Excessive CEO pay has become a flashpoint in the debate over growing wealth inequality. While company executives amass billions, the gap between their salaries and those of average workers continues to grow. This disparity is a key consideration for Triodos Investment Management (Triodos IM) when selecting and engaging with companies, say investment analysts Lilia Feghiu and Fabian Meijs.
“In our recently updated paper about excessive remuneration we show that the gap between CEO compensation and employee wages has grown significantly,” says Fabian Meijs. In 1978, a typical CEO earned roughly 30 times more than the median employee. By 2023, that number had ballooned to over 300 times. “This imbalance is increasingly difficult to justify and leads to all kinds of undesirable side effects,” he continues.
This trend appears unstoppable, with Musk’s eye-popping compensation package of USD 56 billion serving as the latest example. “Is it ethical for one person to have so much more money and power? A CEO deserves to be paid well for good performance, but it shouldn’t spiral out of control, especially when it contributes to greater wealth inequality,” Fabian Meijs argues. “In the case of Tesla, we decided a few years ago not to invest in the company because of what we then already thought was an excessive pay rate.”
The alarming rate of wealth inequality
The stark disparity between CEO pay and the average worker’s salary can create tension within a company, but unjustifiable income differences also reverberate through society. Fabian Meijs explains: “CEOs build generational wealth, passing it on to their children and grandchildren, who typically attend private schools and receive the best job opportunities. By contrast, the children of employees usually do not have the same advantages.”
“The growing wealth gap is increasingly seen as a serious challenge to social cohesion and our democratic institutions,” adds Lilia Feghiu. “Inequality is not just an economic issue but very much a social and political one.”
Remuneration packages should challenge a CEO
According to Lilia Feghiu, the focus should not solely be on the absolute level of CEO pay but also on the structure. “An executive should be paid based on their performance according to clear criteria, not just for holding the position. A CEO must be incentivised to grow the business and support long-term goals like sustainable growth, return on investment and climate policies. These criteria should be integrated into the remuneration structure with a long-term view.”
Bonuses for short-term goals, like a certain share price level, do not support long-term growth. Lilia Feghiu: “Apart from the fact that the share price can only be controlled by the management to a very limited extent, it entirely lacks a long-term perspective.” Short-term stock-related bonuses may tempt CEOs to take on excessive risks that could harm the company and ultimately destroy shareholder value.
Fabian Meijs points out another potential danger for shareholders. “In Tesla’s case, the proposed compensation package was in the form of newly issued shares, which dilutes the stake of existing shareholders. I find it odd that so many shareholders approved the package – was it just to ensure Musk’s focus remained on Tesla?”
The growing role of ESG metrics
A long-term approach to executive compensation should also incorporate environmental, social and governance (ESG) factors. While some companies have begun integrating these metrics into their incentive plans, these measures are often insufficient and do not drive meaningful change.
Triodos IM has been pushing to integrate ESG factors into executive pay structures. “Any reward structure should be based on ESG metrics,” Lilia Feghiu emphasises. “We want executives to focus on long-term, sustainable value creation – not just the next quarterly report.”
Progress is being made. Lilia Feghiu observes: “More than five years ago, it was almost unheard of to include ESG metrics in a structured way. That has changed. We now see that companies are also starting to include ESG metrics in their long-term plans. This is exactly what we want to see, if only because most ESG issues cannot be solved on an annual basis. Now, we have to safeguard that metrics are effective and measurable and contribute to real change.”
Call to action to investors
Triodos IM has been actively addressing these issues by engaging with companies in its Impact Equities and Bond portfolios to ensure that remuneration packages are more equitable and sustainable. “We’ve had success with companies, such as Besi, where we’ve pushed for change,” says Fabian Meijs. “By setting limits on CEO pay and ensuring that relevant ESG goals are incorporated into incentive structures, we can make a difference.”
Triodos IM uses a rigorous framework to evaluate CEO pay, taking into account both the level of remuneration and the structure of the compensation package. For example, companies with excessive absolute pay and a size-adjusted CEO-to-median employee pay ratio above 100:1 are flagged for further engagement. Fabian Meijs explains: “Of course, we also consider the size of the company. For the largest companies we could accept a pay ratio of up to 250:1.”
In addition to setting clear thresholds, Triodos IM engages with companies to ensure their pay structures align with long-term goals. “If a company refuses to engage with us, we simply won’t invest,” Lilia Feghiu says. “It’s about choosing companies that not only have a positive impact but are also committed to responsible governance.”
Triodos IM urges investors to step in before the consequences of unchecked pay policies become irreversible. It’s time for shareholders to demand a more equitable, performance-driven approach to executive compensation - an approach that aligns with the ESG and impact policies of many institutional investors. “It is sufficiently clear that extreme levels of income inequality hinder economic growth, destabilise society and are unethical,” Fabian Meijs concludes. “If investors make their voices heard, change can happen.”