Pay and the Perception of Fairness

     Once upon a time, I worked for a high-tech division (Bell Laboratories) of a company. Within the company, the technical people knew what the pay scale was on a statistical basis. Each level of promotion was paid the square root of two, on average, times the average pay of the level below. Thus, my department head (the manager of my manager) would, on average, be paid twice the amount that someone at my level, on average, would get paid. This went up at least four levels. It did NOT go to the very top (more on that later) but it did go up a ways.
     There were sub-levels to which the square root of two did not apply. For example, the equivalent of a SW Engineer I versus a SW Engineer II did not connect to the ratio of the square root of two. But, in general, people knew what type of average deltas existed between levels (and even sub-levels, to a point). I keep saying "on average" because, as was (and still is) true for most companies, the monetary amount for each level was not publicly discussed -- neither the average nor the range.
     This worked well. The precise amount did not matter too much. Maybe each level could have increased by the square root of three rather than two. It couldn't be a lot more than that, however, and still be considered "fair". It was known, and understood, that each level had more responsibility than the previous but -- beyond a certain ratio -- pay ratios could get out of whack (no longer at a reasonable point). Perception of fairness depended on two things -- visibility of ratios and a translation of that to a delta of responsibilities and duties.
     How high up in the hierarchy did this pay ratio between levels apply? I don't know. As stated earlier, it made it four levels up. Beyond that, I don't know except that it did NOT apply to the highest executive levels. Thus, at some point, the ratios were discarded.
     This discrepancy, or abandonment, of fairness at the higher layers was a topic of discussion. Most of the time it was just something in the background as we were doing OK within the company and system. One year, however, the CEO doubled their salary while doing a pay freeze for the rest of the employees. That did not go down well but it was known that most of the people were there because they could do the work they wanted to do -- not primarily for the money. But the perception of fairness never returned and morale never quite made it back to the same levels.
     So, how should a CEO be paid? What is fair? If you used the formula I mentioned at the beginning here, then a CEO of a huge corporation should be paid about 16 times that of a regular worker. Is that close to the reality? Nope. Not even in Poland, where a CEO gets about 28 times that of a regular worker. If we used the (straining the "fairness" doctrine) square root of three (rather than two) ratio, it would mean that a CEO of a huge corporation would be paid 81 times that of a regular worker.
     What is it like in the United States? About 354 times that of a regular worker -- it continues to go up and up. The highest in Europe is a ratio of about 148 to 1 in Switzerland. An article with more numbers is here.
     So, once again, what is fair? More important, what meets the PERCEPTION of fair? Perception of fairness goes hand in hand with perceived mobility. If I can work hard and get that golden apple, that brass ring of the merry-go-round, that round-the-clock money mill then almost anything can be perceived as fair. Dreams of winning the lottery just don't allow reality and statistics to interfere.
     Note that there are two categories of CEOs -- those who are heads of private corporations and those who are heads of public corporations. The CEOs of private corporations often have relatively low salaries because they have large amounts of equity (ownership) and recognize that putting money back into the company (if successful) will give them a higher eventual rate of return. Taking out a lower salary allows the money to be used to actively grow the company. When I was "Vice President of Engineering" of a company that I co-founded, my salary was only a little (not even the square root of two ) higher than the rest of the employees.
     The CEOs of public corporations have salaries, perks, "golden parachutes", and so forth determined by the board of directors. They will have equity as part of their compensation but their salaries have no direct interaction with the equity. In other words, a lower salary does not translate into higher potential equity and a higher salary does not mean less equity.
     So, how is the compensation package of the CEO of a for-profit (non-profit is similar but generally has a ceiling beyond which people won't tolerate) public corporation determined? First, please note that public corporations (those which have had a successful Initial Public Offering (IPO)) are going to be beyond the small scale of most private corporations. Saying, as an example, that an average employee's compensation package (salary, taxes, benefits, physical overhead, etc.) is $50,000/year this would indicate an average U.S. CEO salary of $17.7 Million/year. Obviously, a company grossing $15 Million/year cannot pay this. Probably a company would have to start reaching a $500 Million/year gross income before their board of directors would even consider a $17.7 Million/year compensation package for the CEO.
     The above referenced study actually indicates the average CEO salary in the U.S. is approximately $12.3 Million/year (less than that $17.7 Million/year of the example calculation). I have not seen a distribution graph of CEO salaries. However, the highest paid CEO in the U.S. for 2017 is $236 Million/year. My suspicion (not verified by any hard data) is that the distribution does not follow a standard bell curve. I think that there are a lot of lower salaries from smaller companies that bring down the average from the higher paid ones. But, since the average still exists at 354 times average worker, there also has to be a lot of very highly paid ones.
     These highly paid CEOs are not really in the salaried employee category. They are Rock Stars, Professional Sports First Draft Picks, Celebrity Panelists, and so forth. Their compensation packages are based on competition between boards of directors which keep inflating compensating packages in order to "win" -- show that they have a better CEO because they are paid more. There is no tie between company performance and package and most have such extensive separation packages that someone can be hired as a CEO, do a horrible job, and leave with enough money to support 1,000 (or more) families for a year.
     Boards of directors are theoretically determined by the stockholders -- but stockholders care primarily about quarterly results and, with the mega corporations, even effective losses of hundreds of millions of dollars, don't affect the bottom line much. If that is so, does it really matter what the CEOs are paid? Some say no, it doesn't. Personally, I think (like the situation from my earlier career days) it poisons morale. And, whether it affects the stockholder's value or not, that $236 Million/year is paid for by at least $1000/employee in the one company. In other companies, it may affect the "average" employee even more. But it is still all part of the package of valuation of employees at companies -- not just the CEO's compensation package.

Regulations create level playing fields for businesses

   It seems to be fairly "normal" for businesses to complain about, and fight, every new regulation that is proposed or enacted. This isn't unreasonable as it will be true that a new regulation will require different procedures (and probably additional paperwork). However, that is not the same as saying that regulations are bad for businesses -- but it can be a difficult balancing act within the global economy.

   Regulations are a way to tell businesses what practices are acceptable to the society in which they function. They fall into three general categories (actually, almost anything can be broken up into however many categories as are desired -- I am choosing three). These categories are economics, labor, and environment. There is also a fourth category which involves product regulations -- for the product quality and safety of the consumer but that does not directly apply to this blog.

   Economic regulations involve the way the products of a company become part of the general economy. This will involve taxes. Generally, businesses want to pay fewer taxes and the general population wants them to pay more taxes. It will also involve tariffs -- both import and export. Tariffs are special taxes that are involved with the movement of products and money across country borders. This is a part of the balancing act.

   Let us say that Country A, as part of the standards for their society, requires all businesses to ensure that any water used by the business to be cleaned to drinking standards before being released back to the environment. This requirement (or regulation) adds 5% to the cost of doing business in Country A. Country B does NOT have such a requirement and, thus, businesses can produce the same product for 5% less. This puts businesses in Country A at a price disadvantage. A tariff on products imported from country B gives the businesses a more equal competitive situation. (Note that the tariff does not help the environment in country B.)

   Regulations may also be in the category of labor use. Minimum wage laws (or "living wage" laws whenever they start being enacted) say that people cannot officially be employed without a certain level of pay. Restrictions on number of hours worked per day, or week, directly affect the number of people employed. "Child Labor laws" restrict the age of workers and the number of hours per day that they can work at what ages. Mandatory sick days allowed (paid or unpaid) create a situation where workers are not compelled to work even when sick (this also benefits the general population when the food industry is involved). Vacation days, holidays, and other types of paid, or unpaid, absences help the overall health of the people who work for a business.

   Environmental regulations are basically a matter of how businesses are allowed to affect the environment. Usually a person thinks of manufacturing companies for this. However, the requirement that a business have, and maintain, a parking garage would also be an example of an environmental regulation as it reduces the amount of land that cannot be used for vegetation. Another non-manufacturing law might be a requirement to turn off 70% of the lighting during non-working hours.

   Of course, environmental regulations apply more directly to manufacturing businesses. It is similar to teaching a child to "clean up their own mess". A business would, naturally, prefer other people to take care of their messes. Note that not having environmental regulations does NOT decrease the cost to clean up -- it moves it from the business to the general public. In fact, it probably costs less for the mess to be cleaned up at the site of creation of the mess than after it has dispersed and damaged other parts of the environment.

   It would be completely possible for a business to do everything well on their own initiative. They can treat their people well, be good to the environment, and be a good neighbor within their communities. There are many small businesses that strive hard to do such and other, larger, businesses that recognize that there are inherent benefits (lower turnover of staff, better public image, etc.) to do such. However, businesses that do NOT behave well can have financial advantages over their competitors -- and this does not help society as a whole.

   Regulations provide a framework that is acceptable to the local society that allows businesses to compete without having uneven costs of providing services.