What does fair pay really mean?

Earlier this month, the Aspen Institute’s Business and Society Program convened a panel to discuss fair pay for executives. Don Lowman, Senior Partner and Global Leader—Rewards and Benefits at Korn Ferry, joined the panel, which included Erica Smiley, the Executive Director of Jobs With Justice, a national network of community labor coalitions; and Damon Silvers, the Director of Policy and Special Counsel for the AFL-CIO. The panel was moderated by Judy Samuelson, Executive Director of the Aspen Institute Business and Society Program.

Not only is there a wealth gap in organizations, but that gap is increasing. From 2009 to 2019, the pay for CEOs in the top 300 U.S. businesses rose by 7.3 percent annually, while the pay for other employees rose by only 3 percent annually. The crises of 2020 shone a spotlight directly on pervasive issues of economic inequality, forcing organizations to face head-on the topic of pay equity.

The role of the Board in setting fair pay

Executive pay usually consists of three main components: a base salary, annual incentives, and longer-term incentives. While executives’ base pay has increased generally at the same rate as rank-and-file employee pay for the past several years, their incentives have skyrocketed at a staggering pace, particularly those denominated in company stock. Now that companies have become more transparent about their pay ratios when comparing CEO pay to that of the average worker (thanks to rules and regulations adopted following the Great Recession), people are raising increasing concerns about the fairness of executive pay, and whether boards are doing their jobs in assessing and properly rewarding executive performance.

Lowman observed that, for many years, boards have benchmarked executive pay against their peers, confirming whether they are remaining competitive in the market. They have also assessed financial performance, focusing significantly on total shareholder return to determine the appropriate level of incentives. But both of these conventional and increasingly problematic measuring sticks fail to directly consider the organizations’ larger purpose and growing societal responsibilities. And they fail to reflect the growing importance many investors and other stakeholders are placing on key environmental, social, and governance (ESG) metrics.

Both Smiley and Silvers advocated for broader employee participation in executive pay decision-making, but they took different approaches. Smiley suggested that, because corporations have a level of public accountability, they need to establish structures to shrink the gap between the highest-paid executives and the lowest-paid workers. For example, organizations that reduce the gap between top and bottom pay rates might become eligible for more contracts at the state and local level.

Meanwhile, Silvers supported tying pay directly to performance and incorporating three general rules:

1. Performance has to be properly measured, it has to be long-term, and it can’t be gameable.
2. Executive pay must be proportionate to the pay of other people in the organization.
3. Metrics cannot be perverse; pay can’t be set up in a way that incentivizes executives to engage in exploitative behavior vis-à-vis the company as a whole or society generally.

Silvers further proposed that companies should not structure executive pay in a way that incentivizes draining cash from the corporation, which cripples the ability to innovate and create future value. Instead of making cash payouts to equity, he advised making more profitable investments in the firm itself. Smiley agreed, adding that it is problematic to tie executive pay to the markets instead of the broader public good. To rectify these problems, she suggested involving more people throughout the company in decision-making structures and developing a tax system that incentivizes lower pay gaps and reinvestment in companies.

How Boards can develop a more holistic approach to pay fairness

Smiley recommended that boards ask themselves what they’re trying to accomplish: maximizing the money that executives walk away with or benefiting workers and society as a whole through the company’s offerings. From there, boards should decide how best to achieve their goals, keeping in mind that substantial pay gaps usually lead to high turnover, resentment, and eventual failure.

In setting appropriate incentives, Silvers urged boards to “be serious about getting the time horizons right,” with respect to both economic cycles and to “what we know about people’s ability to game things when they control a firm.” He also hoped that boards would consider the signals their pay decisions send about how the organization values human capital. He added that boards need to consider how pay reflects their broader, long-term goals, including innovation, growth, and the company’s overall purpose and achievements.

Lowman suggested that companies should worry less about benchmarking and conforming to the way things have always been done. Instead of quietly staying within the current mainstream, he argued that boards should consider pay from a different perspective, using these questions to guide their discussion:

• If we were starting the company today, what would we adopt as our philosophy about executive pay?
• How would we want our executives to be paid relative to everyone else in the organization?
• What main metrics would we use to judge success, not just in the next year but over the next decade?
• What kind of people would we want to have in these roles doing these jobs?
• What rules would we set to make sure those things happen?

He added, “Boards should revisit their fundamental pay philosophies, challenging themselves to think about whether they truly reflect who they are as an organization, and if not, what should change.”

Watch the webinar to learn more the panelists’ viewpoints and additional suggestions for establishing fairer pay structures for executives. Then, for a deeper dive, download the Modern Principles for Sensible and Effective Executive Pay and contact our Executive Pay and Governance Services team for guidance as you start to rethink your executive pay structures.