The Implications of Income Inequality

 
 

income inequality risk management

Nigel Travis is the chairman and CEO of Dunkin’ Brands, the parent company of Dunkin’ Donuts and Baskin-Robbins. And as of his July appearance on CNNMoney, where he commented on the news that New York’s Wage Board recommended that fast food workers earn $15 per hour, he is also an internet meme. A picture of Travis has circulated on social media with the caption, “Dunkin Donuts’ CEO says $15 an hour is ‘outrageous.’ He makes $4,889 an hour.”

Several articles in major newspapers have also criticized Travis with headlines like “Dunkin’ Donuts CEO tone deaf on minimum wage” in The Boston Globe and “Dunkin’ CEO says raising minimum wage to $15-per-hour is ‘absolutely outrageous’…as he lives in mansion and makes $10 million per year” in the Daily Mail. Seattle Times columnist Jon Talton went so far as to call Travis “the best advocate for the $15 minimum wage,” writing that “when high-paid executives get hysterical about improving the pay of their workers, it doesn’t help their case.”

Nigel Travis is not the first corporate leader to be targeted by advocacy groups and the media for a compensation package that dwarfs those of the company’s workers, and he certainly won’t be the last. In August, the Securities and Exchange Commission adopted a final rule that will require every public company to disclose the ratio of their CEO’s total compensation compared to that of the organization’s median worker. Although the rule does not go into effect until the fiscal year beginning Jan. 1, 2017, its adoption has already drawn concern throughout the business community. Considering the uproar stemming from Travis’ brief commentary on a proposed minimum wage increase, corporate leaders must assess all of the risks that can stem from the increasing focus on income inequality.

According to the Economic Policy Institute, the CEO-to-worker compensation ratio was 20:1 in 1965 and has grown steadily to almost 296:1 in 2013.

The Context of Income Inequality

While the United States has always been an economically unequal society, most economists agree that inequality has been increasing since the 1970s. According to the Economic Policy Institute, a nonprofit and nonpartisan think tank, the CEO-to-worker compensation ratio was 20:1 in 1965 and grew steadily to almost 296:1 in 2013. Meanwhile, Emmanuel Saez and Gabriel Zucman, economic researchers at the University of California, Berkeley, found that the share of all wealth owned by the richest 0.1% of Americans has grown from 7% in 1978 to 22% in 2012.

Until recently, many Americans seemed not to know or care about the growing divide in income and wealth. Even at the height of the so-called Great Recession in 2009, only 47% of Americans polled by Pew Research agreed that there were “very strong” or “strong” conflicts between the nation’s rich and the poor. By late 2011, that figure had grown to 66%. Since then, income inequality has become a regular topic of political debate and public discourse.

Many observers attribute the increasing focus on wealth and economic inequality to the Occupy Wall Street movement that began in New York City’s Zuccotti Park in September 2011 and spread to cities and towns across the country. Although the protestors were derided at the time for not outlining a clear platform of demands, their efforts to provoke public discussion about income inequality and the divide between the 99% and the 1% has had a lasting impact.

Less than a year later, in November 2012, approximately 200 fast food workers in New York went on strike, demanding a $15 minimum wage in what was then the largest labor action in the industry. The “Fight for 15” movement grew from there, holding strikes and walk-outs, filing lawsuits over wage theft, and generally keeping the issue of income inequality prominent in the media. On April 15, 2015, roughly 60,000 workers in more than 200 cities across the United States took part in the largest coordinated protest by low-wage workers in history. By then, the movement had grown beyond the fast food industry to include home-care workers, child-care staff, security guards and anyone who earned less than what they considered to be a living wage.

As of mid-2015, Seattle, San Francisco and Los Angeles have begun phasing in a $15 minimum wage. Democratic presidential candidate Sen. Bernie Sanders introduced Congressional legislation to raise the federal minimum wage to $15 per hour. What was once considered inconceivable has become more and more commonly accepted as a necessary and even moral imperative for many American businesses.

Given an informed choice, they found consumers would prefer to purchase from firms with relatively low CEO-to-median-worker pay ratio such as 5:1 or even 60:1, as opposed to firms with high ratios such as 1000:1.

The Risks of the Pay Ratio Disclosure Rule

A recent online presentation by business law firm Dorsey & Whitney LLP and Cam Hoang, senior counsel and assistant corporate secretary at General Mills, examined many of the risks public companies face as a result of the SEC’s new pay ratio disclosure rule. At the most obvious level, Dorsey & Whitney predicts that companies with high ratios between CEO and median worker pay may see negative consequences related to media coverage and public relations. The compensation for the CEOs of public companies is already disclosed in SEC filings, and such disclosures have led to negative attention for companies with highly-compensated executives. For example, the AFL-CIO reports that one of the most highly-trafficked sections of its website it its Executive PayWatch page, which names the 100 most highly-compensated CEOs in America alongside testimonials from low-wage workers at their companies. Similarly, California-based nonprofit As You Sow recently published a report entitled The 100 Most Overpaid CEOs: Executive Compensation at S&P 500 Companies. Apart from potentially influencing public opinion, the AFL-CIO, As You Sow and like-minded organizations also lobby institutional investors, such as mutual and pension funds, to closely examine executive compensation data for their stock holdings as a measure of shareholder value. This attention will only increase as information about the relative compensation of public companies’ median employees becomes public.

Beyond the public relations implications, Dorsey & Whitney also noted potential employee-related issues for firms with low median employee pay, such as reduced morale and a negative impact on hiring and retention. While pay is often a taboo subject among co-workers, disclosing the median compensation for workers at any firm will inevitability lead employees to compare themselves against that measure. Particularly for those who fall below the median, this information may hurt morale and productivity, and even lead some to seek employment elsewhere if they feel the median compensation is too low to justify putting more time and effort toward moving up in the organization. Conversely, morale may be boosted among those employees who are paid above the median thanks to their improved understanding of their value within the organization.

Finally, it remains an open question how the public will be affected by this information. In a recent working paper, Harvard Business School researchers Bhavya Mohan, Michael Norton and Rohit Deshpande found in six separate studies that pay ratio disclosure can indeed affect the intentions of consumers. Given an informed choice, they found consumers would prefer to purchase from firms with relatively low CEO-to-median-worker pay ratio such as 5:1 or even 60:1, as opposed to firms with high ratios such as 1000:1. Lower CEO-to-median-worker pay ratios also improved consumer perceptions of products at different price points as well as their ratings of the firm’s warmth and competence. Further, the researchers found that firms with a high CEO-to-median-worker pay ratio must offer a 50% price discount to achieve the same customer satisfaction that a firm with a low ratio achieves at full price.

From negative publicity to reduced investor stock valuation, and from reduced employee morale to diminished customer opinion, it appears that the increased social focus on income inequality from the SEC’s pay ratio rule may have significant potential risk management implications for public companies.

Mitigating Pay Ratio Disclosure Risks

Given that the ever-increasing disparity between executive and worker pay is such a widespread phenomenon, risk managers at individual companies might be at a loss to imagine what they alone can do to address the issue. Fortunately, experts in the field have already begun to weigh in.

Eleanor Bloxham, founder and CEO of The Value Alliance, an advisory firm for multinational public companies and private start-ups, provided a comment letter to the SEC supporting the pay ratio disclosure rule as an important development for both investors and companies. She acknowledged the risks of the new rule for public companies, but also suggested its implementation could be an opportunity for corporate leaders to reexamine their compensation strategies for the long-term benefit of their employees and shareholders.

Because the SEC rule requires the calculation of total compensation including benefits, Bloxham suggested that companies could increase employee stock ownership as a method to boost the compensation of the median worker. Even more important, she said, corporate leaders need to begin to understand how their employees actually live in order to better inform decision-making about compensation.

One unconventional way to increase this understanding would be to take a note from the Undercover Boss television show where executives work alongside low-level employees, Bloxham said. In her experience, too many companies have gotten away from the age-old strategy of “management by walking around.” Crucially, she noted, “communication at the workers [regarding compensation] is not going to get anywhere. Instead, we need communications that begin with understanding and learning from the workers, and with the workers.”

For a company with a higher CEO-to-median-worker compensation ratio, there is no easy answer to how it will mitigate the risks to its reputation, stock value, employee morale and customer opinion. One thing risk managers can agree upon is that the time to begin addressing these issues is now, rather than in 2017.

The Broader Implications for All Organizations

Perhaps the greatest risk to American organizations regarding income inequality is the greatest unknown: How far will the public take its concern? What began as the rallying cry of an encampment of disenfranchised people in New York City has gone on to propel one of the largest labor movements in recent memory and has imbedded itself into the consciousness of Americans of all races, classes and creeds. The unfairness of the current economic system is no longer just a discussion topic in universities and coffee shops, but in factories and on the streets of every American city.

While the SEC’s pay ratio rule only directly impacts public companies, privately-held organizations should consider the likelihood that their stakeholders and customers may begin asking for this information as well. As the Fight for 15 movement continues to have success, employers offering less to their workers may rightly wonder how that decision will affect their reputation in their communities and among their own employees.

All indications are that discussions around income inequality and specific proposals such as the $15 minimum wage will only increase as the 2016 election season ramps up. Corporate leaders must therefore begin intentionally addressing the related risks, or risk joining Dunkin’ Brands’ Nigel Travis in the world of internet infamy.

 

More articles by »

About the Author

Will Kramer, CSP, CPCU, ARM-E, ARM-P, is an independent risk management consultant and freelance writer.

 
 
 

Leave a reply

required

required

optional