Rule #1 Finance Blog

With Investor Phil Town

Rule #1 Question of the Week: Management and Pay Ratios

This week's Rule #1 Question of the Week derives from a comment Randy left on the recent "How Much Should CEOs Make?" post.  Randy said, in response to pay ratios between the lowest and highest paid members of a company:

>> Something like 14 times what the lowest paid person makes. <<

I've never understood why such a ratio has any relevance at all?

If it were, shouldn't the same apply to any line of work — professional basketball player vs janitor that cleans up the stadium, headlining movie star vs set carpenter, etc.

Or, if it were, you'd be saying the CEO of a $50 million company should be making no more than the CEO of a $500 billion company, since the lowest paid employees of the two companies are probably making the same amount of money.

Or, what if the lowest paid employee of the company is the worker in a Pakistani manufacturing plant, who is only making $40 per month (I think that's the amount I saw Nike was paying overseas workers a few years ago)?

Here's how I responded to his question:

The number is relevant because of how much it has changed in twenty years — and the change reflects CEO self-interest (as opposed to leadership) and Boardroom complacency.

The reason I don't care if the owners pay A-Rod $50 million a year is
because he is talent, not leadership and not management. Same with
actors and directors.

Talent gets what it gets as long as it can
deliver. Leaders, on the other hand, are in the business of leading.
And that business, in my opinion, is all about service, vision,
managing the process, and credibility.

An actor doesn't have to set an
example. A basketball player doesn't have to be a great guy. All they
have to do is the job they were hired to do. And it so happens that
their job is so difficult that the ones who do it well are worth the
money. And there is no question that they do the job well, is there?
You hit .400 or you don't. You open movies or you don't.

But a leader
is playing a different kind of game. His or her job is to inspire
others to do better than their best. And the CEO who takes a huge
paycheck while his workers can barely make ends meet is, like I said, a
bit too much like someone in the middle ages saying 'let them eat cake', and I don't like it. Let's have leaders who are in business for some
other reason than to make money for themselves. Let's have leaders who
have a Big Audacious Goal that excites people and makes them love
coming to work every day. And let's have leaders who lead by example.

And is ripping off the business for 20 million bucks a good example, or
does it create cynicism? I really don't like bad leaders as a company
owner since it plants seeds for a crop I don't want to harvest.

Now go play.

Phil