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Why Are CEOs Making So Much More Than Their Workers?

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A compensation consultant who spoke to my corporate governance class at Harvard University last week said that the ratio of total CEO pay to the pay of the average worker at a company may not be what you think. Ratios of 500 or even a 1,000 to one may occur, this Boston pay advisor predicted. Embarrassment and tough questions will follow.

Next month, the Securities and Exchange Commission (SEC) is expected -- at long last -- to issue a draft rule outlining how US listed companies are expected to calculate this CEO to worker pay ratio. There has been fierce resistance to the ratio by corporate management, lawyers and lobbyists against the calculation and disclosure of this ratio, which was mandated in the Dodd-Frank Act of 2010.

Resistance centers on the complexity of calculation, the cost and the usefulness, according to companies.

For example: Is total CEO compensation intended, realizable, or realized? (These numbers are all different, and is part of a larger pay debate. The regulator focuses on intended pay, which may not be what the CEO actually receives, or is entitled to receive.)

For the average employee pay, what if the company has 1000s or 10s of 1000s of employees? What about part-time employees? Contractors? People who are hired or quit during a given year? Different countries? Are bonuses, long-term incentives, and pensions and benefits calculated as well, for each employee?

You would like to think that the average employee wage is easily calculated and companies should already know this information, but this is not the case. Nevertheless, the SEC should be clever enough to issue guidance in the new rule so that the average employee wage can be calculated in as cost effective a manner as possible.

Next, what is the usefulness of such a ratio, companies ask? A CEO to worker pay ratio, for example, would be very different for a bank (think Bank of America), as compared to the retail sector (think Wal-Mart), where average worker pay is different. Therefore how can there be meaningful comparison?

Likely what will happen are different ratios for different sectors, and the ratio will be relative to a company's peers. This will be useful to corporate boards and shareholders.

For senior management and boards, a CEO to senior management ratio above 2 or 3 times can signal succession or talent management red flags (a CEO earning five times the next highest executive means there may be no internal successor). A CEO to worker ratio that is too high relative to peers within an industry could signal CEO entrenchment, a complacent board, or even low employee wage relative to the norm.

Taken as a whole, very high CEO to worker pay ratios can signal systemic wealth disparity. CEO pay has been outstripping executive and worker pay year over year by a wide margin because of structural issues related to "peer group benchmarking" (the very way CEOs are paid). This structural pay inequity is unrelated to CEO performance. There are societal costs to wealth disparity as well. Having CEO to worker pay ratio data may change the way CEOs are paid. Or not. But one thing for certain, there will be surprises.

Richard Leblanc is a governance lawyer, academic, speaker and independent advisor to leading Canadian and international boards of directors. He can be reached at rleblanc@boardexpert.com.