A regulation mandated by the 2010 Dodd-Frank financial reform legislation and adopted by the Securities and Exchange Commission in 2015 requires public companies to publish the ratio between the compensation of the CEO and the median annual compensation of every other employee in their proxy statements, starting with the 2017 fiscal year. The regulation was left in place by the Trump administration, although the SEC has made it slightly easier for companies to comply.
Not surprisingly, as companies have started to share this information, much attention has been paid to how much CEOs earn. The net result of this information coming out is the rather unsurprising insight that most CEOs make a lot of money. Companies have rightly been more worried about reporting the median employee salary, which some business groups have said is difficult to calculate and to communicate.
The intent of the rule was that by publishing this information, companies would have an incentive to raise the average wage of their employees to lower their CEO-median employee ratio in comparison to their peers. After all, as the denominator grows bigger, the ratio gets smaller. While there is certainly some truth to this effect, a much more interesting effect is emerging as companies release information about the median wage of their employees. Some of these disclosures are eye-popping; Facebook, for instance, reported a median employee salary of over $240,000, according to the Wall Street Journal, but of course this doesn’t count all the subcontracted workers it uses for services like security, cleaning, and food service at its facilities.
One of the observations we have made about the reporting of the median employee pay data is that, by definition, half of employees are paid below average. While some employees realize that they are paid below average, and are accepting of it, for a significant number of employees this certainly comes as alarming news. But now that more companies are reporting this information, we get to see how median employee compensation compares across companies. Deb Lifshey, Managing Director at Pearl Meyer & Partners, LLC, discussed these comparisons in a recent post at the Harvard Law School Forum on Corporate Governance and Financial Regulation:
We were surprised to learn that among the 500 median employee pay levels tracked to date, the average of employees identified at median is nearly $75K, which is larger than many expected. The flip side of what appears to be a relatively high average median employee pay figure is the fact that half of a company’s population will now perceive themselves as being paid less than their peers. If they believe they are paid less than median, it may impact productivity and job satisfaction and even lead to retention issues. The problem is compounded this year if these workers understand that corporate tax cuts led to a windfall for their employer, which may not have been shared among employees.
Not surprisingly, the highest average median pay, based on data collected thus far, is found within the utility sector at around $151K, with energy ($107K) and real estate ($104K) following a distant second and third. Industries at the lower end of averaged median employee pay are consumer discretionary ($42K), consumer staples ($44K) and industrials ($60K).
Like other critics of the pay ratio reporting rule, Lifshey argues that it fails at its goal of unmasking companies that overpay their CEOs or underpay their employees by comparing them to their competitors, because these comparisons are not as meaningful as they may seem: To return to the example of Facebook, an otherwise identical company that employed its custodians and security guards directly rather than through an outside contractor would have to report a much larger pay ratio—but that wouldn’t tell us much.
While numerous reasons exist for this discrepancy across companies (different workforces, locations, business models, etc.), the reality all US companies must now face is that median salary numbers are being widely reported, against which their employees will inevitably compare themselves. That creates yet another concern: Employees now have learned whether their compensation is above or below average not only for their company, but also for their industry.
A key insight we have learned about employee pay perceptions in our research at CEB, now Gartner, is that employees usually judge whether they are being paid fairly or promoted often enough based on how they compare to others, not on how they are doing in the abstract. Average performers are usually OK with being paid less than their most productive and hardest-working colleagues, but they do mind if their pay is not differentiated from that of low performers, or if they are earning less than their colleagues for reasons they don’t understand. As more of these pay ratios are disclosed, executives must think through what their own data looks like to their employees, as well as must how their pay ratio—and more importantly, their median pay level—compares to their talent competitors.