The Executive-Worker Pay Gap Isn't Without Consequences

Take a minute to consider these two hypothetical situations and choose which you would personally prefer. (Note that prices for goods and services are the same in both situations, meaning that the purchasing power of money is equivalent.)

• Situation A: Your current yearly income is $50,000; others earn $25,000.
• Situation B: Your current yearly income is $100,000; others earn $200,000.

Strikingly, when this same situation was presented to hundreds of faculty, students, and staff at the Harvard School of Public Health, half of the respondents reported that they would prefer situation A. That is, half of the participants would prefer a world where they earned half as much, provided they made more money than others.

This survey maps to organizational life: When people ask whether they are satisfied with their pay, they first compare their efforts and pay to their coworkers’. Social comparison escapes nobody—in fact, even monkeys socially compare their “pay."

Managing Pay (Un)wisely

Organizational managers are wise if they work toward ensuring that their pay systems are fair. This is because employees who are paid fairly contribute significantly more; meanwhile, when employees perceive that others are paid more without proper justification, employees get angry and disengage from their work (or even worse—steal from the organization).

This fairness principle is intuitive. Notwithstanding, I get worried that contemporary managers continue to unduly disrespect this fairness principle. I teach students about pay fairness each year, and each year I revise my slide deck to increase the figures representing inflation-adjusted CEO compensation and the corresponding CEO-worker pay gap.

To illustrate, a few years ago, I surprised students with the calculation that 2018 CEO compensation has risen by 940 percent since 1978. However, I had to revise my slide when 2020 CEO compensation growth reflected a 1,322 percent increase, and again when the 2021 increase constituted a 1,460 percent gain. This latter figure corresponds to 399 times more money than the average worker. Of note, CEOs are not the only ones enjoying monstrous gains, as other executives and high earners have enjoyed a 385 percent increase. In short, executive pay continues to grow exponentially.

Critically, this increase in compensation is not co-enjoyed by the average worker, who has only seen an 18 percent pay bump since 1978 (despite an S&P stock market growth of over 1,000 percent). However, this 18 percent increase masks the reality that some workers’ inflation-adjusted pay since 1978 has gone down. As always, the poor and underprivileged suffer the most—those without college degrees have experienced a median wage decline of 11 percent since 1979.

For the current outlook to be fair, CEOs need to be producing 1,460 percent more (and non-degree holders need to be producing 11 percent less) for their companies than they did in 1978. Moreover, CEOs need to be producing as much value as 399 average workers on a day-to-day basis.

Does this pass the equity test? Plato would balk and reinforce his conviction that nobody should be paid more than four times any other. Peter Drucker, the “father of modern management,” would also shake his head and say, as he did years ago, “I have often advised managers that a 20-to-1 salary ratio is the limit beyond which they cannot go if they don’t want resentment and falling morale to hit their companies.”

Organizations Are Not All Equal in Their Inequity

If you are one of the 99 percent of people who hasn’t enjoyed a triple-digit (or quadruple-digit) pay increase, you should take comfort in knowing that class-based pay disparity is less of a problem within some organizations. I was intrigued by the online search engine tool furnished by AFL-CIO which pulls CEO-to-worker pay ratios (using median pay as the worker comparison point—these ratios would be much larger if we were to compare against the lowest-paid employees). Whereas some S&P 500 companies have huge pay gaps such as Amazon (6,474:1) and McDonald’s (2,251:1), other reputable companies have modest pay gaps such as Berkshire Hathaway (6:1) and Google (21:1).

As we would expect according to principles of fairness, Berkshire Hathaway has been recognized as a great place to work. Meanwhile, some worry about Amazon running out of potential workers to hire within the next few years as they churn and burn through hundreds of thousands of workers who deem the work not being worth the pay, quitting sometimes after only a few days or weeks. Remarkably, Amazon’s annual turnover rate has been calculated at 150 percent by The New York Times¹, and roughly 100 percent by other sources².

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Lest you think I’m drawing an unfair comparison here, consider another S&P 500 company who is more of a direct competitor to Amazon, who also mostly employs warehouse workers—Costco. Per the AFL-CIO calculator, Costco’s ratio is 218:1—a 30x reduction to Amazon's ratio. Yet Costco's annual turnover rate is lower than 10 percent company-wide for those employed at least one year—a figure that holds even during “Great Recession” years, such as 2021 and 2022. Employee reviews of these companies confirm what theory predicts—employees at Costco feel like they are treated with dignity and respect, and accordingly stay longer and are more engaged in their work.

Implications

Fairness is a universally endorsed moral value. When we are treated fairly, it is the most natural response to reciprocate in kind. When we are instead treated unfairly, the resultant poisons we call anger, envy, and resentment will diminish the spirit and vigor of all but the strongest individuals.

Fortunately, there are companies who go to great lengths to ensure that their pay practices are fair and that their executive-to-worker pay ratio is justified. And practically, technology and transparency are making it easier to identify the fair from the unfair. It is on the heels of this knowledge that I offer students one of my most helpful pieces of advice: Find an organization who treats employees with dignity and respect and commit yourself to their cause—everything else will subsequently fall into place.