CEO Vs. Worker: New Rule Requires Pay Ratio Disclosure

After three years, the Securities & Exchange Commission is finally following through on one of the Dodd-Frank law’s more controversial requirements: It has proposed that public companies disclose how the pay of their CEOs compares to that of their workers.

Labor unions and those on the liberal side of the political spectrum back the move. Public companies and their trade associations are much less enthusiastic.

The requirement is an outgrowth of two phenomena: public disillusionment with Wall Street after the financial crisis of 2008 and the ever-widening disparity between the earnings of chief executives and their employees, a gulf that is contributing to increasing income inequality in the United States.

From 1978 to 2012, CEO compensation rose by about 875 percent, according to the Economic Policy Institute, a nonprofit think tank based in Washington, D.C. That increase was “a rise more than double stock market growth and substantially greater than the painfully slow 5.4 percent growth in a typical worker’s compensation over the same period,” the EPI said in a report released in June.

One way to measure this disparity is by calculating the ratio of CEO pay to that of a median worker. That CEO-to-worker compensation ratio was 20.1-to-1 in 1965 and 29-to-1 in 1978, according to the EPI. It “grew to 122.6-to-1 in 1995, peaked at 383.4-to-1 in 2000, and was 272.9-to-1 in 2012, far higher than it was in the 1960s, 1970s, 1980s, or 1990s,” the report said.

Although the EPI can fairly be described as left-leaning, measurements by other news organizations of the CEO-to-worker pay ratio also indicate huge disparities. In September, The Wall Street Journal reported that the ratio stood at 319.7-to-1 in 2011. Bloomberg News, in looking at the Standard & Poor’s 500 Index, reported in September that “the average multiple of CEO compensation to that of rank-and-file workers is 204, up 20 percent since 2009 … .”

“The simple fact is that large pay disparities between CEOs and their employees affect a company’s performance,” Richard Trumka, president of the AFL-CIO, said Sept. 18, when the SEC proposed the rule requiring disclosure. “When the CEO receives the lion’s share of compensation, employee productivity, morale and loyalty suffer. In contrast, reasonable CEO-to-worker pay ratios send a positive message to the workforce that the contributions of all employees are important to running a successful company.”

The Center on Executive Compensation, based in Washington, D.C., had a very different take. “The SEC’s proxy disclosure rules are intended to educate investors and promote their understanding of a company’s executive compensation practices so that they can make better investment decisions,” it said in a statement.

“However, the pay ratio provision does not provide material information to investors, would be extremely costly to implement and is inconsistent with the purposes of compensation disclosure in a company’s proxy statement.”

The center also holds that the ratio is potentially misleading, failing to provide a fair comparison across companies in vastly different industries and with vastly different geographic footprints. The center is an arm of the HR Policy Association, which represents human resource executives of more than 325 of the largest companies in the U.S.

Also opposing the rule are the U.S. Chamber of Commerce, the National Restaurant Association and National Retail Federation. Mallory Duncan, senior vice president and general counsel of the National Retail Federation, told Arkansas Business that the ratio is “potentially misleading because in the way that it’s set up, it’s going to present sort of an apples to kumquat comparison with other companies.”

He pointed to the retail, hospitality and agriculture sectors as examples of industries that have seasons — Christmas, vacation, harvest — and so have many seasonal and temporary employees. The pay of those workers would bring down the median for the entire sector of which they’re a part, Mallory said, skewing the ratio.

Randy Hargrove, a spokesman for Wal-Mart Stores Inc. of Bentonville, said the retailer wasn’t taking a position on the SEC’s proposed rule. Julie Bull, a spokesman for Dillard’s Inc. of Little Rock, declined to comment.

Michael Pakko, the state economic forecaster and chief economist for the Institute for Economic Advancement at the University of Arkansas at Little Rock, said he didn’t see a sound economic rationale for the rule.

“Perhaps the notion is that this would tend to shame some companies into not paying their CEOs as much as they do or something like that,” he said. “[But] the point of disclosure rules, particularly by the SEC, is to provide information to investors and potential investors, and the compensation for CEOs and other corporate officers is already a matter of required full disclosure.”

Josh Bivens, the research and policy director of the Economic Policy Institute, said pay ratio disclosure provides more “transparency” about the issue of chief executive compensation. It also gives those who think CEO pay is excessive and that CEO pay practices don’t further efficiency “a tool with which to make their case,” he said.

Bivens, asked whether there was a sense that just forcing companies to disclose the pay ratio would shame them, said, “I think so, yes.

“Disclosure alone will not do the job for sure, because it’s true: Anyone who is really interested can figure out what CEOs are generally paid. The way I see it is: CEOs have substantial market power over their own pay. And one of the things that provides a check on them demanding ever-greater pay increases is kind of a vague outrage constraint.”

Pakko fears unintended consequences. “If there’s a problem with CEO pay being out of control or rising too rapidly, that’s really something for the shareholders of a company to address,” he said.

In fact, Dodd-Frank includes a provision that requires companies to routinely give shareholders a “say on pay,” and after three years, shareholders haven’t had much to say.

Steven Hall & Associates, a New York executive compensation consulting firm, reported last week that 3,047 companies had held say-on-pay votes in 2013 and only 65 — about 2 percent — failed. That’s consistent with the first years of the provision.

“If there’s a particular problem, you would think that there’s some market failure that you need to address,” Pakko said. “And it would make more sense to directly address that market failure than to address the symptom, which is the salary difference itself. And if there is no market failure, then introducing any sort of government intervention is likely to lead to a less efficient allocation of resources.”