This is one of three opinion articles debating the merits of the new CEO pay ratio rule. See the others here and here.
The Dodd-Frank pay ratio requirement should be repealed, as the disclosure would neither provide shareholders with useful information nor facilitate a better understanding of pay practices.
Timothy J. Bartl
Instead, the rule produces a misleading, immaterial, and politically motivated disclosure while creating an administratively burdensome reporting requirement. The SEC-estimated first-year implementation costs of $1.3 billion and ongoing annual costs in excess of $520 million far outweigh any purported benefits. Companies could put these resources to better use by investing for the future and creating jobs.
While the commission’s final rule contains several attempts to provide companies with flexibility in complying, the rule does nothing to materially mitigate the huge compliance costs.
Most notably, the rule requires the disclosure of the ratio of the median pay of all employees globally to the total pay of the CEO. That reinforces a common misconception: that the data required to calculate the pay ratio is readily available. In reality, most global companies have decentralized human resource operations, reflecting that labor markets — and the regulations that govern them — are local. Companies thus deliver HR services through numerous payroll and pay reporting systems aimed at accommodating a variety of jurisdictions.
In fact, none of the 131 companies that responded to a 2013 Center On Executive Compensation survey on pay ratio stated that there was any business purpose to calculating the ratio. In addition, the survey showed that limiting the calculation to U.S. employees would reduce compliance costs by at least 50%. Yet the SEC provided only narrow exclusions in its final rule that do little to mitigate the compliance costs.
As the SEC itself acknowledges, the ratio will vary dramatically from company to company and thus will not be comparable. Moreover, the disclosed ratios will not provide insight as to whether a company’s compensation is appropriate. The pay ratio of a particular company depends on a variety of factors, such as the industry in which the company operates, the geographical locations of the company, the types of employees that make up the company (i.e., professional vs. retail), the company’s business structure, and the competitive market for talent.
Contrary to the arguments of some activists, differences in pay ratios would not reflect differences in risk between companies. Instead, different ratios would merely reflect differences in market rates of pay for various positions across geographic areas, and neither a higher nor lower ratio would indicate a greater or lesser investment risk.
More importantly, investors are not interested in this disclosure. Since 2010, the 15 shareholder resolutions calling for a pay ratio-style disclosure received an average support of less than 7% of shareholders. In other words, 93% of shareholders voted against requiring a pay ratio disclosure. To the extent the pay ratio is used, it will be micro-minority activist investors who will seek to use it as a leverage point to promote their own narrowly tailored agendas.
For these reasons, the Center On Executive Compensation strongly supports passage of pay ratio repeal legislation in the House — H.R. 414, sponsored by Rep. Bill Huizenga (R-MI), and S. 1722 sponsored by Sen. Mike Rounds (R-SD).
Timothy J. Bartl is president of the Center On Executive Compensation, a research and advocacy organization representing chief human resources officers of leading companies.
