Views on improving the integrity of global capital markets
23 September 2013

SEC Pay Disclosure Ratio: Populist Red Meat or a Somewhat Useful Tool? Yes and Yes

On 18 September, the SEC voted by a 3-2 margin to propose rules for pay disclosure ratios at companies that list with the SEC. In a nod to complaints by business groups that such a rule would be too costly, the SEC proposed that businesses can use sampling and estimation methods to determine the median pay of workers. The plan as proposed does not allow companies to exclude part-time workers or employees based in foreign countries from the calculation.

It is important to understand that a 3-2 vote to circulate for public comment has a long road to travel before a final vote that may or may not approve a final rule. The proposal will be subject to a 60-day public comment period once it is published in the Federal Register. New SEC Commissioner Michael Piwowar had particularly harsh words for the proposed rule. As reported by the Wall Street Journal, Piwowar said “supporters want to use the ratio to ‘shame’ CEOs but ‘the shame from this rule should not be put on the CEOs, it should be put on the five of us who would be voting on this proposal today.’”

The proposal would require companies to disclose their CEOs’ total compensation as a multiple of median total worker pay. Total compensation would have to include salary, bonus, stock-and-option awards, long-term incentive pay, and change in pension value.

It is likely a bogus argument that such a ratio is too hard to calculate. It is unlikely that many corporations lack the ability to put together such a ratio, especially when the SEC has given them a great deal of discretion in deciding how to do so. Many companies already track median-pay data in order to benchmark their pay practices. You can also find pay ratio information on your Bloomberg terminal. In an article reporting on the development of the proposed rule, 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.

I do, however, agree with SEC Commissioner Piwowar, and many in the issuer community who claim that this rule will primarily be used to shame companies. And in some cases that may be helpful, because on some occasions shaming a board about executive pay may be necessary.

Overall, I have my concerns about the rule. The pay ratio, although a useful tool, lends itself to rather sensational proclamations of unfair and unjustified pay. The first story on an “outrageous” pay ratio will grab attention and spur outrage. The 100th story will leave people bored and has the potential to diminish the effectiveness of the rule.

Engagement between issuers and investors is on the rise due in no small measure to things like the financial crisis, “say-on-pay” votes, and majority voting standards that require a director to receive majority support in order to stay on a board. I hope any new pay ratio tool would enhance engagement rather than undermine it.

Understanding executive pay and whether or not it is justified/fair/good for shareholders — like most important things — cannot be reduced to one number. But since we are all human, we prefer simplicity. We want one data point that will say whether pay is just or not, when pay is more complex than that.

What if a CEO gets a big stock kicker one year because the stock she couldn’t touch for five years vests, causing the company’s pay ratio to jump from 75 to 150? That one ratio number may spur outrage for no good reason.

Such a pay package may well be “about right” in the eyes of most institutional investors. These same investors may well be faced with outrage over a pay ratio number that seems high to a public or media that doesn’t bother to read the rest of a company’s Compensation Discussion and Analysis report. Will those institutional investors be able to stand up to their investors and defend such a pay package? We may find out soon enough.

About the Author(s)
Matt Orsagh, CFA, CIPM

Matt Orsagh, CFA, CIPM, is a senior director of capital markets policy at CFA Institute, where he focuses on corporate governance, ESG, and climate change analysis. He writes and speaks frequently on these topics on behalf of CFA Institute. His paper, Climate Change Analysis in the Investment Process was named “Best ESG Paper” by Savvy Investor in 2021.

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