Any day now, expect the AFL-CIO to produce another hugely inflated CEO-to-worker pay ratio, debunked in advance

“…Bottom Line: The AFL-CIO can only get a distorted and wildly inflated CEO-to-worker pay ratio of something like 360-to-1 every year with a flawed apples-to-oranges analysis that compares the total annual compensation of a small, select group of CEOs in their prime earning years heading America’s largest multi-national corporations, who probably typically work 50-60 hours per week or more, to the average annual cash wages of part-time rank-and-file employees who work less than 34 hours per week on average, often for small companies that aren’t anywhere close to the size of S&P 500 companies. According to this 2015 report from Business Insider, S&P 500 companies employ only 17% of workers in the US, so it’s not really fair to compare the salaries to S&P 500 CEOs to all of the rank-and-file US workers, since a large of majority of those workers aren’t employed by large multinational companies in the S&P 500.Once we make a more statistically valid apples-to-apples comparison, the CEO-to-worker compensation ratio falls by two-thirds from the AFL-CIO’s expected 364.5-to-1 ratio to 124-to-1 once we consider total (median) compensation for both CEOs and full-time (40 hours per week) rank-and-file workers employed by companies with 500 or more workers. If we assume a 60-hour work week for the average worker (to be comparable to the workweek of an average CEO), the CEO-to-worker compensation ratio falls by two-thirds to only 83-to-1 for median CEO pay. Further, even if we could confiscate 100% of the compensation of all S&P 500 CEOs, the typical rank-and-file worker would probably get about $1.34 per week in additional after-tax earnings. Big deal….”

Mark Perry, "Any day now, expect the AFL-CIO to produce another hugely inflated CEO-to-worker pay ratio, debunked in advance," American Enterprise Institute, May 20, 2019, https://www.aei.org/carpe-diem/its-that-time-of-year-expect-afl-cio-to-produce-another-hugely-inflated-ceo-to-worker-pay-ratio-any-day-debunked-in-advance-2/

Any day now, expect the AFL-CIO to produce another hugely inflated CEO-to-worker pay ratio, debunked in advance

Ahead of this year’s annual AFL-CIO report on executive pay, the Wall Street Journal last week published its second new annual report on CEO compensation in 2018 for the S&P 500 companies along with several related articles here and here. Therefore, like last year, I’m able to preempt the AFL-CIO and publish a rebuttal to its anticipated massively inflated 360+ CEO-to-worker pay ratio before its analysis is released, instead of responding to their report after it has gone public and gets widely and blindly reported by the media without anyone (except John Merline of IBD in 2015 ) ever questioning “the statistical legerdemain used to produce it” (see below).

As I have reported annually every May since 2014, here is a summary of the main flaws in the “methodology” used by the AFL-CIO to produce its wildly inflated 360+ CEO-to-worker pay ratios year after year:

The AFL-CIO uses the mean (average) CEO compensation figure each year, which is always much higher than the more realistic and more typical median CEO compensation. Based on the Wall Street Journal‘s CEO pay database in 2017, the mean compensation for S&P 500 CEOs was $13.5 million, which was 13.4% higher than the more realistic median pay of $11.9 million for the typical CEO in that year. For 2018, the Wall Street Journal is reporting that the median compensation for S&P 500 CEOs last year was $12.4 million, a 4.2% increase from the median compensation in 2017. (The Wall Street Journal did not provide a complete database of CEO compensation for 2018, so it’s not possible to report the mean compensation this year for S&P 500 CEOs using WSJ data.)
Applying the 4.2% increase in median pay in 2018 for median compensation, I predict that the AFL-CIO will be reporting average CEO compensation in 2018 of something like $14.5 million (it reported $13.94 million for CEO compensation in 2017, which was higher than the $13.5 million average according to the Wall Street Journal). In that case, the expected average CEO compensation reported by the AFL-CIO of $14.5 million will be about 17% higher than the more realistic compensation of $12.4 million for a typical S&P 500 CEO as reported by the WSJ using median pay.
The AFL-CIO compares total CEO compensation (base salary plus all additional forms of compensation including cash bonuses, stock awards, option awards, pension benefits, etc.) for executives in their prime earning years managing the world’s largest corporations to cash-only pay for part-time rank-and-file workers of all ages working for companies of all sizes (including small grocery stores, independent small restaurants, etc.).

The analysis below summarizes my corrections for those statistical flaws above that are used by the AFL-CIO annually to get an exaggerated, inflated CEO-to-worker pay ratio:

In previous years, the AFL-CIO reported the methodology it uses to calculate annual worker pay as follows:

The average annual income earned by rank-and-file workers is taken from the U.S. Bureau of Labor Statistics Current Employment Statistics survey. Specifically, it is the average hours and earnings of production and nonsupervisory employees on private nonfarm payrolls. The average weekly pay is multiplied by 52.

Based on the AFL-CIO’s methodology, here’s how average worker pay will be updated and calculated for 2018. The AFL-CIO will use an average hourly wage of $22.70 for production and non-supervisory workers last year (BLS data here) and an average workweek of only 33.7 hours (BLS data here) for the average rank-and-file worker. Assuming 52 weeks of work per year: $22.70 per hour x 33.7 hours per week x 52 weeks ≈ $39,779 average annual cash-only earnings for the typical part-time worker in 2018. Conveniently, the fringe benefits that all rank-and-file workers, even part-time workers, receive as part of their total compensation are always completely ignored by the AFL-CIO.

Therefore, the AFL-CIO engages in some questionable statistical chicanery by sloppily reporting an apples-to-oranges comparison of: a) total CEO compensation for only about 500 CEOs working full-time in their prime earning years to b) the cash wages only for 1o4.3 million rank-and-file workers of all ages working for companies of all sizes, who work an average of less than 34 hours per week, and are therefore working part-time, not full-time, on average. But you would never know that from the AFL-CIO’s website because the average hourly pay and average hourly workweek of rank-and-file workers are never reported, and I guess nobody has ever bothered to check to find out that the AFL-CIO is using average annual cash-only income (excluding fringe benefits) for a mix of full-time and part-time employees whose average workweek was only 33.7 hours last year.

For 2018, the CEO-to-worker pay would be about 312-to-1 ($12,400,000 ÷ $38,640) comparing the Wall Street Journal‘s reported median compensation of $12.4 million for S&P 500 CEOs to the annual cash wages for part-time workers using the AFL-CIO’s methodology, see graph above. Assuming that the AFL-CIO reports average CEO compensation of $14.5 million in 2018, we can expect its new forthcoming CEO-to-worker pay ratio to be around 364.5-to-1 for 2018 (see graph above), slightly higher than the 361-to-1 ratio it reported for 2017. Using a more realistic estimate of the compensation for an S&P 500 CEO (median instead of mean) reduces the CEO-to-worker pay ratio by more than 14%. But that’s not the most important correction to make, so let’s now adjust for hours worked and add fringe benefits for rank-and-file workers to make a more accurate comparison since CEO pay is based on total compensation including all fringe benefits.

Questions: a) How would the CEO-to-worker pay ratio change if we: a) calculate average worker pay for full-time workers, b) compare the average pay for a rank-and-file worker who works the same number of hours that a typical CEO works, e.g., 50 or 60 hours per week, c) compare total compensation of both CEOs and rank-and-file workers working full-time including fringe benefits for the rank-and-file, and d) consider only those workers who are employed by companies with 500 or more workers to consider the workers most likely to actually work for an S&P 500 company? The graph above summarizes how the CEO-to-worker pay ratio would change, here are the details:

1. Correcting for the AFL-CIO’s Statistical Shortcomings/Legerdemain

a. Using the WSJ data, a typical S&P 500 CEO earned $12.4 million last year. Assuming a 40-hour workweek for full-time workers employed by private companies with 500 or more workers, who received average hourly compensation of $49.85 last year including fringe benefits (BLS data here, Table 8), and annual total compensation of $99,700, we would get CEO-to-worker compensation ratio of only 124-to-1, or less than half of the previously calculated 312-to-1 ratio. In other words, expect the AFL-CIO’s CEO-to-worker pay ratio to be conveniently inflated again this year by a factor of more than 2X by using cash wages only for part-time workers and comparing it to the total compensation for S&P CEOs! Talk about bogus statistical chicanery! And year after year, the media never questions the AFL-CIO’s totally flawed methodology and parrots the inflated and wildly exaggerated CEO-to-worker pay ratios.

b. Since we can realistically assume that no S&P 500 CEO works only 40 hours per week, let’s assume a 50-hour workweek for full-time rank-and-file workers to make a more realistic comparison, and use hourly compensation of $49.85 like above and annual total compensation of $124,625 for workers employed by companies with 500 or more employees. That would result in a CEO-to-worker compensation ratio of only 99.5-to-1 see graph above.

c. To make it an even more realistic comparison to the average workweek of an S&P 500 CEO, let’s assume a 60-hour workweek for full-time rank-and-file workers and annual total compensation of $114,348 we would get CEO-to-worker compensation ratios of 83-to-1.

Conclusion: By considering both total compensation (including fringe benefits) for both CEOs (and using median CEO pay) and rank-and-file workers working for large companies with more than 500 workers, and by considering longer workweeks for rank-and-file workers that would be more comparable to the hours worked by a typical CEO of a major multi-national corporation in the S&P 500, we can get a more accurate apples-to-apples comparison. Those more accurate comparisons result in CEO-to-worker compensation ratios of between 124-to-1 (for rank-and-file workers averaging 40-hour workweeks) to as low as 83-to-1 for rank-and-file workers putting in 60-hour weeks that might be the most comparable to the workweek of a typical S&P 500 CEO.

Let’s keep this analysis in mind in the coming weeks when the AFL-CIO’s reports something like last year’s 361-to-1 CEO-to-worker pay ratio that will generate sensationalized media coverage even though it is hugely exaggerated by a factor of more than 2X and probably more realistically inflated by a factor of more than 4-to-1!

2. Confiscation and Redistribution of CEO Pay

And what’s the whole point of the AFL-CIO’s annual reports on wildly inflated CEO-to-worker pay ratios? The sub-title of the AFL-CIO’s Executive Paywatch report in 2017 pretty much sums it up: “More for Them, Less for Us.”

The AFL-CIO’s message seems to be that if CEOs weren’t being so generously over-compensated, then the rank-and-file workers would be doing much better and making higher wages. For example, according to the AFL-CIO in 2015:

America is supposed to be the land of opportunity, a country where hard work and playing by the rules would provide working families with a middle-class standard of living. But in recent decades, corporate CEOs have been taking a greater share of the economic pie while workers’ wages have stagnated.

The AFL-CIO has fallen here hook, line and sinker for the zero-sum, fixed pie fallacy, one of the most common economic mistakes that falsely assumes that there’s a static fixed pie and therefore one party can gain (get a bigger slice) only at the expense of another (who’s left with a smaller slice). But let’s assume that there is a “fixed pie of wages” and do some confiscation and redistribution of CEO compensation to see how that would affect average rank-and-file worker pay.

Q: If the average CEO of an S&P 500 company received $14.5 million last year, then as a group, those 500 CEOs received about $7.25 billion in total compensation in 2018. If the AFL-CIO could wave a magic wand and confiscate that entire amount and redistribute $7.25 billion to the current 104.3 million rank-and-file workers, what would each one get?

A: An annual increase in pay of $69.50 for each rank-and-file worker before taxes, or about $1.34 more per week and about only 3 cents per hour. In other words, complete confiscation and redistribution of S&P 500 CEO compensation would make almost no difference for the average rank-and-file worker.

Bottom Line: The AFL-CIO can only get a distorted and wildly inflated CEO-to-worker pay ratio of something like 360-to-1 every year with a flawed apples-to-oranges analysis that compares the total annual compensation of a small, select group of CEOs in their prime earning years heading America’s largest multi-national corporations, who probably typically work 50-60 hours per week or more, to the average annual cash wages of part-time rank-and-file employees who work less than 34 hours per week on average, often for small companies that aren’t anywhere close to the size of S&P 500 companies. According to this 2015 report from Business Insider, S&P 500 companies employ only 17% of workers in the US, so it’s not really fair to compare the salaries to S&P 500 CEOs to all of the rank-and-file US workers, since a large of majority of those workers aren’t employed by large multinational companies in the S&P 500.

Once we make a more statistically valid apples-to-apples comparison, the CEO-to-worker compensation ratio falls by two-thirds from the AFL-CIO’s expected 364.5-to-1 ratio to 124-to-1 once we consider total (median) compensation for both CEOs and full-time (40 hours per week) rank-and-file workers employed by companies with 500 or more workers. If we assume a 60-hour work week for the average worker (to be comparable to the workweek of an average CEO), the CEO-to-worker compensation ratio falls by two-thirds to only 83-to-1 for median CEO pay. Further, even if we could confiscate 100% of the compensation of all S&P 500 CEOs, the typical rank-and-file worker would probably get about $1.34 per week in additional after-tax earnings. Big deal.

When it’s released, the 2018 CEO-to-worker pay ratio reported by the AFL-CIO gets my annual “Biggest Blindly Accepted Statistical Fairy Tale of the Year Award.” Well no, it’s actually a tie with the gender wage gap myth and the incessantly repeated “77 cents on the dollar” statistical falsehood. What’s disappointing is that much of the mainstream media seem to blindly accept both of these statistical falsehoods without ever challenging the “statistical legerdemain” that are used to produce and perpetuate these statistical myths. One exception was this excellent article in 2015 by Investor’s Business Daily’s John Merline, (“Do CEOs Make 300 Times What Workers Get? Not Even Close“) who concluded:

What’s not understandable is why the mainstream press keeps repeating the massively inflated 300-to-1 number without noting the statistical legerdemain that produced it.

MP: Post will updated appropriately once the AFL-CIO releases its Executive Paywatch 2019 report based on 2018 data.