Are highly paid corporate superstars worth it?

Where’s the outrage ? The howls of fury that he’s not worth it, that he’s being paid squillions more than his fellow workers ? Not a whisper, not a squeak. No one dares say a bad word about the news that Barcelona’s Lionel Messi is about to strike a deal that will make him one of the most expensive footballers on the planet. Maybe Cristiano Ronaldo, but then he earns more than Messi from sponsorship.

Word from Camp Nou is that Messi is being offered a four year contract which will pay him between £500,000 and £1m a week, giving him a cool £54.8m a year or £220m over four year. Add on match bonuses and sponsorship deals and he might get nearly as much again.

What’s so intriguing about Messi’s deal is the way Barca’s president, Josep Maria Bartomeu, says the centre striker is worth it because of what he does for the team and for the socios – the club members – who own Barca. The Argentine not only pulls in the crowds but has 89m Facebook likes and 75m followers on Instagram: that means more advertising, sponsorship and kudos for the club.

More to the point, Barca puts a monetary value on Messi’s contribution. Of the £615m revenue for the last season, Messi is thought to be responsible for 20% of the total. So the business case is transparent – Barca is paying up to £50m a year for a talent that brings in £120m of income.

Chief executives around the world must be feeling sick with jealousy over Messi’s deal-making skills, and not just the numbers but the way he is being feted for his talent. There are only a few CEOs who can compete with football’s mouth watering numbers. Sir Martin Sorrell of WPP made £70m last year while in the US Ginni Rometty of IBM cruised home with $32m.

Yet rather than being hailed as heroes for creating value and glorified for creating new jobs, most CEOs of publicly listed companies in the UK and the US are dumped on for earning too much, and certainly too much more than their employees. For the pay gap – the ratio between the CEO, and other highly paid directors, and the average worker in a company – has become the symbol of all that is wrong with pay. And it’s true that the gap has stretched to the most extraordinary degree. In the UK, the gap over the last thirty years or so in both the private and the public sector has become so big that CEOs now earn on average 180 times their average employee. Always bigger, in the US that ratio is up to 2,000 times.
This is a gigantic leap from the 1980s when the multiples earned by top company bosses – and high earners in schools, in medicine and the judiciary – were roughly around 20 to 40 times the lowest employees in their workplace. No one ever talked in terms of multiples, it was as though they worked invisibly by osmosis. Apart from great entrepreneurs running their own private companies, there was a sense of a social contract between the highest paid and the lowest.

By the early 1990s that had all changed. One of the first of the fattest fat cat packages was the $100m paid to Michael Eisner at Walt Disney. This set the bar. Other companies caught up – claiming that their CEOs were also rare talents and demanded rare pay to match. (Rather like the universities today which all charged the top whack of student fees, no one worth their salt wants to be seen in the bottom quartile of pay, whether their return on equity justified it or not.)

Public outrage over high pay reached its peak over bankers bonuses after the financial crash of 2008, prompting at least some sort of response from the bankers who have attempted to link bonuses with long-term performance.

Governments, though, on both sides of the Atlantic, tried to address the outrage. Here in the UK the government is working on new plans to suggest obliging companies to publish pay ratios as the US has done with the Dodd-Frank reforms. But both governments have gone soft on the idea. And they may be right. New research to be published in the US at the annual American Accounting Association in August questions whether high pay ratios are the bad guy they are made out to be.
In a fascinating paper, Do High CEO Pay Ratios Destroy Firm Value?, three academics say that the widening gap between CEO and worker pay is inevitable in an environment of complex business organizations.
After analysing 800 companies, the authors conclude that the high pay ratios of their CEOs are associated with both strong company stock performance and heightened profits.
While they go to pains to say they are not moralising about the ethics of high pay, they also argue that the “demoralizing effects (if any) of high pay disparity between senior executives and workers are not sufficiently large to harm the overall firm value and performance… On average, high pay ratios are not symptomatic of corporate governance failures and CEO rent extractions. Instead the results are consistent with the argument that high CEO pay ratios are an outcome of market competition for scarce CEO talent.”

So-called scalability, they say, is the reason for the widening pay gap, claiming that it is the complexity of corporates over the last few decades that have led to such increases because “decisions made by individuals at higher levels of the organization have firm-wide implications…[while] the firm-wide impact of a single rank-and-file worker is likely to be marginal at best.”

They conclude that: “Therefore, the incremental talent/ability at the CEO level commands a disproportionately greater increase in compensation.”

This is provocative stuff. It will be manna from heaven for defenders of high pay who argue that top CEOs – just like Messi and other celebrities like singers and actors – are unique talents in a tiny marketplace who create wealth for their employees and shareholders. Or indeed, their socios.

If the study is correct – and more research should be done – then critics of high pay ratios face a conundrum. Who would want or dare to rob companies of the best possible talent they can get ? If these CEOs are shown to be truly brilliant at creating value, they will continue to command the highest pay. Shareholders are certainly not going to want to boot them out.

Yet the reality is that the subject of how we reward people is a complex muddle, a lottery. Look across any room or workplace and you will see disparities in pay between people doing more or less the same job. We know that better looking people earn on average about 4% more a year – or £250,000 over a lifetime – than less blessed workers. Women earn on average 13% less than men in the UK while in the US, the difference in pay for black and white people is its widest in 40 years – with black people earning nearly a third less than white people with the same qualifications doing the same job.

There are some answers to the conundrum. Ownership helps. Start by reforming pay packages – get rid of complex share option schemes for CEOs and executives – and make directors buy shares with their own money so they have skin in the game. And spread share ownership between all employees. More of that another day.