Last year, the typical American family earned $51,939, while the average CEO made $22.6 million. What accounts for the glaring discrepancy? Investopedia breaks down the numbers. (Related: A Guide To CEO Compensation)

Reality check - Are CEO salaries really that high?

CEO salaries can appear to be mind-boggling, but keep in mind: cash payouts make up just a fraction of actual earnings. According to a Hay Group survey of 50 major companies, only 37% of CEO salaries were rendered in cash, with 54% coming in the form of stocks and options. (Perks and pensions made up the remainder.) And in a broader survey of 300 companies, Hay Group reported the following:

  • Base Salary: 14%
  • Bonus/Annual Incentive: 22%
  • Stock Options: 16%
  • Restricted Stock: 16%
  • Performance Awards: 32%

Here, stock options, restricted stocks, and performance rewards, and bonuses made up 86% of the average CEO’s compensation package. Granted, the numbers may look astronomical. But keep in mind: they’re closely tied to long-term incentives and concrete results. (Related: CEO Benefits You Wish You Had)

Nevertheless, the average base salary (14% of $22.6 million) still amounts to $3.164 million—which is 60 times more than the average American household brought in last year. How can those earnings be justified? For starters, let’s consider the targets involved and factor in the dearth of qualified candidates: 

  1. High Performance Benchmarks: Chief executives do not have it easy. The CEO is a one-man (or, much less frequently, one-woman) army, tasked with extremely difficult mission objectives. These may involve the quick turnaround of loss-making companies, rapid expansions to new, global markets, basic shifts from old business models and exhausted revenue streams, and the transformation of private companies working towards an IPO. Before they do anything else, would-be CEOs have to sell the Board of Directors on their vision. They must make existential risks seem necessary, as well as palatable. To clear the bar, they’ll need to exhibit a rare combination of confidence, experience, strategy, and drive—and the learning curves involved can be impossibly steep. (See related: Highest-Paid CEOs)
  2. The Great Man Theory: Superstar CEOs like Jack Welch (GE) and Steve Jobs (AAPL) became synonymous with the brands they represented. Their human capital was an enormous resource, which they leveraged to transform their businesses, generate unheard-of profits, and produce deep, innovative, industry-wide changes. It’s almost impossible to estimate the true worth of this kind of CEO. (Related: What CEOs Actually Do - Video)
  3. The Role Of Executive Hiring Firms: CEO hires are often outsourced to executive search firms—companies that command significant commissions, recouped as a percentage of hiring agreements, for the referral of eligible candidates. This industry standard encourages high payouts, even as the involvement of hiring firms leads to attrition at the highest levels. The cycle lends itself to upwardly-spiraling salaries.
  4. Regulations on CEO Salaries: Industry regulations allow for a great deal of flexibility in regards to pay-package structures, performance benchmark assessments, and other factors which work in the CEO’s favor. There’s more than one way for boards to up their offers when competing for top-tier candidates. 
  5. Salary Decision Makers: More often than not, a board decides the CEO’s salary. But CEOs themselves tend to sit on the boards of other companies, resulting in peer-to-peer situations (akin to the revolving doors between Congress and K Street) that lead to high payouts.
  6. Peer Company Comparisons: CEO payouts are benchmarked against industry standards, so that high offers, or over-inflated ones, on the part of any one corporation, have the effect of raising the ante for all other bidders.
  7. Regulations And Company Policies: Company policies and restrictions on eligibility may shrink the pool of available candidates down to a fishbowl. For example, a policy mandating 20 years of relevant experience, in a small or tightly-controlled industry, might narrow the list of prospective CEOs down towards the single digits, and drive compensation packages through the roof.
  8. Instant Situations: Sudden developments (which might include scandals, unplanned resignations, and the death of sitting CEOs) may cause the need to fill a position overnight. If no eligible successor exist within the company, the incoming CEO might be free to write her own ticket.

The Bottom Line

Critics argue that CEO salaries are indefensibly high. But for companies doing the hiring, the stakes couldn't be higher. Competition for top-tier talent is remarkably fierce, and CEOs expect to be compensated for their experience, their vision, their leadership abilities, and their total, around-the-clock dedication to short-term goals and long-term objectives. Regulations and industry standards may change in the future, and stockholders will continue to demand accountability. But executive officers who see around corners and deliver concrete results will always be rare and, in a real sense, invaluable.          

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