Views on improving the integrity of global capital markets
06 August 2015

SEC’s CEO-Worker Pay Ratio Rule: Is It a Mixed Bag for Investors?



The SEC approved a rule yesterday that requires companies to compare CEO and average worker pay — the “pay ratio” rule.

Getting to this point has kept the SEC busy in the last few months working through its backlog of required Dodd-Frank rulemaking.

Way back in 2013 the SEC first voted to propose a pay ratio rule, and immediately the proposed rule became a political football. Those who favored the rule believed it could be a useful tool to help investors better understand pay. Those opposed to the rule believed it was only a tool meant to shame companies and their boards. So we asked our members in an informal poll what they thought. Here is what they said:

  • Useful tool for investors to better understand pay – 43%
  • Used to shame companies and their boards – 43%
  • Inconsequential – 12%
  • No opinion – 3%

Well that certainly cleared things up.

So is the proposed rule a useful tool, or simply a way to shame companies on pay? Yes.

Will a pay ratio rule be useful? Likely, yes. Any bit of information that can help investors understand a company’s pay practices can be useful. Most large institutional investors we speak to echo this sentiment. They will look at it as just one part of their overall investment and voting process.

Will a pay ratio number be misconstrued by people who are predisposed to complain about executive pay? Most definitely, yes. A pay ratio number is only one piece of data that any investor reviewing executive pay should look at. Investors who base their investing or voting decision on only one piece of data, ignoring all the rest of the data on pay are doing themselves and their clients a disservice.

If a bad pay ratio number (whatever that turns out to be) is just one of a number of poor pay practices at a company that receives scorn and negative say-on-pay votes from investors — that’s fine, and likely deserved. We caution investors to take a measured approach with the pay ratio, and use it as only one tile in a larger mosaic they use in seeing the complete picture of a company’s pay practices. We encourage investors to get the whole story on pay before making their investing or say-on-pay voting decisions. We covered how companies can best disclose executive pay in a format that is useful to investors in our recently published CD&A Template.

Investors React

We reached out to institutional investors to gauge their reaction. We found that they tended to agree that the rule could be useful, but is not necessarily a game changer:

We’re largely supportive of the new rule, but at the same time we aren’t under any illusions that it will dramatically change investors’ understanding of compensation practices. Although the new disclosures are sure to provide fodder for the media, it won’t materially affect our own ability to analyze the incentives embedded within executive compensation arrangements.

Another investor emphasized that the data we get from the rule may be more illuminating over time:

One thing I think it’s important to consider is that companies say the pay ratio will not be comparable across industries because it will be highly sensitive to offshoring, franchises, outsourcing, service models, etc. That is probably a legitimate concern. So from an investor’s standpoint, to the extent the ratio has any utility, it will be in the time series … that is, observing movement in each company’s pay ratio over time.

Silver Lining for Companies?

The SEC is giving companies some leeway in how they calculate average worker pay — by using sampling to estimate the figure. Companies will only need to update the metric every three years and can exclude as much as 5% of foreign workers in the final calculation. Companies won’t have to start reporting the pay ratio until 2017, so we’ll have two more years of rhetoric from both sides of the issue before we see any actual numbers. More importantly we hope we will have two years of engagement between companies and their investors to talk through expectations on the pay ratio, and so companies can gauge what investors care about concerning pay.

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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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