The Good, the Bad, and the Ugly of the CEO Pay Ratio

In August the SEC adopted a measure that will require public companies to publish a CEO pay ratio in their financial statements. The ratio, which compares median worker pay to the CEO’s salary, is a provision of the 2010 Dodd-Frank act and it takes effect in January 2017.

Some of the early, albeit unofficial, CEO pay ratios seem to demonstrate an enormous pay disparity between the leadership and workers in a company. In other cases, it calls attention to CEOs with strikingly low compensation for the position they hold. For instance, Apple’s Tim Cook has a CEO pay ratio of 43:1, Ford’s Alan Mulally has a 113:1, and Goodyear’s Richard Kramer has a whopping 323:1 ratio. IBM and Intel have ratios of 25:1 and 30:1 respectively.

Any time procurement is evaluating a publicly traded company, we naturally make use of their financial statements and annual reports, which are valuable sources of information. But is this new ratio relevant to the evaluation of a supplier for financial stability, risk, and collaborative potential? Should procurement take this information into consideration when ranking and selecting suppliers?

The Good

The CEO pay ratio is being touted as a source of valuable information to investors as well as consumers. In a time when the minimum wage is a regular part of the public discourse, there is interest in having a single figure that represents the difference in compensation at the highest and median levels. When procurement represents a company that is B2C, they have to be very careful about the risk of negative public sentiment. Companies may be held responsible for the negative reputation of their suppliers, especially when the partnership is high visibility. In cases such as these, procurement may want to look at the CEO pay ratio as a way of staving off potential sources of negative publicity or reputational risk.

The Bad

Although there is a lot of interest in the new ratio, it is not without its detractors. Some claim that at best the ratio misrepresents how companies feels about employees, and at worst creates negative press without actually offering any meaningful value. The fact that the ratio compares the difference between the CEO’s compensation and the median employee salary means that the number of low-level employees skews the ratio significantly. A good example of this is Warren Buffet’s Berkshire Hathaway (9:1) versus Wal-Mart (537:1). At the very least, the ratio should only be compared between companies in the same industry or using the same business model.

The Ugly

Although the CEO pay ratio is stated as a very simple number, it is not a straightforward calculation. As with anything else, there are rules and exceptions to the calculation. The SEC allows companies to use a statistical sampling to determine their median salary and to exclude up to 5% of their foreign workforce. They can use the same median salary for up to three years, and are allowed to make adjustments for cost of living and can select the date they want to pull the salary data from as long as it is within three months of reporting the ratio. While all of these allowances are realistic ways to address the messy business of boiling so much information down to a single number, they do raise questions about how reliable the resulting ratio is.

As procurement professionals, we have to take advantage of all of the information available to us when making a decision or a recommendation that involves suppliers. We have a responsibility to make sure that the information we collect is presented and used in the appropriate context. We can’t mislead but we can’t allow ourselves to be surprised by publicly available information either. At the end of the day, the CEO pay ratio is one more piece of information we can factor in when creating a complete picture of a supplier. It should be no less and no more heavily weighed than any of the other details included.