In setting compensation, companies consider internal equity (where the compensation system is perceived internally to be fair) and external equity (where the compensation for any particular position is competitive with the external market). Most companies focus primarily on external equity when it comes to executive pay. If they find that a competitor is paying its CEO or chief financial officer a certain amount, they think their pay has to be comparable or higher. Few companies are content to be average; many strive to be at the 75th percentile or beyond. This has created a ratchet effect that has led to rapidly rising executive compensation in recent decades.
If external equity is not tempered with internal equity, it can lead to a system that is perceived to be unfair internally, which is a huge de-motivator. At Whole Foods, our salary cap has been in place for about twenty-five years (the ratio has risen gradually over the years to its current nineteen-to-one level to stay reasonably competitive with the external market), and inadequate compensation has never caused us to lose any senior executives we wanted to retain.
There is another rationale for the salary cap. We want leaders who care more about the purpose and people of the company than they do about power or personal enrichment. Our senior executives are well compensated, but they are clearly not making the most money they could. If they simply want to maximize their personal compensation, they could certainly make more than they do at Whole Foods Market. Indeed, many of them routinely receive offers that are considerably larger. But our leaders believe that their compensation at Whole Foods is reasonable and fair compared with others within the company. Although most would not turn down more if offered more (human nature being what it is), by any reasonable standard they are wealthy and can do what they want in life.This reflects a third reason we believe a salary cap is good: it attracts people with a higher degree of emotional and spiritual intelligence. At some point, people have enough money to have financial security, live a comfortable, adventuresome lifestyle, and fulfill most of their aspirations in life. It is a mark of emotional and spiritual maturity to be able to say, “I have enough.” Past a certain point, it is not healthy to want more; actually, it is a kind of sickness.
Reprinted by permission of Harvard Business Review Press. Copyright 2013, Harvard Business School Publishing Corporation. All rights reserved.