Runaway CEO salaries, gender pay gaps and minimum wage wars are igniting debates about income inequality. The issues are more complicated than you might think, Lehigh experts say.
The headlines are designed to shock, and shock they do: "Chipotle's CEO makes 1000x the salary of average worker" (New York Post), "Wage Gap Costs U.S. Women $500 Billion a Year, Report Finds" (Huffington Post), "It's officially impossible to afford NYC rents on the minimum wage" (New York Daily News).
Former Democratic presidential candidate Bernie Sanders struck a chord with millions of Americans when he made the growing inequality between the super-rich and everybody else the centerpiece of his campaign. In the past few years, that outrage has caught fire with the "Fight for $15" campaign among groups trying to raise the minimum wage and through "Say on Pay" efforts in which shareholders of companies have the right to vote on executive compensation.
But don't storm the barricades just yet. A look beyond the headlines reveals stubborn complexities in the debates over how to fix runaway executive compensation, the minimum wage and the gender pay gap.
If CEO pay is too high, how can it be reined in without hurting companies' ability to attract talent? If the government gets involved, would the cure be worse than the disease?
With the gap between what men and women earn, how much is outright sex discrimination and how much stems from other factors that don't lend themselves to lawsuits and legislation?
When the minimum wage is raised, what is the tipping point where mandatory pay hikes mean fewer jobs? $10? $12? $15?
"Salary and wage issues are increasingly salient in our understanding of the balance of free enterprise and regulation," said Georgette Chapman Phillips, dean of the College of Business and Economics at Lehigh. "The choices that leaders will make on these provocative topics will reverberate for decades to come."
Few statistics are as likely to rile up middle-class Americans as the gap between the multi-million dollar compensation packages awarded to top CEOs and the wages earned by average workers.
In July, the Economic Policy Institute, a labor-backed think tank, reported that in 2015, CEOs in the biggest American companies earned "an average of $15.5 million in compensation, which is 276 times the annual average pay of the typical worker."
"While the CEO-to-worker compensation ratio is down from 302-to-1 in 2014, it is still light years beyond the 20-to-1 ratio in 1965," the report said. The group attributed last year's smaller gap to a dip in the stock market that affects the value of the stock options in CEO compensation packages.
But the gap doesn't tell the whole story, nor is there an easy fix, said Andrew Ward, associate professor of management in Lehigh's College of Business and Economics.
CEO pay has escalated in part because the job of running a company has changed dramatically since America's economy went from largely domestic to one of global trade, he said. Fifty years ago, when an organization was rigidly structured, "it didn't matter so much who the CEO was because the organization performed as it performed," said Ward, who also serves as associate dean for graduate programs and holds the Charlot and Dennis E. Singleton '66 chair.
Today, with the advent of the Internet, digital technologies and other advances, companies have become less hierarchical and more creative, with the need to adapt faster to a rapidly changing business landscape, he said. As a result, "boards have realized that who they have as a CEO is much more critical. Now there's much more of a competitive marketplace for that CEO talent."
Boards of directors look at hiring a top chief executive as an insurance policy, Ward said. If they hire someone with a stellar reputation and the company performs poorly, board members can argue that it's not their fault because they chose someone who everyone agreed was a great pick. The CEO becomes the scapegoat for the company's failure.
Companies that have tried to place structural limits on the compensation of their executives have discovered it can make it difficult to recruit talent.
Ben & Jerry's, the community-minded ice cream company famous for its funky flavors like Cherry Garcia and Chunky Monkey, started off limiting the pay of its CEO to no more than five times its lowest paid worker. Then it raised that ceiling to seven to one before dropping the cap on executive pay when it chose a leader from outside the company to replace co-founder Ben Cohen, who stepped down in 1994.
Salary caps like Ben & Jerry's don't just affect the CEO but also the entire executive team, according to Ward.
"They couldn't pay market wages or anything close to it for their financial officers and accountants and all sorts of people, and it caused problems in the organization because they just couldn't get executives in general," Ward said.
At the other extreme, CEO pay gets ratcheted up when boards of directors look at those executive salaries as a competitive race to the top with an "our CEO is better than your CEO" type of thinking.
The American way
Top corporate executives in countries such as Germany and France don't make nearly the amount of compensation that America's highest-paid CEOs receive, but that's not surprising given cultural differences.
"European countries are generally much more focused on equality in society," Ward said. "They have much higher tax rates, much higher social security systems, public health care, which has the effect of equaling society.
"That's been much less part of the culture in the United States," where taxes are lower but the social safety net isn't as strong. "We have a philosophy that it's more about the individual and less about the collective benefit. That translates into the way we structure compensation."
It's reflected too, he said, in the way that sports figures and celebrities are compensated.
Some critics of executive pay argue that the huge compensation packages aren't always tied to a company's performance. Public outrage hit a high in 2009 when it was reported that insurance giant AIG planned to pay its executives hundreds of millions of dollars in bonuses while accepting about $170 billion in a government bailout.
There are drawbacks to tying CEO pay largely to stock prices, because it could lead a CEO to sacrifice long-term growth and stability to short-term profits. "If you do it wrong, you incentivize short-term thinking," Ward said.
As the Economic Policy Institute indicated, stock options impact CEO pay. "Back in the 1950s and '60s, the pay was smaller but almost none of that was tied to the performance of the company," he said. "Where that escalation occurs is where the bigger chunk of that CEO's pay is tied to performance. On the whole, U.S. companies have performed astoundingly well since the 1960s, so that has had the effect of escalating that pay differential."
Still, Ward said, "There's also the other argument that CEO pay has gotten too high and out of control. And I think there is validity to that." But he opposes any government effort to place limits on executive compensation, raising concerns about that type of marketplace interference.
"It's the job of the company to determine [compensation] rather than a cap being put on that by the government. Steve Jobs started Apple. Should there be a limit on how much Steve Jobs got paid from Apple? If he hadn't created it, it wouldn't have been around in the first place."
Last year, the Securities and Exchange Commission approved a rule mandating that large public companies calculate the difference between the compensation their top executives earn compared to the median pay of the rest of their workers. The regulation, which was part of the Dodd-Frank law, is slated to go into effect next year, with the first worker-to-CEO ratios expected in 2018. The rule has been widely seen as a way of publicly shaming companies into curbing runaway CEO pay.
"Say on Pay" campaigns—in which shareholders get to vote on CEOs' pay packages—may be having an effect on curbing over-the-top compensation, according to the Wall Street Journal/Hay Group. The WSJ/Hay Group CEO pay survey found in 2015 that for the second year in a row, pay increases for CEOs were "significantly lower than increases in shareholder value."
A gender pay gap?
Of the 100 largest public companies in the United States, only eight are led by women, but those women earned more than their male counterparts in 2015, according to a report released in May by Equilar, an executive compensation research company. Those eight women earned an average of $22.7 million compared to $14.9 million for the male CEOs.
But that's a very small subset of chief executives and says as much about how few women are leading large companies as it does about advances in closing the gender pay gap. A broader look at the issue of a gender pay gap tells a more complicated story.
The pay gap debate moved front and center last spring when five stars of the U.S. Women's National Soccer Team filed a complaint against their employer, U.S. Soccer, over wage discrimination. They maintained they are paid almost four times less than players on the U.S. Men's Soccer Team, despite making nearly $20 million more in revenue in 2015 and attracting more viewers—25.4 million—for last year's Women's World Cup Final than for any soccer match—men's or women's.
It's the latest chapter in a decades-long debate. When the movement for equal pay for women took off in the 1960s and 1970s, feminists wore buttons that said simply: "59 cents"—the amount that women were paid for every dollar men earned. And while that gap has closed considerably—it's now about 79 cents, according to the U.S. Census Bureau—the remaining disparity is not an easy fix.
Robert J. Thornton, who holds the Charles William MacFarlane Professorship of economics at Lehigh, and Judith A. McDonald, also a professor of economics at the university, studied the starting salaries of new college graduates from 2000 to 2010 and found that about 90 percent of the gap in starting salaries can be explained by the different majors that men and women congregated to and the types of job offers.
"Women are more likely than men to select majors commonly associated with lower earnings, such as education, health and psychology, whereas men are more likely to choose majors that lead to higher-paying jobs, such as engineering, mathematics and physical sciences," Thornton and McDonald wrote in a 2015 article for the journal Research in Labor Economics.
In an earlier study, they found that the same pattern has held since the mid-1970s.
"We think it's changing a little bit now," Thornton said. "There's a lot of interest in more women going into STEM fields."
Corinne Post, associate professor of management at Lehigh, has researched disparities in the workplace and career trajectories. She said some of the wage gap could be traced to more women than men taking time out for family purposes, such as raising children. But research also shows that men and women in the same position have different experiences at work.
So, for example, Post said a firm that was concerned about pay disparity found that its saleswomen were often given territory with traditionally poor sales.
"That would be consistent with a large body of research showing that men and women get different kinds of assignments and opportunities that then lead to these differences in salaries and wages," Post said. "So if I'm not given a good assignment with an opportunity to prove myself or a high growth client or industry, I'm not going to look as good to people as the others who have been given the opportunities."
Post said some of the skills that women frequently bring to the workplace tend to be invisible or undervalued.
"There was a really interesting study about science and engineering [research and development] and about how women on these teams—anticipating some of the issues that can arise—put a lot of effort into nurturing relationships that down the line proved to be very fruitful," Post said. "Now nurturing a relationship is not necessarily something that will come up on an evaluation of [research and development] project leaders or innovators. However, it will lead to greater success."
"What we know about the gender pay gap is it gets larger over time," she said. "So that initially at the start of a career, [pay] might look very similar."
A woman might graduate from college with an accounting degree, and her starting salary could be the same as her male counterparts, for example. But a wage gap develops as women take time off or seek more flexible schedules to care for children or aging parents.
"Because most of the disparities happen as a function of negotiation of assignments to projects, very quickly those disparities begin and of course they have a snowball effect," Post said.
Because the gender pay gap in many fields has a variety of causes, few of the solutions are clear-cut. Yet it's a mistake to believe today's employers are blind to gender. Claudia Goldin, a Harvard University economics professor, studied the gender makeup of the best orchestras in America. In the 1990s, such orchestras started having musicians audition behind a screen so those judging could only hear the music they produced.
In their 2000 paper Orchestrating Impartiality, Goldin and Princeton economist Cecilia Rouse found that not only did the blind auditions result in more women being hired by orchestras but it also increased the number of women who were willing to audition.
Minimum wage wars
Given the overall gender pay gap, it isn't surprising that the minimum wage disproportionally affects women. According to the Pew Research Center, men in America make up 53 percent of the labor force, but among those people who earn the minimum wage or less, 62 percent are women.
Experiments in raising the minimum wage are playing out across the country. Some states such as New York and California aren't waiting for Congress to raise the $7.25 federal minimum wage and are increasing their own dramatically over the next few years.
At the heart of the issue is whether such a hike costs jobs, especially for those on the lowest rung of the ladder, as employers hold off on hiring or even lay off workers because they have to pay higher wages that eat into their profits.
Lehigh's Thornton said for years most economists opposed raising the minimum wage, believing it was a job killer. Then Princeton University economists Alan Krueger and David Card did a study in 1992 in which they compared employment at fast food restaurants in New Jersey, which had just raised the minimum wage from $4.25 to $5.05 an hour, with the restaurants in Pennsylvania, which had not. They found the hike did not lead to a loss of jobs.
Krueger and Card revamped their study in 2000 and got the same results, which have been bolstered by other studies since then. The prime skeptics of their work have been economist David Neumark of the University of California at Irvine and Federal Reserve economist William Wascher, whose research has found that minimum wage increases have led to less employment.
Thornton said he believes overall that hiking the minimum wage by incremental amounts won't hurt employment appreciably, but it's also not as effective in reducing poverty as, for example, expanding the earned income tax credit.
"A lot of people who get paid the minimum wage are not in poverty," Thornton said. "So it's a very blunt instrument for eliminating poverty."
Several states and some cities have raised their own minimum wage beyond the federal $7.25 an hour, but New York and California are entering new territory in their plans to increase the minimum wage to $15 over the next few years. For businesses in New York City with 11 employees or more, the minimum wage will hit $15 an hour by the end of 2018, but elsewhere in the state, the increase to $15 will take longer. In California, the minimum wage is expected to hit $15 by 2022.
So the question is, what is the tipping point? Even Krueger, whose study changed the minimum wage debate, said in 2015 that a $15-an-hour minimum wage could be counterproductive, costing the jobs of the people who can least afford it.
"This is uncharted territory for us because we've never seen increases in the minimum wage of this magnitude," Thornton said. "There is clearly going to be a tipping point, but I don't think anybody knows what that is. We've never been there before."
Story by Margie Peterson
Illustrations by Sonia Roy