January 21, 2022 Executive Compensation Executive & Director Pay Design QuickTakes

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Executive & Director Pay Design

Should Increasing CPI Result in Higher Compensation?

Although we live in a highly inflationary environment at present, the views about the duration of the inflation are contentious.

Some see it as transitory, ending as supply chain disruptions fall away and Covid recedes. Others see it as continuing, especially if we enter a wage/price spiral, where rising wages lead to even higher prices. A big issue facing businesses is whether inflation should lead to higher levels of compensation. The answer is: “it depends.”  

One cannot treat the labor market as homogeneous when it comes to increasing compensation in the face of inflation. It varies by industry (especially tech vs. non-tech), level in the organization (executive, salaried—especially greater than $100,000), and function/profession. The response to inflation varies widely when considering each group. Be clear though, that pay is only part of the answer as other factors such as job flexibility and advancement opportunities may play as big, or a bigger, role, than pay. 

First things first. If there is a view that inflation is transitory, then companies should consider one-time adjustments such as hiring, retention, and other special bonuses that are not baked into future pay or lead to increased benefits costs. If there are other factors involved in attracting and retaining talent, such as an ongoing supply/demand imbalance, one-time actions are likely not enough. 

Inflation likely does contribute to certain wage increases, especially for front-line workers seeking to achieve a living wage or more. Some 39% of businesses in a recent Conference Board survey said they’re raising pay to keep up with rising inflation. Although not universal, this will certainly continue if cost of living adjustments become prevalent as was the case in the inflationary period of the 1970’s and 1980’s.  

Although inflation has played a role in driving wages up recently, the far bigger driver has been the supply/demand imbalance caused by Covid and the “great resignation.” Companies and organizations of all stripes have had to increase starting pay, use hiring and retention bonuses, employ creative benefits and perks to compete for front-line workers over the last year or so. Note that once wages start to exceed the value contributed by employees (especially if companies are hard-pressed to pass on price increases to customers), the greater the pressure on companies to increase productivity, especially through automation. An example is the poultry industry where packers have moved to automate deboning, both to deal with the spread of Covid and to combat higher labor costs. Another example is the use of automated ordering in the restaurant industry. As technology in connectedness, AI, and robotics improve, automation will likely play a greater role. 

As one goes up the employee hierarchy, the market basket of goods used in the CPI represents a smaller proportion of the annual spend of higher salaried workers and executives. Thus, inflation is less of a driver of increased compensation for these groups. However, given that rents and implied rents, which have skyrocketed, represent fully one-quarter of the CPI, even salaried workers are not totally detached from the effects of inflation. 

The technology industry has been on fire, as a bevy of new IPOs and SPAC-based mergers create new competitors for talent within the industry resulting in an extreme war for talent and rapidly increasing compensation. The high value-add of these workers can justify big increases in compensation. In addition, digitization, the Internet of things, the greater demand for automation, and the expanding use of AI, have increased the demand for tech talent in other industries. A prime example is the automobile industry, with the increasingly autonomous nature of vehicles. 

Unsurprisingly, the functions/professions seeing upward compensation pressure are those representing the greatest current demand and opportunity for value add, rather than inflation. Some of the functions affected include technology-related positions related to digitization; human resources given the issues related to the great resignation; legal because of the increasingly demanding governance environment; finance for industries experiencing significant M&A activity; supply chain management given the logistical challenges companies are facing; and engineering. 

Ultimately, the impact of inflation on pay is not straightforward, so companies need to consider their specific situation before adjusting compensation. 

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