How One McKinsey Consultant Helped Create The Massive CEO-Employee Pay Gap

Mckinsey & company

McKinsey is the world’s largest and most profitable consulting firm, as well one of the most difficult places to get hired.

Over its 87-year existence it’s had a massive impact on the U.S. economy according to “The Firm,” a forthcoming book by Duff McDonald. In a New York Observer column, pointed out by Mike Dang at The Billfold, McDonald argues that the massive modern-day gap between executive and worker pay has its origin with the consulting firm.

It’s a fascinating story that all started with General Motors commissioning a study on executive pay from McKinsey consultant Arch Patton. He found that from 1939 to 1950, hourly employee pay more than doubled, but top management pay went up only 35%.

The study, published in the Harvard Business Review, became a series and turned national attention toward executive compensation, promoting the idea that higher pay and bonuses were the lever to attract and retain top executives.

Patton became a superstar, hired by managers who were not surprisingly interested in hearing they were underpaid. McKinsey’s CEO apparently thought this type of consulting was beneath the firm, but wasn’t about to turn down the money.

“For several years, Mr. Patton personally accounted for almost 10 per cent of the firm’s billings,” McDonald writes. “At the end of the war, only 18 per cent of companies in the country had bonus plans. By 1960, about 60 per cent of them did.”

In 1961 came the books “Men, Money and Motivation: Executive Compensation as an Instrument of Leadership” and “What Is an Executive Worth?

One McKinsey consultant told McDonald that Patton wrote “the same article [26] times for the Harvard Business Review.”

Because of its popularity and McKinsey’s influence, the idea became an entrenched philosophy, as did the concept that as a company grows, so should CEO pay.

While Patton’s compensation philosophy started with rigorous analysis of performance, soon it took on a life of its own, with executive pay spiraling higher and higher, while worker pay was left to languish.

Here’s where we are today, according to a report by The State Of Working America, a project of the Economic Policy Institute:

CEO To employee ratio

The AFL-CIO puts the number even higher, saying that the average Fortune 500 CEO makes 354 times the average wage of their employees. Some executives make 1,000 times more.

Of course, McKinsey and Patton weren’t the only factor. Bull markets and economic expansion help push pay upwards and encourage investors to look the other way — and once it moves up, pay is slow to move back down. Meanwhile, slack labour markets and weak growth prospects help to explain stagnant wages.

Regardless, McKinsey and Patton may have been a major driver in the gap between CEO and employee wages exploding by a factor of 10 since the middle of the century.