No Muda in Aisle 7

The furor surrounding executive pay usually centers on either the (gross) disconnect between performance and pay or the somewhat vaguer feeling that it's (grossly) unethical for the average CEO to be making  so much money.

But there's a lean perspective to the argument for lower CEO pay as well.  Stratospheric compensation for top executives, as well as the CEO, undermines a sense of community and shared commitment to the company, which in turn erodes employee loyalty and increases turnover.  And that's waste, pure and simple.

The Wall Street Journal today ran an article on executive pay at Whole Foods Market.  The company raised the cap on executive salaries to 19 times average pay in order to retain its top talent:

The increase was needed "to help ensure the retention of our key leadership," Chief Executive John Mackey wrote in a Nov. 2 message to employees.  Mr. Mackey said every top executive, except him, had been repeatedly approached by search firms seeking to lure them to rivals.

Notwithstanding the increase in the salary cap, the company's top six executives hit the maximum, and had to forfeit as much as $237,000 for which they were eligible under a bonus program.  Mackey's total compensation in 2005 was around $2.7 million, about 96 times the average worker. (According to the Institute for Policy Studies, in 2005 the average big company CEO made 411 times the typical US worker.) 

You'd think that with such a low compensation ceiling -- and with real, quantifiable lost income -- executives would be leaving in droves.  But they're not:

Executives say they stay for other reasons.  The company prefers to promote from within, so executives tend to be loyal veterans.  Whole Foods' top 25 executives have an average tenure of 18 years, and a 2% annual turnover rate. . . .  [The company's] corporate culture is another draw.  Paula Labian, vice president of human resources, says the company's egalitarian philosophy -- all employees vote on their benefits packages every three years -- and its many social-welfare and environmental projects keep her there, despite offers of twice as much in pay. 

Think of the muda that Whole Foods reduces with their policy: they don't squander shareholder money on gargantuan pay packages, they don't lose talented managers, and they don't lose critical institutional experience and know-how.  (For contrast, think about Home Depot and its former CEO, Bob Nardelli.)

Would this approach work everywhere?  I doubt it.  It's hard to image lower pay flying in a Wall Street investment bank.  But it does work for Whole Foods, and would probably work for other companies as well.  If nothing else, the sense of egalitarianism would go a long way towards improving relationships between management and staff in the Detroit, where top brass seems to go out of their way to irritate the UAW; check out Mark Graban's excellent comments here.)

Next time you hear about a company's board of directors claiming that they had to provide their CEO with a staggering pay package, think about what the real cost to the company might be.

Comments

[Dawn McGhan]

Whole Foods has an admirable policy, but it very dependent on leadership development that creates bench strength at the same rate as company growth. That's tough to pull off, especially if a company is growing fast. If they had to recruit from the outside, I doubt they'd have many takers who voluntarily reduce their salaries. Having it not increase "equitably" is one thing, but having it reduced is another.

I personally have no problem with "humongous" pay packages as long as they are generating even greater company performance. How is it any different from a baseball player that earns multiples of what even highly-paid CEO's make? Both create value for the organization and their customers as long as performance exceeds compensation.

[Thomas Sortino]

Nice post, Dan. Whole Foods is a great place to shop, and looks good on paper, but this is the first time I have seen data on the turnover rate - very impressive! I wonder if the that rate is similar at all levels? When looking at the imbalance in compensation, it is tempting to go for the 'quick fix' and legislate something, but it is much more effective, if slower, to get people thinking along the lines of 'how does a pay ration of 411:1 show respect for my employees?'