Half a century ago, the ratio of CEO-to-worker pay was around 20-to-1, according to the Economic Policy Institute. In 2013, it was 295.9-to-1. CEO compensation has increased by 937 percent just over the last three decades (since 1978). The rise compares with a dismal 10.2 percent hike for the average U.S. worker over the same period, putting into stark contrast the relative fortunes of the superrich and everyday employees in an increasingly economically divided America.
Economists who study income inequality state that ever-expanding executive compensation packages have played a substantial role in increasing the divide between the rich and poor. Thomas Piketty, a French economist, stipulated that higher wages for top earners in corporate America had been among the main drivers of the widening income differences in the US. “The system is pretty much out of control in many ways,” he said (according to NY Times).
In a lagged and dilatory but thought-provoking move in the US corporate governance and transparency landscape, SEC approved Dodd-Frank’s requirement on disclosing CEO vs. Worker Pay Gap after five years of procrastination (Congress passed the Dodd-Frank financial reform bill in July 2010. Dodd-Frank created the disclosure requirement but left the SEC to determine exactly how the rule would be implemented).
“The rule, which is mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, would provide investors with information to consider when assessing CEO compensation, while providing companies with substantial flexibility in calculating the ratio.”
The SEC required companies to disclose the median compensation of all its employees, excluding the CEO, and release a ratio comparing that figure to the CEO’s total pay. Companies would have to report the pay ratio starting in 2017.
The concession: Democrats vs. Republicans
The five-member commission was divided into a 3 vs. 2 in approving the rule. White and the SEC’s two Democrats, Luis Aguilar and Kara Stein, approved the rule while their Republican counterparts stand against it. Democrats have said the metric will be helpful to shareholders who are deciding how to vote on executive pay packages. “While there is no doubt that this information comes with a cost, the final rule recommended by the staff provides companies with substantial flexibility in determining the pay ratio while remaining true to the statutory requirements” of Dodd-Frank, White said at the meeting. Sarah Anderson, analyst at the left-leaning Institute for Policy Studies, praised the SEC’s decision. “We finally have an official yardstick for measuring CEO greed,” she said. “This is a huge victory for ordinary Americans who are fed up with a CEO pay system that rewards the guy in the corner office hundreds of times more than others who add value to their companies.” The SEC has been under mounting pressure by Democrats, like Massachusetts Senator Elizabeth Warren and unions such as the AFL-CIO, who support the rule and have lamented delays in its adoption. The measure was tucked into the 2010 Dodd-Frank law amid concerns about the growing disparity between compensation for chief executives and their corporate workers. “Pay ratio disclosure should provide a valuable piece of information to investors,” said Democratic Commissioner Kara Stein said.
Business groups, on the other side of the bargain, have argued that the pay information will be very costly and time-consuming for companies. The U.S. Chamber of Commerce maintains it will cost U.S. companies more than $700 million a year, compared with the SEC’s estimate of about $73 million. Reaction from the business community and conservative Republican lawmakers was swift and sharply negative. “At best, pay ratio is a misleading, politically inspired, and costly disclosure that fails to provide investors with useful, comparable data,” the Chamber of Commerce said in a statement. For example, it said, a domestic company might have a narrower pay ratio than a multinational company because of legal, currency or cost-of-living differences. That would be “like trying to compare baseball to basketball stats,” the group said. Daniel Gallagher, one of the two Republicans voting against the action, called it “a nakedly political rule” serving no purpose other than “naming and shaming” CEOs. He suggested the rule may violate the Constitution. “This rule is more harmful than helpful,” David Hirschmann, head of the Chamber’s Center for Capital Markets Competitiveness, said in a statement. He said the Chamber would explore options to “clean up the mess” it believes the rule has created.
The first disclosures of the ratio will most likely start to appear in filings in early 2018. Before then, opponents of the rule may try to overturn the rule in the courts. Daniel M. Gallagher, one of the Republican commissioners who voted against the rule, said at Wednesday’s meeting of the commission that it “may be the most useless of our Dodd-Frank mandates.”
A little on the Nitty-gritty of the Fact Sheet
Section 953 requires additional disclosure about certain compensation matters, including pay-for-performance and the ratio between the CEO’s total compensation and the median total compensation for all other company employees. As required by the Dodd-Frank Act (Section 953), the rule would amend existing executive compensation disclosure rules to require companies to disclose:
The median of the annual total compensation of all its employees, except the CEO;
The annual total compensation of its CEO; and
The ratio of those two amounts.
Annual total compensation: total compensation for the last completed fiscal year, calculated using the definition of “total compensation” in existing executive compensation rules, namely Item 402(c)(2)(x) of Regulation S-K.
To identify the median employee, the rule would allow companies to select a methodology based on their own facts and circumstances. A company could use its total employee population or a statistical sampling of that population and/or other reasonable methods. A company could, for example, identify the median of its population or sample using:
Annual total compensation as determined under existing executive compensation rules; or
Any consistently-applied compensation measure from compensation amounts reported in its payroll or tax records.
A company also would be permitted to identify its median employee once every three years unless there has been a change in its employee population or employee compensation arrangements that it reasonably believes would result in a significant change to its pay ratio disclosure. Smaller public companies — those with less than $75 million in total shares held externally or less than $50 million in annual revenue — are exempt from the disclosure. So are emerging growth companies and investment companies. Companies can exclude from the median pay calculations up to 5 percent of their employees outside the U.S. The rule also lets companies make a so-called cost-of-living adjustment — reflecting that lower wages in some places can buy the same goods and services as higher wages in other places — which would most likely increase the median employee pay figure. Still, companies applying the adjustment would also have to disclose the ratio without the adjustment.
The rules will be effective 60 days after publication in the Federal Register.
Concerns: Does the concession worth it?
The Fact Sheet states the following:
“The rule addresses concerns about the costs of compliance by providing companies with flexibility in meeting the rule’s requirements. For example, a company will be permitted to select its methodology for identifying its median employee and that employee’s compensation, including through statistical sampling of its employee population or other reasonable methods. The rule also permits companies to make the median employee determination only once every three years and to choose a determination date within the last three months of a company’s fiscal year. ”
Heather Slavin Corzo, a director at the AFL-CIO, said she was pleased that the SEC completed the rule but remained concerned about “weaknesses that could lead to loopholes,” including letting companies take out a portion of their overseas workers from the median. “When calculating the median employee pay figure, the rule allows companies to choose a statistical sampling of its employees, rather than an actual survey of all its workers. Moreover, companies can exclude up to 5 per cent of their employees who are not in the US” and “Companies can calculate the median pay of employees on any date within the last three months of its fiscal year. Selecting the right date could result in the company leaving out many lower-paid seasonal workers,” she said. The point made by Corzo is highly relevant.
Here are few of the other flagrant frailties on the technical side.
“Median compensation of all its employees, excluding the CEO” should also include the senior executives such as CFOs who are getting paid way higher than the average worker. Otherwise, the median compensation of average employees would be skewed when companies exclude the non-US low paid workers and include senior executives like the CFOs and COOs. As a result, it would not deliver its full capacity as an indicator of corporate responsibility towards equality.
It is reasonable to say that companies this big has most of these data available instantaneously and objectively (at least the raw data for crunching up numbers and reaching the numbers and information required) in their accounting information systems (AISs), why should companies use a less objective approach like sampling (when they have access to the whole population) to do so and be allowed to exclude non-US employees who are usually paid less than their US colleagues in Asia, South America, and Africa at their discretions, as implied by the law (for other reasons except data privacy acts of the country involved). Although, some analysts said that companies were not wrong in underscoring the potential costs of the rule. While corporations have advanced payroll systems that would seem to make it relatively simple to calculate a median wage, they said that the rule required companies to make new calculations for workers across the globe.
Amir Hossein Rahdari
Director of Research, Corporate Governance and Responsibility Development Center