As Labor Unions Mobilize, Here’s How Executive Compensation Actually Works
Originally published at Forbes.com
From Detroit to Hollywood, labor unions are making a statement to America, “We’re still here.” This year, more workdays have been lost to organized labor action than in any year since 2000.
What is the primary driver? It’s a combination of factors: The current rise in the rates of inflation and interest, after two decades of abnormally low numbers, along with an extremely tight labor market. The resurgence of union activity is neither unexpected nor unpredicted. As interest rates slow economic output, while the COVID-era benefits that kept many workers out of the labor pool vanish, a disconnect between employers and union officials gradually grows.
Recent strikes are taking pages from past playbooks, painting a picture of corporate excess. A traditional part of the proverbial playbook is to cite “excessive” executive compensation, both as an absolute and in terms of the ratio to the compensation of the average worker.
Does this tactic work? That’s actually a two-part question:
Does it work to affect the negotiation of new labor agreements?
Does it affect how boards view and decide on executive compensation arrangements?
As a tactic for gaining public support, executive compensation shaming is understandable. It will always be with us. And it is certainly a better message to the American public than something like, “Support our pay increases so you can pay more for the company’s products.”
To understand how the setting of executive compensation actually works, it is helpful to back up and review who represents whom, and the duties each have to their respective constituencies.
Organized labor legitimately represents the interests of covered workers, as well as advancing the broader influence and long-term success of the union itself. But a union’s interests do not necessarily align with those of the shareholders, and corporate boards understand that. Of course, public perception is a consideration for companies, but it is contingent on boards discharging their primary duty. They represent the interests of shareholders, knowing that all employees—whether organized or not—have their own self-interests, which may run in a different direction than the board’s duty.
A board’s checklist is straightforward:
Attract and retain the caliber of leadership talent that will work best to make the company successful, and reward shareholders appropriately
Recognize the competitive market for leadership talent and find the right balance to recruit effective leaders, without overpaying compared to the competitors for that talent
Increasingly design the features of executive compensation so that only better outcomes in shareholder terms generate a higher level of incentives
Which voices matter most to boards? Finding the sweet spot in executive compensation is a multi-part balancing act, but the shareholders are always at the top of the list. All companies—in Detroit, Hollywood, and everywhere else—maintain a direct dialogue with the leading individual shareholders and fiduciaries with major positions. Discussions with them include succession planning, the market for critical skill positions, but most significantly, the competitive comparison and structure of executive compensation plans.
To its credit, the U.S. Securities and Exchange Commission has done useful things to make the disclosure of the structure of compensation arrangements more transparent, so that shareholders at large and other constituencies can better judge the degree of alignment. Transparency leads to more trust.
Shareholder governance organizations also play a pivotal role in making or withholding recommendations on directors and compensation schemes that are included in proxies for shareholder approval. Of late, both shareholders and regulators, as well as boards, have become more focused on the self-interest of these organizations themselves and the advisory services they sell with regard to improving the ratings they receive.
In the coming years, I expect to see increased pressure to reduce the monopoly power of the major services and introduction of other competitors with more neutral incentive structures. But, to be fair, shareholder governance organizations have been responsible for productive increases in transparency, making it clearer that boards are, in fact, finding relatively appropriate balance points.
Over the last decade or more, the members of board compensation committees have seen a much heavier workload, with the demands on compensation committees outpacing their counterparts. The employment of consultants that work exclusively for the board compensation committee—and not for management—has become standard practice. And these consulting companies provide the data and expertise to ensure that boards really do understand the competitive landscape and best practices, independent of the descriptions and desires of management.
Now, back to question #1: Boards see the executive compensation shame game as a distraction that comes with their increased workload. The board, along with management, is responsible to foster productive relationships with the entire workforce, using the same criteria it uses with executives.
Whether it’s a CEO or an entry-level employee, the considerations aren’t that different. What is the actual market for various kinds of talent? Which levels of compensation allow the company to compete with other firms making the same product or selling the same service? If a company offers pay below market rate, to what extent does that undermine recruitment and retention?
Unless both talent and capital earn returns—consistent with what market forces impose on those against whom companies compete—the result is failure. The company fails, and so do all of the relevant constituencies. When discussing executive compensation, just remember that nuance matters, and the market dictates everything.