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Is It Time to Extend the Say on Pay to the Employees?

We need a fresh look at the whole concept of "Pay for Performance." But maybe the problem isn't with the basic concept of Say on Pay -- it's that the wrong group is asked to weigh in.
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It's been another bellwether year for highly compensated CEOs. The New York Times' annual survey on executive pay reports that the ten highest paid corporate executives each made more than $50 million last year. For our largest companies, the top-200 received, on average, $22.6 million, a fat increase over the prior year at $20.7 million.

Given the competitive bench-marking system that drives pay up, and up, and up in public companies, salaries are likely to continue to grow -- and to contribute to the widening wealth gap and distrust by the American public.

Shareholders were granted the right to "vote" on pay packages as part of the Dodd Frank Act passed by Congress in the wake of the mortgage crisis. The vote is non-binding, but can be embarrassing for the CEO on the rare occasion it goes negative. However, as Gretchen Morgenson reports in The Times, a little belt-tightening or changes in governance practices is typically all that's needed to win back trust in the following year. In fact, pay at public companies has grown 12 percent annually since the votes began.

And therein lies a conundrum. Shareholders have been given the so called "Say on Pay," but most individuals with stock investments don't really care if the CEO is making more money than they might see in several life times, as long as the share price continues to go up. Most of us saving for retirement barely know what stocks we own; our shares are voted by institutions who make more money when the executives are making more money. So the merry go round continues to spin.

As Roger Martin reminds us, the stock price is a rude measure of the true health of the company and has little to do with management decisions and the company's future. Yet, since the 1980s, the trend has been to compensate executives in equity or rewards linked to the stock price -- so-called "Pay for Performance." The result? sky-rocketing pay, and more management decisions, like stock buybacks, geared to boost the stock price at the expense of the long-term health of the company -- and economy.

For the vast majority of shareholders, the decision rules about what constitutes out-sized pay are elusive. With 95 percent of the votes cast in favor of the pay plans, it appears Congress has handed oversight of pay to those least likely to do anything about it.

What's the answer?

We need a fresh look at the whole concept of Pay for Performance. But maybe the problem isn't with the basic concept of Say on Pay -- it's that the wrong group is asked to weigh in. What if employees were granted the right to a non-binding vote on the compensation of their chief executive -- what might we expect to see? Here are several reasons to consider shifting the Say to the employees:

1. It's a matter of equity. The best arbiters of fair pay are those who show up every day to design and produce, sell and serve. There is real science behind how the top pay -- vs. the pay rate on the proverbial shop floor -- translates into measures of "felt-fairness" and employee motivation. A negative employee vote on the pay of the executive might be just the signal Boards need to see something is truly amiss in the culture of the enterprise that will eventually be felt in productivity and service quality.

2. Employees know what real Pay for Performance looks like. Employees are more likely to notice and care about internal business practices that fall below the bar but may take years to show up in the stock price. From a culture that lacks integrity or transparency, to the kind of deferred maintenance and safety shortcuts that result in human and environmental disaster, race-to-the-bottom business behaviors affect employees much more than the shareholders -- who can simply sell their shares if they are unhappy.

While employees may be conflicted and fail to speak up when business practices are producing bad results -- think GM -- they are far more likely than shareholders to send a warning signal across the bow -- as whistleblowers have done for decades. Employees are best-positioned to discern when PR is out of line with reality. It's time to move off the stock price as the sole measure of Pay for Performance. Employees can help with the shift.

3. It's not the shareholders' money. Shareholders have specific, but limited, rights. They have no claim on the cash on the balance sheet except in bankruptcy, in which case the shareholder is only paid after everyone else with a legitimate claim or contract is satisfied. In spite of the misnomer of "owning the company," most shareholders are traders, not owners; many are not even real investors in the Warren Buffett sense of the word. Employees, on the other hand, have great concern for the long term health of the company -- and for those with firm-specific knowledge, they have a lot at risk.

The SEC has the potential to make the current pay situation worse with a proposal to tie pay to a measure of "Total Shareholder Return" or TSR. The stock price is only the most rude measure of success and in the short-run is only vaguely connected to the kinds of performance that matter the most to people and the planet.

Just like the Say on Pay vote has come to represent a general census on the relationship between executives and shareholders, an internal vote might prove revealing -- a real bellwether on the health of the company from those who know it best. Shareholders are right to be concerned with how a company spends its money, but it's still the company's money. Why not embrace the increased accountability and information that could come from an employee vote on CEO pay?

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