The False Fairness of Percentages and Percentiles (Gwen Moritz Editor's Note)

by Gwen Moritz  on Monday, Oct. 24, 2011 12:00 am  

My mother was the first member of her family to earn a high school diploma, and she never spent a day in college, but she was very sharp with figures. She explained mortgage amortization to me when I was about 12 - doesn't every mother? The definitive symptom of dementia was when she could no longer balance her checkbook.

Mom worked as a school secretary in North Little Rock, and even though my father was an administrator whose annual misery was negotiating with the teachers' union, she sympathized with the teachers.

Something insidious was happening with school salaries, she told me: across-the-board raises. To give the higher-paid administrators the same percentage raise as teachers and support staff, she showed me with unassailable mathematical precision, was creating an income gap that was getting wider every year.

And yet it seems so fair. If everyone gets 3 percent or 5 percent, everyone's standard of living is improving at the same rate, right?

Except 5 percent of $100,000 buys a lot more than 5 percent of $50,000. And next year, 5 percent of $105,000 will buy a lot more than 5 percent of $52,500, and so perpetually on.

While the difference between the two salaries stays in proportion, the difference between standards of living grows bigger with each raise. The people who have more get more more, and the people who have less get less more. (And some of those administrators, she told me knowingly, didn't deserve more more.)

Much fairer, my mother thought, than an equal percentage would be equal raises in take-home pay. An additional $1,000 buys just as much for the person who was making $100,000 as it does for the person making $50,000, and the wage gap wouldn't grow eternally wider.

Current events have reminded me of my mother's lessons in basic finance, specifically Herman Cain's 9-9-9 tax proposal and the Washington Post's fascinating report about "peer benchmarking" in executive compensation.

The Post's story (published Oct. 3 and available online) relied on new transparency requirements by the Securities & Exchange Commission to show that executive compensation at publicly traded companies is often more closely tied to the pay packages of other executives than to the performance of the individual.

"[A]t the vast majority of large U.S. companies," Post reporter Peter Whoriskey wrote, "boards aim to pay their executives at levels equal to or above the median for executives at similar companies." And he quoted former Federal Reserve Chairman Paul Volcker, who called this phenomenon the "Lake Wobegon syndrome," in homage to Garrison Keillor's fictional hometown, where "all the children are above average."

The result is something far more insidious than anything my mother observed in lowly Arkansas school salaries of the 1970s.

Executives who are demonstrably below average in performance as measured by stock value are being rewarded because some other company rewarded its execs, who may have gotten a raise merely because yet another executive did. If our executive weren't above the 50th percentile, he wouldn't be our executive, right? If you look at it that way, it seems perfectly fair.

 

 

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