The Wealthy Employee: Why Money Ought to Go Below the CEO

6th in a series of excerpts from the book The HIP Investor (John Wiley & Sons, 2010). See other articles in the series here.

Healthy, wealthy and wise, said Ben Franklin. Leading companies seek out strategies to build wealth and health for employees, typically resulting in higher customer satisfaction and productivity. The last feature highlighted Health. Wealth is the second metric in our discussion of the five categories of quantifiable metrics that can drive financial performance (Health, Wealth, Earth, Equality, and Trust). Leading companies boost the income and assets of their employees, resulting in stronger financials for everyday employees and for their long-term bottom line.

Three Core Metrics to Building Employee Wealth

There are three groups of quantifiable metrics a HIP investor can use to evaluate companies on Wealth:

1. How a firm provides for employees’ savings and retirement
2. The level of employee pay relative to industry peers
3. The CEO’s compensation relative to average staff pay

1. Wealth Building and Matching for All Staff

For customers to be truly satisfied, employees need to consistently perform well; and to achieve that, employees must be satisfied with their employers. HIP companies seek to align their goals with employee goals through wealth-matching programs. These programs can vary from pensions, to 401(k) matching, to access to company stock, and options to buy that stock. Offering ownership in the company is an effective tool for aligning employee and employer interests.

It is not easy to compare wealth-matching programs across companies. They vary not only by investment type (pension, 401(k), stock grant) but also by the rate of matching employee contributions. The best plans typically match 6 percent of employee contributions, whose simplest form can be a dollar-for-dollar approach.

At Whole Foods (Nasdaq: WFMI), more than 13,000 staff have received stock options from the company. “Leadership grants” of these options recognize team member performance, and “service hour grants” recognize employee actions in the community (these totaled nearly half of WFMI’s stock grants in 2007). In addition, more than 2,000 staff typically choose to buy Whole Foods stock quarterly at a 5 percent discount, collected through payroll deductions.

Companies applying an inclusive approach, like Whole Foods Markets, cultivate strong staff loyalty and lower turnover, leading to higher customer satisfaction. Whole Foods shareholder value consistently grew in the early 2000s until its erosion in 2006 to 2008 from competitive pressures. Whole Foods commitment to employees’ compensation and benefits may have helped contribute to its 2009 out-performance against the S&P 500.

2. Employee Pay Relative to Industry Peers

If people flock to the highest pay, then why doesn’t everyone work in financial services, health care, or technology sectors that exhibit the highest pay rates? And why would anyone work in retail or food service sectors characterized by the lowest pay rates? In fact, absolute pay levels do not alone provide the necessary information. Indeed, leaders in each sector may not necessarily pay the highest. For example, Disney (NYSE: DIS) historically pays under the average compensation for the opportunity to work with the “Magic Kingdom.” Top-paying firms, especially in investment banking, typically want staff to put in extraordinarily long hours. But the level of relative pay within an industry or sector does tend to be a contributing factor for a HIP portfolio.

HIP investors don’t have an easy job figuring out pay levels. Despite the detailed financial statements issued by companies, it is rare to find in the financial statements a total compensation number to divide by the total number of staff to calculate an average pay per employee.

However, employees can self-report pay at Web sites like PayScale, SimplyHired and JobNob. Yet these are not very reliable—the number of respondents is a small fraction of the entire company, and the pay rates reported tend to be those of higher paid managers, scientists, and executives. Some of the websites have features to adjust for geography, years of experience, and role, which can help yield a more reliable estimate.

For a HIP portfolio, proceed with caution. Check to make sure there are enough respondents to make the information comparable. Be careful in calculating averages, as the number of employees who reply varies by years of experience, job type, and geography. A HIP investor can calculate a weighted average adjusting for those factors to make the numbers more comparable. This research can help set the stage for identifying companies with pay policies consistent with balanced wealth creation for employees, not just executives.

3. CEO Compensation Relative to Average Staff Pay

You would expect higher levels of CEO compensation to correlate to increased shareholder value. But does the ratio of CEO-to-worker pay correlate with higher financial performance? For an overall portfolio, HIP has calculated that a lower ratio of CEO pay to average staff pay correlates to higher levels of financial performance. However, results for individual companies may vary widely. HIP investors realize that CEOs can be paid relative to increases in long-term shareholder value, but that overall lower CEO-to-worker pay ratios connote more employees sharing in the wealth, which fosters higher employee dedication and productivity resulting in financial success—for the CEO, the workers, and you as an investor.

According to The Corporate Library, the average compensation for an S&P 500 CEO was $10.4 million in 2008, and increases by 36.5% from 2010-2011 (according to CNN Money). The average worker’s compensation is just over $40,000, according to the Bureau of Labor Statistics, based on a 40-hour work week and median employee wages of $20.62 per hour in 2008. Therefore, the average CEO makes more than 300 times the average worker’s pay.

As a HIP investor, you can research these figures easily at the Web site for the AFL-CIO (http://www.aflcio.org/corporatewatch/paywatch/), the largest union organization in the United States. You can also view the differences in calculations compared to the Securities and Exchange Commission (SEC). The AFL-CIO calculates what the stock and option grants are worth at fair value.

To calculate a score, take the CEO compensation from the AFL-CIO database, and divide by an estimate of the average worker’s pay. About one-sixth of the S&P 500 score under 100 for this ratio. Some include CEOs who already own plenty of stock like Steve Jobs of Apple (Nasdaq: AAPL) and Marc Benioff of salesforce.com (NYSE: CRM). The highest ratio companies score over 500, many of who are in the financial industry. Some even score over 1000 (in 2008), like Bob Simpson of XTO Energy (acquired by Exxon Mobil, XOM, in 2010) and Eugene Isenberg of Nabors Industries (NYSE: NBR), whose companies beat the S&P 500 during years of rising oil prices, but have been more at parity when energy prices stabilized.

Companies that help staff build income and assets while maintaining fair pay can deliver bottom-line productivity and profits, which of course is HIP. In our next feature, we will examine how Earth metrics align closely with drivers of profit, highlighting a better environment for investors and stakeholders.

To navigate this series, please use this table of contents.

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R. Paul Herman is CEO and founder of HIP Investor Inc. Herman is the author of “The HIP Investor: Make Bigger Profits by Building a Better World,”  published by John Wiley & Sons in 2010. Herman is a registered representative of HIP Investor Inc., an investment adviser registered in California, Washington and Illinois.

NOTE: This feature, excerpted and adapted from the HIP book, is not an offer of securities nor a solicitation. The information presented is for information and education purposes, and is not an investment recommendation. Past performance is not indicative of future results. All investing risks losing your principal. The author may invest in the companies mentioned above, and several are included in the HIP 100 Index portfolio. Details and full disclosures are at www.HIPinvestor.com

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