Real Pay, Realizable Pay, Pay Ratios and Reality

Dan Walter, Performensation

Pay ratios are the most commonly used tool when discussing the unfairness between executive pay and that of the rank and file. Recently, on the PayScale Career News blog which caters to individuals managing their careers, there was an article showing CEO-worker pay ratios at several well-known companies. Ratios like 1,034:1 (Walmart) and 0:1 (Google) are attention grabbers. The question is whether this tells all, or even a significant portion, of the real story.

For worker data, PayScale used employee crowdsourced data. For CEO data, information came from Forbes’ annual executive compensation report (full methodology here).

When you look closely at the Forbes data you will see that Michael Duke, CEO at Walmart made $23M in 2012. This is an impressive number to be sure. You will also see that he made about $54M over the past five years. That comes to an average pay of $10.8M (ratio of 482:1) per year, hardly pedestrian, but not even half of what was reported for 2012. It also shows that Mr. Duke owns more than $56M in company stock. This amount does not include any unvested stock, or its potential value. But, the 2012 number does seem to include income from equity compensation transactions that year. Confusing? Yes. Helpful? Not as much as you may hope.

Pay ratios are also difficult because CEO is an easily definable role, while “worker” is not. Let’s compare. Company 1 may have a large staff while paying them poorly, resulting in a high ratio. Company 2 outsources much of their low-level work (paying them even less), but keeps a well-paid staff of experts and professionals, resulting in a lower ratio. These two companies may compete directly. Their total labor costs (employed and outsourced) may be the same. The CEO at Company 2 may actually make more. But, Company 1 looks bad in this regard, due to the lower average pay of his workforce. What happens if Company 1 also employees nearly all of their staff in the US? Are they better or worse than Company 2 that outsources the same work to a company in another country?

In a recent article, I discussed “realizable pay”. Realizable pay is compensation calculated at the end of a measurement period. It includes the value of unvested full value awards, such as Restricted Stock and RSUs, and the intrinsic value of any “in the money” stock options. Since this measurement uses real values, it better reflects the pay to be delivered and more tightly links to corporate performance and Total Shareholder Return over the period of the award.

Realizable pay for most average workers is generally not dramatically more than their current total direct compensation. For CEOs, this number can be volatile and may make all the difference in the world. So, should we compare realizable pay? Should we only look at multi-year averages or means? Does pay ratio really mean anything in a world where many workers perform jobs similar to those performed decades ago, while CEOs run companies many times larger, with dramatically more global competition, higher job risk, more complex interactions and compliance issues.

Should CEO pay first be weighted by the overall size and complexity of the business? Should worker pay be scaled and scored the same way? Of course, these types of scoring systems would also be fraught with complaints and problems. They would also take massive amounts of time, money and systems, just to make people unhappy.

Pay ratios are a fascinating statistic. Just remember that they do not, and cannot, communicate an entire story. Use them wisely. Use your compensation professional skills to dig into what you see and make sure you understand it. Your employees look at these ratios, as do your shareholders, politicians and the media.


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