Last week the SEC finally proposed rules to require public companies to disclose the pay ratio between their CEO and their employees, as mandated by Dodd-Frank. Companies would have to disclose the ratio between CEO compensation and the median pay of their employees. Update: Comments due December 2nd.
As reported by the WSJ, the ratio of “average” pay jumped from 51.6 in 1981 to 319.7 in 2011, according to data compiled by Kevin Murphy of the University of Southern California. The AFL-CIO sampled S&P 500 firms and claims the ratio went from 42 in 1980 to 380.
In response to complaints from multinationals that tallying pay for workers around the globe would be prohibitively expensive, the SEC’s draft largely leaves estimating and sampling methodology up to individual companies.
Critics, such as new SEC Commissioner Michael Piwowar, complain the sole purpose of the rule is to shame CEOs and the result will be layoffs of the lowest paid workers and/or more outsourcing (Player of the Week, WSJ, 9/18/2013). See this interesting rebuttal filed by Dr. Sue Ravenscroft, Roger P. Murphy Professor of Accounting at Iowa State University.
Proponents, such as Brandon Rees, acting head of the AFL-CIO’s Office of Investment, counter “The proposed rule-making will increase investors’ sensitivity to the impact of higher CEO pay levels on a company’s performance.” Rees expects boards to focus more closely on the impact of CEO pay on employee morale and productivity and offer investors more detail about how they select performance targets tied to CEO compensation. (SEC Wants Boss-Employee Pay Gap on Display, WSJ, 9/18/2013)
The WSJ editorializes that (Opinion: Coming SEC Rules on CEO Pay Will Hurt, Not Help, WSJ, 9/18/2013):
Companies within the same peer group with similar businesses will have vastly different CEO pay ratios depending on whether they operate their business with their own employees or franchise their locations to other employers, whether the bulk of their employees are located inside or outside the U.S., whether their non-U.S. employees are paid less because they are covered by government social welfare schemes funded by company taxes, fluctuations of currency exchange rates, etc.
As Matt Orsagh (SEC Pay Disclosure Ratio: Populist Red Meat or a Somewhat Useful Tool? Yes and Yes, CFA Institute, 9/23/2013) points out, coming up with the ratio is not difficult. “Bloomberg estimated that the average multiple of CEO compensation to that of rank-and-file workers is relatively easy to find, and that it is 204, up 20% since 2009.” Orsagh hopes the ratio, like say-on-pay, will lead to further dialogue between shareowners and boards. He fears the public and media will fail to understand some packages that make sense and that knowledgable institutional investors may find it easier to remain silent, rather than standing up for what is right.
More from Sullivan & Cromwell LLP, SEC Proposes CEO Pay Ratio Rule, HLS Forum on Corporate Governance and Financial Regulation, 9/23/2013:
The proposed rule will not affect the 2014 proxy season. The rule would become effective with respect to the first fiscal year commencing on or after the effective date of the final rule. For newly public companies, the disclosure requirement would apply with respect to compensation for the first fiscal year commencing on or after the date the issuer becomes subject to SEC reporting requirements.
The proposed requirement would not apply to foreign private issuers, smaller reporting companies or emerging growth companies under the Jumpstart our Business Startups Act.
See also The Five Most Important Things Companies Need to Know and Do About the SEC’s Proposed CEO Pay Ratio Rules by Jim Barrall, Partner, Latham & Watkins LLP.
I’m with Orsagh in seeing pay ratio disclosure as a further opportunity for dialogue. Relying heavily on competitive benchmarking in setting CEO compensation could be a costly misstep based on outdated and flawed rationale, according to researchers from the University of Delaware.
However, I am also mindful of studies such as “Executive Superstars, Peer Groups and Over-Compensation — Cause, Effect and Solution,” which finds there is little market for CEOs. They are not frequently moving from one top slot to another and when they do, it’s often disastrous. Researchers Charles M. Elson and Craig K. Ferrere conclude we could end the “ratcheting up” effect of CEO packages by looking first to how employees are paid. According to Elson:
Pay, rather than being externally developed, can be based internally. In other words, you’ll design a compensation package around an internal scheme. From the HR perspective, you can be more consistent.
If they do, it will be a boon to employee morale and is likely to lead to better appointments from internal candidates. Spencer Stuart found that in 2012, 73% of newly appointed CEOs among the S&P 500 companies studied were internal placements. Also see Surprise, CEOs: You’re on Candid Disclosure! from Alyce Lomax.
Read Release Nos. 33-9452; 34-70443; File No. S7-07-13. I often find if helpful to read comments submitted by others to the SEC. And, of course, the SEC wants your comments. No, you don’t have to be a CEO, director or union official. Your opinion matters, but only if you send it to the SEC. Use their online form but feel free to send the bulk of your comments as an attachment. Comments are due December 2, 2013.