Peter Drucker Advocated a Ratio of 20 to 1 for CEO to Average Worker Pay

By John Hunter, author of the Curious Cat Management Improvement Blog (since 2004).

Dr. Deming didn’t directly address executive pay as far as I know. Executives were paid well and without much detrimental impact on companies historically. In the 1980s many CEOs started treating corporate treasuries as personal bank accounts and problems exploded. Peter Drucker had no issue with high and reasonable CEO pay, as things became more and more abusive he spoke out more and more strongly about the damage being done by CEOs and those allowing such behavior. Since that time things have progressively and dramatically worsened as pay for senior executives exploded.

Rick Wartzman, Executive Director of the Drucker Institute, wrote, in 2011, to the Securities and Exchange Commission in support of requiring public companies to disclose the pay of their typical worker compared to the pay of their chief executive.

When it came to the relationship between a CEO’s pay and that of the average worker, Drucker advocated a ratio around 25 to 1 (as he suggested in a 1977 article) or 20 to 1 (as he expressed in a 1984 essay and several times thereafter). Widen the pay gap much beyond that, he said, and it makes it difficult to foster the kind of teamwork and trust that businesses need to succeed.

“I have often advised managers that a 20 to 1 salary ratio is the limit beyond which they can not go if they don’t want resentment and falling morale to hit their companies,” Drucker explained (At last year’s World Economic Forum in Davos, Switzerland, those looking to cap runaway CEO pay came to refer to the 20 to 1 mark as “the Drucker principle.”)

In a 2004 interview, Drucker elaborated further: “I’m not talking about the bitter feelings of the people on the plant floor… It’s the midlevel management that is incredibly disillusioned” by king size CEO compensation.

I agree with Drucker’s reasoning and the Drucker Institute’s continuing to take a stand against the bad practice of so many CEOs today. If someone wants a lot of money to lead your organization and they are qualified, fine. If they won’t run your organization for less than a king’s ransom find someone who is more interested in leading your organization than in treating it as their personal bank account.

It is hard to know how strongly Dr. Deming would feel about the problems caused by the current epidemic of overpaid executives. I feel strongly he would have vigorously objected to the damage being done to corporations and the management system by such practices. But that is my opinion, and it is possible I am wrong. Though I don’t know of any prominent Deming practitioners that support the current practices.

I have written about the problems caused by such practices over the years. In fact, I include it in what I call the 2 new deadly diseases: extremely excessive executive pay and the broken patent and copyright systems.

I do not feel you can have respect for employees while taking extremely excessive executive pay packages. The thinking behind a few people deserving much of the reward doesn’t reflect the principles of Deming’s management system or any thought to valuing contributions of everyone. Saying you value people while you take enough to build yourself several castles has to be seen as false praise.

As I wrote in 2005, Excessive Executive Pay:

The excesses are so great now they will either force companies to:

• take huge risks to justify such pay and then go bankrupt when such risks fail (and some will succeed making it appear, to some, that the pay was deserved rather than just the random chance of taking a large risk and getting lucky).
• make it impossible to compete with companies that don’t allow such excesses and slowly go out of business to those companies that don’t act so irresponsibly
• hope that competitors adopt your bad practice of excessive pay (this does have potential as most people are corrupted by power, even across cultural boundaries). However, my expectation is the competitive forces of capitalism going forward are going to make such a hope unrealistic. People will see the opportunity provided by such poor management and compete with them.

As long as the pay packages were merely large, and didn’t effect the ability of a company to prosper that could continue (slicing up the benefits between the stakeholders is not an exact science). The excesses recently have become so obscene as to become unsustainable.

CEOs have created an industry in apologizing for such excessive pay and for paying large amounts to those on board with the understanding they go along with such massive pay. Even Warren Buffett, when he found Coke’s pay package unduly excessive, his son didn’t vote against it.

Buffett also noted during the interview how difficult it can be to sit on company boards and oppose a pay plan. His son, Howard Buffett, serves on Coke’s board and supported the pay plan. Buffett said that he has never heard anyone speak out against a compensation committee’s plan in 55 years of serving on company boards.

“Taking them on is a little bit like belching at the dinner table. You can’t do it too often,” Buffett said. He added that he’s voted in favour of compensation plans he hasn’t agreed with in the past.

When one of the 3 richest people on the planet, representing a company (Berkshire Hathaway) that has owned a huge portion of the company (Coke, in this case but also in many others) for decades feels it is impossible to even question pay packages you can certainly see how well CEOs have arranged things to take whatever they want. Only when the abuse so so massive that huge publicity was brought on Coke and the weak way in which Warren Buffet had allowed shareholders to be so poorly treated did he finally put on pressure to reduce how excessive the plan would be. This illustrates how badly they system is working now.

Please share your thoughts on the topic and if you have an opinion on if massively large pay practices (say 100 times median pay for a CEO) are contrary to Deming’s management system. We are well past 100 times now, by the way. And that level is already 5 times worse than Peter Drucker advocated for.

Related: Toyota Post Record Profit: Splits $15 million in Pay and Bonus for top 21 Executives (2014) – “Too often, executive compensation in the U.S. is ridiculously out of line with performance” Warren Buffett – Executives Again Treating Corporate Treasuries as Their Money (2011) – Massively Unjust Executive Compensation Damages Companies and Investments (2012) – CEOs Plundering Corporate Coffers (2008) – More Evidence of the Damage Done by Kleptocrat CEO Pay (2014) – Losses Covered Up to Protect Bonuses – “Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior.” Warren Buffett 2010 Letter to shareholders. – CEO’s Castles and Company Performance (2009)