Why Compensation Ratios Must Be Encoded

In the conventional firm, the CEO-to-lowest-worker compensation ratio is a number nobody encoded. It is a result. It emerges from a thousand discretionary board decisions about benchmarks, peer groups, retention concerns, and incentive design. The S&P 500 ratio now sits near 290:1. It was 21:1 in 1965. No board ever ratified the change. The change was the absence of a binding constraint.

The SAVI Capital Model holds a different position. Tenet 2 sets a maximum CEO-to-lowest-worker compensation ratio of 15:1 to 20:1, codified in fund governance documents rather than left to board discretion. The figure matters. The codification matters more.

This article is about why.

The Wrong Framing Question

The first thing to dispense with is the framing question itself. The conventional reader asks whether 15:1 to 20:1 is a reasonable cap on executive pay. It is the wrong question. The cap is not a moderation of pay. It is the structural answer to a prior question that the conventional firm refuses to ask: what is leadership compensation actually for?

If leadership compensation exists to attract talent in a tight market, then any ceiling distorts the market and the firm loses. If leadership compensation exists to encode the firm's view of the relative value of work performed at the top versus the bottom of the organization, then a binding ratio is the only honest expression of that view. Conventional firms operate under the first answer and produce the second outcome by accident.

The SAVI Capital Model operates under the second answer and produces the outcome by design.

The Conventional Baseline

According to the Economic Policy Institute, CEO compensation grew 1,085 percent from 1978 to 2023. Typical worker pay grew 24 percent over the same period. The CEO-to-worker compensation ratio moved from 21:1 in 1965 to 290:1 in 2023. The Economic Policy Institute argues, with extensive evidence, that the growth in executive pay over this period is not driven by superior productivity, scarce skill, or market-clearing competition. It is driven by managerial power: the structural capacity of executives to shape the boards, peer benchmarks, and consultant frameworks that set their pay.

This is not a marginal claim. It is the consensus of decades of governance research. The ratio expanded because no one was empowered to constrain it. Boards were captured. Compensation committees referenced peer benchmarks that referenced other peer benchmarks. The cycle ran without an exit. In leveraged-buyout-owned portfolio companies, the dynamic can compress further: management equity packages negotiated at close, ratchet provisions, and exit-linked compensation can push effective ratios well above the public-company baseline.

The Figure Is Not Radical

In the United States, Internal Revenue Service guidance on reasonable compensation for nonprofit executives has historically referenced multiples in this range when evaluating whether compensation arrangements satisfy the reasonable-compensation test. Several European public companies operate at ratios inside this band voluntarily. Recent institutional research from Institutional Shareholder Services shows that European companies increasingly link executive pay to non-financial metrics, with seventy percent including environmental and social criteria in variable pay structures, compared to thirty-nine percent in North America. The drift toward moderation is observable across multiple jurisdictions.

The 15:1 to 20:1 figure is therefore not unprecedented. It is not radical. It is what reasonable institutional observers have always understood to be a defensible range for leadership compensation relative to the lowest-paid worker in the same organization.

The argument is not that the figure is novel. The argument is that almost no one has encoded it.

Why Encoded Matters More Than the Ratio

Here is the operative distinction. A compensation ratio in a values statement can be revised by the board on a quiet Tuesday. A compensation ratio in a fund governance document, a limited partnership agreement, or bylaws subject to limited partner consent cannot. Encoding shifts the cost of revision from management to the firm's capital partners.

This is not a rhetorical move. It is a legal one. In conventional structures, the board chair can convene a special compensation committee meeting, approve a benchmark study, and lift the ratio by fifty points without anything more than a footnote in the proxy. In an encoded structure, the same change requires the consent of the limited partners who ratified the governance document at fund formation. Limited partners who consented to a 20:1 ceiling did so because they believed the ceiling was a feature, not a bug. Asking them to relax it requires the firm to argue, on the record, that the original commitment was wrong.

Most firms will not make that argument. The encoding does the work.

This is the same mechanism by which the preferred return to limited partners is held inviolate during a fund's life. No one renegotiates the preferred return because performance disappointed. The preferred return is encoded, and the encoding is what makes it a preferred return rather than a preference. The SAVI Capital Model applies the same legal architecture to the compensation ratio. The ratio is not a value the firm holds. It is a term the limited partners can enforce.

The Economic Argument

The conventional objection to compensation ratios is that they impose a binding constraint on the firm's ability to attract and retain executive talent in a competitive market. This objection treats the ratio as a cost. It is more useful to treat it as a structural decision about where the firm spends its compensation budget.

A firm operating at 290:1 spends its compensation budget heavily at the top. A firm operating at 20:1 spends the same total budget more evenly across the workforce. The total is not the variable. The distribution is.

When wage compression at the top frees capital for wage expansion at the middle and bottom of the organization, that capital does not disappear. It funds retention. It funds training. It funds the operational stability that allows a portfolio company to invest in product, quality, and customer service rather than continuously replacing departed talent. The productivity gains from this redistribution are not theoretical. Research on profit-sharing structures and shared-capitalism arrangements documents the indirect productivity mechanism in detail. Workers who are paid more competitively at the middle and bottom of the wage distribution exercise greater discretionary effort, accept training more readily, and remain longer in their positions. None of this is a redistribution argument. It is a productivity argument that runs through a redistribution.

For a portfolio company held over a five-to-seven-year period, this matters at the structural level of the investment thesis. A growth-equity-financed company whose middle and bottom wages are competitive with the local labor market does not pay the productivity cost of constant turnover. A leverage-financed company that compressed those same wages to service debt does. Over the hold period, the differential compounds. The encoded ratio is, among other things, a defense against the failure mode that conventional portfolio-company economics produces by default.

The Cultural Argument

Compensation structures signal. This is not a soft observation. Every employee of a portfolio company knows, within rough orders of magnitude, what the chief executive is paid. The presence or absence of a binding ratio between that figure and the lowest-paid worker's wage is a structural fact about the firm. It signals whether leadership is part of the same compensation system as the rest of the organization or operates inside a separate one.

In a 20:1 structure, leadership is inside the system. Promotions move people through the same architecture. Pay decisions made at the top are visible in their relationship to pay decisions made at the bottom. In a 290:1 structure, leadership is outside the system. The chief executive is not the highest-paid employee of the same firm as the lowest-paid worker. The chief executive is the highest-paid member of a different compensation system that happens to share an office address with the lowest-paid worker's compensation system.

The 20:1 ratio does not eliminate hierarchy. It places hierarchy inside a defined and audible architecture. That architectural fact is visible to every employee, every day, and it does work that no values statement can do.

The Structural Test

The hardest question Tenet 2 forces a fund to answer is what happens when the ratio binds. Suppose, mid-fund, a portfolio company faces a CEO succession in a market where the comparable executives are paid at 50:1 or above. The fund cannot match. Does the fund break the ratio, find a different executive, or restructure the role?

The answer matters less than the fact that the question is asked. If the ratio cannot be held during a fund's lifetime, that is a signal, either about the fund's discipline or about the market's tolerance for the model. Either way, the encoding reveals the truth in time to act on it. The conventional firm never has to face the test because the constraint does not exist. The firm operating under Tenet 2 faces the test the first time a binding case arises.

This is the structural function of encoded constraints. They surface the moments when the firm's stated commitments meet the firm's operational pressures. In those moments, the firm either holds the commitment or amends it. The amendment is visible. The cost of the amendment is visible. The discipline of the firm is visible.

A firm whose Tenet 2 commitment has never been tested has not yet demonstrated whether the commitment is real. A firm that has tested the commitment and held it has demonstrated the model. A firm that tested the commitment and broke it has demonstrated something else, and limited partners who ratified the original encoding can act on the information.

Why This Is Tenet 2

The question of why compensation ratios occupy the second position in the Four Tenets architecture, rather than the third or the fourth, is not arbitrary. Tenet 1 establishes equitable profit-sharing as the foundation: fifty percent of net portfolio company profits distributed equally among all employees, separate from salary. Tenet 2 establishes the compensation ratio that makes Tenet 1 coherent. Without a binding ratio at the top, profit-sharing at the bottom can be quietly offset by elastic executive compensation. The two tenets work as a single mechanism.

But there is a deeper reason. Tenet 2 is the binding-mechanism test. Profit-sharing structures, governance protocols, and philanthropic distributions can all be expressed in language that survives scrutiny without ever being binding. The compensation ratio is harder. It produces a number. The number is visible. The constraint is verifiable. If the firm cannot bind itself on this, on a number that any limited partner can audit on any quarter, the firm has not yet demonstrated that any of its other commitments are binding either.

This is why Tenet 2 carries the weight it does. It is the test the model must pass before the other tenets are anything more than language.

Closing

The conventional position is that compensation ratios are a soft constraint, advisory in character, defensible in theory, and ultimately set by market forces and board judgment. The SAVI Capital Model rejects that framing. A compensation ratio that the board can revise is not a compensation ratio. It is a preference. The Tenet 2 commitment is a ratio because the limited partners ratified it, the fund document encodes it, and the firm has bound itself to live inside it.

Encoded because expressed is not sufficient.

That sentence is on the Four Tenets page for a reason. It is the single architectural commitment on which the rest of the model depends. The mechanism is law, not language. The constraint is binding, not aspirational. The ratio is a term of the fund, not a value of the firm.

If a firm cannot bind itself on a number, no other commitment it makes carries weight. Tenet 2 is the test.