Mind the Compensation Gap

Justin Fox from the Harvard Business Review has an interesting post about a topic he sees bubbling up at the World Economic Forum—income inequality. The matter got raised today by Martin Sorrell, CEO of advertising and public relations firm WPP, who said during a session that sustainable growth is bolstered when wealth is distributed more equally.

"Wealthy people invest in financial assets; they create asset bubbles," Sorrell said at the forum, being held now in Davos, Switzerland.

Fox thought Sorrell's comments before some of the world's wealthiest people "seemed like a significant moment." But Fox concludes we probably won't hear much more about the topic at Davos because that's just not a comfortable place for the business community.

Business folks would seem to be stuck. They need a more equal distribution of wealth and income to continue thriving. But it doesn't seem to be in any businessperson's immediate interest—and in many cases contradicts deeply held beliefs—to make the sort of decisions or support the sorts of government policies that might halt the trend toward more inequality.

The talk of income inequality got me reflecting on an interactive Portfolio.com did in 2007. It offered a graphic display of research done by Kevin Murphy from the University of Southern California's Marshall School of Business that compared how much more a CEO of an American company made compared with an average employee.

I got in touch with Murphy today to see how the CEO-vs.-employee gap has looked recently. The lowest ratio was in 1971, the second year tracked in Murphy's research. That year, the ratio between a CEO and an employee was 30.6 percent (averages of $212,230 vs. $6,540). The high point was in 2000, when the ratio was 557.6 percent (averages of $13.9 million vs. $25,010).

The last year for which Murphy has done the calculation is 2009. The ratio was 264.4 percent—the smallest difference between CEO and employee in 13 years. Average compensation in 2009 was $8.47 million while the average worker made just over $32,000. One note: Included in a CEO's compensation were stock options granted, and Murphy figured their worth based on the date they were granted.

Murphy said much of the recent focus on pay can be traced to the Dodd-Frank financial reform law that passed Congress last year. That law required firms to report the median pay for all workers and compare it with the pay for the. "The provision serves no purpose but to try to 'shame' CEOs into lower pay…what this is doing in a 'Wall Street Reform Act' defies logic," Murphy wrote in an email to Portfolio.com.

"The 'level' of pay is the perceived problem they are trying to solve. But…what is the right ratio? How do we know if it is too high or too low?" Murphy wrote. "Isn't it probably mostly a measure of the type and location of business? For example, smaller highly skilled white-collar firms will have low ratios, while manufacturing firms with many low-cost foreign plants will have high ratios. So what?"

That's the question that a bunch of very highly paid business executives are pondering in Davos. Or not. As Justin Fox writes: "It's hard to imagine major progress on the subject of economic inequality being made over cocktails at ski resort.

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J. Jennings Moss is editor of Portfolio.com.