comment On June 30, 2012, at 2:19 AM, Philmoco wrote:

    Good stuff!

    Should be part of mandatory reporting!

    380 to 1! Why am I not surprised that the trends you'd like to scrape off your shoe continue to float across the pond.

    It would be most interesting to see FOOTSIE 500 reporting this greed ratio, especially banks, insurance companies and on a year on year basis.

    It would help lay to rest the lie that super-elevated salaries are needed to maintain top staff standards.

  • Report this Comment On June 30, 2012, at 10:58 AM, blkdrgn wrote:

    This is a limited version of a long standing pet peeve of mine. The vast majority of the comment on cost of production is on the labor component. Union vs non-union. US labor vs. foreign labor. Where have you ever seen the white collar component? What is the management cost per dollar? One of my personal favorites is the lawyer cost per dollar. (All the heated rhetoric about tort reforms should be laid up against what corporate lawyers get paid.) Management costs subtract from the bottom line as surely as labor costs. In the argument over off shoring they are however a no-show. This should be rectified. Further, any shareholder should be demanding this information as it directly impacts their interest.

    Here, not just we small fry have been falling down on the job but the big institutional investors especially. Yes, we deperately need stronger SEC rules on shareholder voting rights. After all, aren't we the owners of the company? Since when don't these guys work for us? The Facebook IPO--"give me your money and maybe i'll cut you in if I feel like it" model be seen for what it is--business as usual. So here we are, we are responsible for tolerating this crap and we should challenge it much more strongly and change it. One thing I have often wondered is whether Fooldom couldn't be a venue for amalgamating votes?

  • Report this Comment On June 30, 2012, at 4:21 PM, Melaschasm wrote:

    There is an easy way to fix this ratio. Outsource all the low paying jobs.

    Hire a service to provide janitors, data entry clerks, mail room people, and assorted other lower paying positions.

    While focus on this ratio makes for good politics it provides no value for investors.

  • Report this Comment On June 30, 2012, at 6:41 PM, dennyinusa wrote:

    Metaschasm

    Why not outsoure all the high paying jobs.

    CEOs do not own company they have no more skin in the company than any other employee.

    This has a direct effect on investors.

    You need to get off your knees if you cannot see that.

  • Report this Comment On July 01, 2012, at 1:27 AM, gumby55 wrote:

    I like the idea of amalgamating votes through Motley Fool. I always feel like the shareholders votes are a joke to 99.999% of the management teams out there anyway

  • Report this Comment On July 01, 2012, at 8:51 AM, BMFPitt wrote:

    This ratio serves no purpose to investors, or anyone really.

    As a shareholder, I care about whether the company is getting value for the money out of its employees - from the CEO to the janitor. I want the component numbers to be as low as possible while attracting and retaining people who can do the jobs well, but the ratio doesn't give me anything by itself.

  • Report this Comment On July 01, 2012, at 1:02 PM, skypilot2005 wrote:

    “CEO pay at most American companies has careened out of control. Shareholders need to raise awareness of what is justifiable and how the best-paid CEOs are creating profits and at whose expense. Disclosing individual companies' CEO-to-worker pay ratio would give some much-needed perspective about corporate priorities.”

    I agree.

    An investor would be hard pressed to present a rational case against it. I haven’t seen one in the comments, so far.

    It’s not about Liberal or Conservative. I. M. O., it’s about Compensation Consulting firms being in collusion with corporate insiders.

    Alyce, Thanks for covering the topic.

    Sky

  • Report this Comment On July 01, 2012, at 11:16 PM, SuntanIronMan wrote:

    "CEO pay at most American companies has careened out of control."

    Small distinction, but:

    CEO pay at most... large publicly-traded American companies indexed on something like the S&P 500... has careened out of control.

    I've never seen any data to suggest the pay most American companies (out of all the companies based in America) is out of control. Just data about the largest companies.

    That may be a distinction without a difference for readers here, since most of us are investing in these large publicly-traded companies. But still...

  • Report this Comment On July 04, 2012, at 6:10 AM, Wesss wrote:

    Quick correction: In paragraph 5 you have "employee" instead of "employ".

  • Report this Comment On July 04, 2012, at 11:44 AM, makmetall wrote:

    Congradulations, finally an article about CEO pay and how crazy out of control it is. This article states the facts nothing more, nothing less. Please post this for the average american to read, it makes total common sense.

    I agree not all CEO are bad, but the stock options and golden parachutes are out of control. We as investors are the ones that loose along with the workers.

    Thank you for such a great article!

  • Report this Comment On July 04, 2012, at 2:25 PM, Wildflyer wrote:

    When was the last time that your mutual fund manager intervened on behalf of its own shareholders, and said "NO" to corporate largess?

    Can't remember? Neither can I, even having owned Vanguard ,TRPrice, and other titans of fairness and shareholder value.

    A few years ago, I urged Brandywine managers to intercede when Isner ,Ovitz and Disney developed an unconscionable "golden paracute" plan,but got silence(probably because they could not hear me from the hollows of Aspen or StMoritz..)

    I suspect that stock fund ,as well as equity investors, will soon be voting with their feet.I,for one, am fed up with this diproportionate CEO pay and fringes .The argument that their talent is expensive has been thoroughly disproven.

  • Report this Comment On July 06, 2012, at 12:18 PM, sonrisa1 wrote:

    An honest C E O would not accept such ludicrous amouts of money he would know he could not possibly be worth so much, if he was working for the company/corporations & shareholder interests also the vast amounts paid to the lobbyists & corrupt politicians (citizens united!"!! & super PACs?)

    The USA is corrupted by the Republican party & KOCHROACHES.

  • Report this Comment On July 06, 2012, at 4:29 PM, ChrisBern wrote:

    I am neither a customer nor a shareholder of HP, so it has literally no bearing on me if HP decides to pay their CEO (or their employees for that matter) a lot of money.

    If I were a shareholder of HP's and their executive pay structure bothered me, I'd become an activist or (much more probably) simply sell the shares. If I were a customer of HP's and their payscale bothered me, I'd simply switch to a competitor.

    That's the beauty of capitalism--anyone can voluntarily pay anyone else anything they want, and whether or not the arrangement lasts will be a function of supply, demand, and profit sustainability.

  • Report this Comment On July 06, 2012, at 4:37 PM, ibuildthings wrote:

    Where I don't have any particular affection or disaffection for CEO's, I recognize that it is pretty dumb to try to repeal the laws of supply and demand. Especially when someone who has accumulated enough resources to walk away rich will be dis-incentivised to continue offering useful talents into the marketplace. If you can afford it, you get the best doctor or lawyer, right? Aren't the corps looking for the same thing?

  • Report this Comment On July 06, 2012, at 9:12 PM, Melaschasm wrote:

    Danny, you missed the point of my post, which was probably because I did not properly explain it.

    If a law was passed requiring this ratio to be published, and shareholders or customers actually cared enough about the information to change their decisions, it would be easy for CEO's to fix the ratio without taking a pay cut.

    Simply requiring that this ratio be published is not going to solve any problems with poor management and executive compensation.

    If you want lower pay for CEOs then we need strong evidence that CEOs who make less perform as well as the high paid people. Then we need shareholders to care enough to demand changes in the compensation system.

  • Report this Comment On July 22, 2012, at 11:14 AM, levelplayinfield wrote:

    Please don't mention the AFL-CIO as a credible source. It's sole purpose is self survival. Even the president and the democratic party finally had to reel in GM's union. I agree with the theme of the article but including the mention of AFL-CIO was just too much to swallow.

  • Report this Comment On July 22, 2012, at 12:16 PM, wolfman225 wrote:

    ^While we're on the subject of the AFL-CIO (and unions in general), can we also call for mandatory disclosure of the pay packages of top union officials as compared to the average workers' salaries?

    I feel pretty safe in predicting that the average union line worker is even more clueless about their leadership's pay than their CEO's.

    Richard Trumka's salary, for example, is nearly $300K/yr (not counting his expense account for "official business"), and he is guaranteed 60% in retirement. Plus lifetime health insurance. No blue collar worker gets close to that. There's also the matter of "income security". Regular union worker's contracts are increasingly vulnerable to forced renegotiation via the bankruptcy of the company (often caused by unsustainable union contracts forced on companies by the leadership). Trumka gets paid as long as the union exists. Big difference.

    Not to mention the various "conventions" and other junkets the upper-level union leadership attend, all paid for out of the dues collected from the rank and file members, none of whom are eligible to attend (unless they happen to be government union employees, hello GSA, but that's a whole 'nother conversation).

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