SEC Goes Ahead with Hated Pay Ratio Rule

A proposal for implementing new disclosure on CEO pay supposedly will provide investors with valuable new information, but in fact it will do nothi...
Alissa PonchioneSeptember 18, 2013

The Securities and Exchange Commission voted Wednesday to propose a rule requiring publicly held companies to disclose the ratio of CEO compensation to the median pay of all other employees. The vote was 3-2 along party lines by the Democratic-majority SEC.

The commission has delayed the rulemaking, required by the Dodd-Frank Act, for three years as companies have pushed back against it. Under the proposal, companies would not have to use a specific methodology to calculate the ratio. Instead they would be able to select one that fit the size and structure of the business and the way it compensates employees.

That’s a departure from Dodd-Frank, which required a specific calculation methodology. The proposal would allow companies to use reasonable estimates when calculating total compensation or any element of it and in determining median employee compensation.

They would, though, be required to disclose the methodology used to identify the median and any material assumptions, adjustments or estimates used to determine total compensation or the median.

Companies have objected that they’re already required to reveal lots of information on executive pay and that identifying the median compensation of all employees would be difficult and costly. Multinational companies have argued that gathering data for employees across multiple countries would be especially complicated.

But a better reason for opposition to the rule is that investors themselves have not been clamoring for it, even though providing more information for investors is the stated reason for the measure. Tim Bartl, president of the Center on Executive Compensation, notes that there have been 14 shareholder proposals asking companies to adopt pay ratio since 2010, and the average investor opposition to them has exceeded 93%.

“Pay ratios will not give any insight on the performance of a company or its management and fail to give investors decision-useful information or assist with capital formation,” said David Hirschmann, CEO of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, in a statement. “This proposal has the potential to drive up compliance burdens and costs for public companies with no benefit to investors – a formula that continues to make it less attractive to be a public company in the United States.”

AFL-CIO president Richard Trumka said in a statement that the pay-ratio rule benefits investors “because it shines a light on the company pay ladder for all employees, not just the pay of top executives that is already disclosed under current rules.”

But Andrew Liazos, a partner in the executive compensation practice at law firm McDermott Will & Emery, charges that unions aren’t nearly as interested in investors as they are in using pay ratio to shame chief executives before the public and gain a chip to use in collective bargaining. “It’s not about shareholders,” he says. “It has a broader purpose.”

Gary Hourihan, senior vice president at executive compensation consultancy Farient Advisors, says the ratio “doesn’t add anything to the clarity of the CEO being underpaid or overpaid. Pay-and-performance alignment is much more of an issue for investors.”

Not only won’t the pay ratio be helpful to investors, it could be misleading, says David Wise, vice president in the executive compensation practice at consulting firm Hay Group. “You’re much more likely to see a high ratio at a retailer than an investment bank, because the median retail employee makes a lot less than the median banking employee,” Wise says. “The nature of the calculation drastically oversimplifies the complexity of how organizations are built or how executives are paid. I don’t think there’s much implication to this ratio other than the headlines in the newspapers.”

Still, Bartl offers that “it’s incumbent on companies, particularly those with global or diverse operations, to carefully analyze the implications and to comment to the SEC about what would be required to comply with this. It’s a little early to judge that now.”

With a 60-day public comment period in place before the proposed rule can be adopted, CFOs may be tasked with helping human-resources executives figure out a statistical method for the calculation, Liazos notes.