Human Capital Briefs

The Factors That Lead to High CEO Pay

September 18, 2015

No matter where you live, the difference between how much CEOs are paid and how much the average worker takes home is, well, big. Probably even bigger than most people think.

 

The reasons why the disparities vary country-to-country are complex, according to a recently accepted paper for the Strategic Management Journal by LSU E.J. Ourso College of Business professor Thomas Greckhamer. A social scientist, Greckhamer attempts to identify combinations of factors on a country-by-country basis that either widen or narrow the pay gap between CEOs and workers. Using data from the IMD World Competitiveness Yearbook from 2001, 2005, and 2009 for 54 countries, he also configured a model featuring power structures he expected to influence compensation, based on prior research of determinants of executive pay.

His conclusions aren’t neat and tidy, but a few things stand out: A country’s level of development matters for workers’ compensation, but not so much for CEOs’. A country that has a high deference for power will probably have higher-paid executives. And the political strength of the labor movement matters. But you also can’t isolate a single one of these factors as the determinant of income inequality.

To better understand how he got these findings, it’s worth laying out the eight compensation-influencing factors used by Greckhamer in his analysis:

1) A country’s level of development. This is important for a variety of reasons he describes in-depth, though the basic point is that high development should result in less income inequality, with both CEOs and workers making more.

2) The development of equity markets. The more developed markets increase ownership “dispersion,” or the number of people who own shares in a company. Greater dispersion, writes Greckhamer, “implies reduced owner-control, which should increase CEOs’ power to allocate more compensation for themselves.”

3) The development of the banking sector. The more concentrated the sector is, the more that should “monitor and control firms and thus constrain CEO power and pay.”

4) Its dependence on foreign capital. When foreign investors have influence over a company’s stock, it can boost income inequality.

5) Its collective rights empowering labor. This is basically collective bargaining rights, which are “a vital determinant of worker compensation” according to Greckhamer, and can also potentially limit CEO pay.

6) The strength of its welfare institutions. Their job, of course, is to “intervene in social arrangements to partially equalize the distribution of economic welfare,” which generally means lowering CEO pay and increasing that of regular workers.

7) Employment market forces. In other words, the supply and demand for executives’ and workers’ skills.

8) Social order and authority relations. Greckhamer describes this as “power distance,” which basically means “the extent to which society accepts inequality and hierarchical authority.” A high power distance tends to lead to high CEO pay and low worker pay.

After running his analysis, he identified how all of these factors work together to shape how much CEOs and regular workers get paid.

The Combinations that Increase CEO Pay

In one scenario, for example, highly developed equity markets, a strong welfare state, and a high power distance – combined with a lack of foreign capital penetration and supported by a few complementary conditions – were key indicators.

Generally speaking, though, a lack of collective labor rights and a high power distance are two of the core and complementary factors most often present in countries with high CEO pay. “This suggests that a combination of high cultural acceptance of hierarchical power structures and a lack of institutions empowering labor are vital institutional conditions for highly compensated CEOs,” Greckhamer writes.

This is pretty obvious, but there’s also a surprise in the data, too. While a few predictors indicate that a shortage of candidates results in higher CEO pay (which would make sense when you think about how market conditions work), there are situations that contradict this. In some locations that are lucrative for top brass, there are plenty of available senior managers to choose from. Greckhamer posits that places with a competitive labor market that also accepts hierarchy and doesn’t have strong labor rights basically operates as “tournaments among an abundant cadre of senior managers and with relatively high prizes for the winners.”

The Combinations that Reduce Inequality 

One factor that doesn’t play much of a role on its own, surprisingly, is a country’s level of development, a finding that contradicts previous research. But that changes when you look more closely. A high level of development combined with a lack of hierarchies seems to increase worker pay. “High development was necessary, but not sufficient, for workers to achieve high compensation,” he told me. This may also be one of those cases where the absence of something is more felt than its presence: “A lack of development was also important for several paths to the absence of high worker pay,” such as the presence of foreign capital and less-developed equity markets.

Unsurprisingly (but importantly), locations with low CEO pay tend to have strong collective labor rights, a strong welfare state, and less power distance across the board.

There’s evidence, Greckhamer explained over email, that countries that both empower workers and culturally reject inequality constrain CEO pay. This, he says, showcases the vital importance of “political forces” – government policies or strong unions, for example – when it comes to executive pay.

Almost across the board, a strong welfare state and/or strong collective labor rights are a core condition for higher worker pay. And low worker pay is almost entirely moderated by a lack of a welfare state and/or a lack of collective labor rights.

“I believe that pay dispersion between CEOs and rank and file employees is a vital questions of our time, both from the point of organization theory and from the point of view of the general public,” Greckhamer says. And because organizations don’t exist in a vacuum outside a nation or culture, studying them within those contexts is essential.

At the same time, because so many different factors are intertwined, the relative lack of action to limit CEO pay makes a certain reluctant sense: Because it’s so seemingly complex, where do you even start?

In light of this, I asked whether his findings were “actionable.” He replied that it “depends to a large extent on whether organizations (or societies) consider a certain issue a ‘problem’ and wish to take ‘actions’ to ‘resolve’ them.” So, for example, these actions could include “a combination of achieving high development, strengthening institutions empowering labor, and cultural interventions aiming to counter any ingrained cultural values accepting inequality between those and the top and those at the bottom of organizations’ hierarchies.” But only if inequality is considered a problem worth acting on.

 

This blog first appeared on Harvard Business Review on 05/22/2015.

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