Columnists

CEO pay debate misses the point misguided

Gideon Muriuki

Cooperative Bank of Kenya CEO Gideon Muriuki earns Sh31.37 million monthly in salary. FILE PHOTO | DIANA NGILA | NMG

Kenya has witnessed moments when the media was awash with questions about the highest-paid personalities in the corporate world.

The media revealed that Cooperative Bank CEO Gideon Muruiki earned 31.37 million monthly in salary alone while KCB’s Joshua Oigara was paid 22.75 million, Safaricom’s Peter Ndegwa 9 million, and the CEO of Struggling KQ earned 8.5 million.

But, what was the purpose of this information? History confirms that sometimes we collect useless information that doesn’t change or inform our decisions.

An example is a request for advice, in a bar, on how to deal with one’s spouse - a piece of advice that eventually remains in the bar. Or, take the example of wealth declaration policies for public servants meant to deal with corruption - how effective have they been?

In Kenya, we have graduated from scandals worth hundreds of thousands of shillings to ones in billions, and we may soon generate a “trillionaire scandal” worth more than the Kenyan GDP.

In fact, during the Cabinet Secretaries’ vetting, we saw the ‘billionaire hustler cabinet’ disclose their ‘eye-catching’ net worth, which might instead trigger a competition as to who will finish top at the end of the Hustler Presidency.

It is in the same vein that I believe CEO salary disclosure has not helped achieve the intended purpose. Methinks the cooperate world ought to focus on how CEOs are paid rather than how much they are paid.

During the Great Depression, the disclosure of the CEO’s salary was intended to broadly lower executive compensation. It did not achieve this goal.

In fact, following the disclosure, the average CEO compensation instead increased relative to the upper quantiles of the non-CEO labour income distribution.

The evidence suggests an upward “ratcheting” effect whereby, given the size and industry of their firms, lower-paid CEOs experienced relative gains while well-paid CEOs did not.

Much of the upward pressure on CEO pay began in the 1930s with the disclosure of CEO pay in proxy statements.

READ: KCB quietly extends CEO Oigara’s contract by one year

And since 2018 public companies have been required to report the “CEO Pay Ratio”, which is the ratio of the total pay of the CEO to the total pay of the “median employee” in a given company.

This requirement is contained in Item 402(u) of Regulation S-K and applies to fiscal years beginning on or after January 1, 2017, in Corporate America. How is this calculated?

Assuming that CEO pay and median employee pay at a company is $5,400,000 and $60,000 respectively for a particular fiscal year then the CEO Pay Ratio would be 90:1.

In the 2008 data, it was discovered that the median CEO Pay Ratio for the companies reporting in corporate America was 70:1. But CEO Pay Ratios vary significantly by company size: from 27:1 for companies with revenues less than $0.5 billion to 230:1 for companies with revenues greater than $15 billion.

It also varies with respect to industry sectors:- 40:1 for companies in the Financial sector to 186:1 for companies in the Consumer Discretionary sector.

Different stakeholders responded to this finding differently. Shareholders and directors were willing to vote for CEO salary increments based on returns since for them the end justifies the means.

On the contrary, many employees were upset to learn, as part of the CEO Pay Ratio disclosure, that their pay levels were below the Median Employee Pay level.

At Wells Fargo, for instance, Reuters published on April 23, 2018: “CEO’s pay details spark push-back by some employees,” More than a dozen employees made posts criticizing pay details that the bank had released.

The statistics above clearly show that there are serious problems with CEO compensation. However, “excessive” pay is not the biggest issue.

Public attention is often misdirected to how much CEOs are paid, instead of focusing on the real problem which is ‘how’ CEOs are paid.

It is important to ensure that the compensation of top executives is performance-based. Sadly, annual changes in executive compensation do not always reflect changes in corporate performance.

If anything, compensation for CEOs should be no more variable than compensation for hourly and salaried employees, for even employees feel that CEOs earn more than the median of their pay.

READ: Banking CEOs’ bonus millions revealed

A closer look reveals that with respect to pay for performance, CEO compensation is rather getting worse; yet compensation policy is one of the most important factors in an organisation’s success.

Not only does it shape how top executives behave but it also helps determine what kinds of executives an organisation attracts.

This is what makes the vocal protests over CEO pay so damaging. These increases in compensation—driven by improved business performance—would not represent a transfer of wealth from shareholders to executives.

Rather, they would reward managers for the increased success fostered by greater risk-taking, effort, and ability.

Because the stakes are so high, the potential increase in corporate performance and the potential gains to shareholders are great.

You buy a Landrover, you get the service of Landrover, you buy a Landcruiser, you get Landcruiser’s services.