CEO Pay Ratio : Unintended Consequences?

The dreaded CEO Pay Ratio Disclosure is almost here! The SEC has proposed the rules for the regulation required by Dodd-Frank. Companies have railed against this rule as being complex, expensive and more hyperbole than helpful. Activists have clamored for the rule to help expose the lack of link between CEOs and those who work at their companies.

I have gone into potential issues in prior posts here at the Comp Café and other places. I won't rehash some of the obvious and commonly stated concerns in this posting. But, I will point out a potentially disastrous unintended consequence.

The rule was written as a last minute addition to the Dodd-Frank Bills, by U.S. Sen. Robert Menendez, D-N.J. A stated goal of the rule was to slow the increase of executive pay by showing the gulf between compensation separating CEOs and their average workers. The idea is that people will see the enormous gap between some CEOs and their staffs and rain down hellfire on those companies until they reduce CEO pay. That result seems unlikely in all but the most egregious and extreme cases.

Let’s talk about a possibility that hasn’t yet been raised.  What if investors do the opposite of what is hoped by the new rule’s benefactors? Investors are pretty single-minded in getting the best return for their investment. They worry about things like keeping costs low and profits high. Investors like when their investments spend money below the level of their peers while providing returns above them.

What if a major investor sees that their company’s CEO to Employee Ratio is 150:1 while a competitor’s is 250:1.  And, what if both CEOs make about the same amount of money and provide the same returns? Will the investors call for a lowering of their CEO's pay? Not likely. Will they demand their company’s CEO be paid higher simply to make the ratios more similar? Again, extremely unlikely. OR, will they ask why the average staff member at the companies they invest in is paid so much more than at the competition? Will the compensation department be asked to explore ways to reduce pay for the rank and file with the goal to get pay ratios in line with “market data”?  Hmm... Maybe.

While I hope this won't be the case, it would not surprise me if it happens.  Remember, you read it at the Compensation Café first!  What are your thoughts about the eventual impact of disclosing pay ratio?

Dan Walter is the President and CEO of Performensation an independent compensation consultant focused on the needs of small and mid-sized public and private companies. Dan’s unique perspective and expertise includes equity compensation, executive compensation, performance-based pay and talent management issues. Dan is a co-author of “The Decision Makers Guide to Equity Compensation”, “If I’d Only Known That”, “GEOnomics 2011” and “Equity Alternatives.” Dan is on the board of the National Center for Employee Ownership, a partner in the ShareComp virtual conferences and the founder of Equity Compensation Experts, a free networking group. Dan is frequently requested as a dynamic and humorous speaker covering compensation and motivation topics. Connect with him on LinkedIn or follow him on Twitter at @Performensation and @SayOnPay.

Comments

[Darcy]

While I understand the thought process behind this ruling, I don't think it will actually provide very useful information. I previously worked in the restaurant industry where most staff are paid at the minimum tip credit wage ($2.13 per hour in federal regulations). That would make the ratio ridiculous even if CEO pay makes sense. I now work in the oil and gas industry where everyone makes a decent wage and so the ratio looks better, even though the CEO makes significantly more. But many people will lack this background information and may end up making decisions without the proper context. Plus I don't know that most serious investors will care about this ratio at all. I guess we'll see how this plays out.

[E. James (Jim) Brennan]

Agree that few will understand the metric well enough to make sensible use of it.

Basing the ratio on the median rather than the average creates great complications, too. The middle number paid to all individual employees is much harder to determine than the simple average. I fear that compliance will be so difficult and costly that it will deflect attention from other more important areas. The consistently unexplained insistence on the difficult median versus the easy average makes me suspect nefarious motives.

[Tony Bergmann-Porter]

As I have said in some other fora, I suspect this will lead to companies staying private, going private, or offshoring altogether. This has nothing whatsoever to do with transparency or informing investors; it is an ideologically-driven initiative to provide sensational data to bait the ignorant.

[[email protected]]

I agree. There will be huge problems caused by people not interpreting this data accurately.

I have to say this is the reason I oppose the SHRM initiative to force companies to publish all sorts of metrics/data. It will not be understood. And I sincerely doubt that investors will be be swayed by it either way.

A very naive initiative that at best won't have any effect ---- and at worst will be a disruptive and irritating nuisance.

[John Bushfield]

This requirement for disclosure will simply add fuel to the pay inequity fire already burning across the land. We already know the ratios will appear dramatic, probably inaccurate (the more complex, the harder to get right), and have no useful meaning, other than make many employees feel bad about their pay.

Yes, the rich are getting richer, and CEO's have become the Antichrist in the 'whose getting paid what' debate. These executives are paid to do a tough job well, and when they do more than the CEO benefits.

I have to say that I'm not surprised SHRM is on the wrong side of this issue. Its sad to see an organization continually squander opportunities to truly advance the profession they purport to represent. Of course, that's just my opinion . . .

[Dan Walter]

A lot of great comments here. Also nearly complete agreement in the lack of usefulness of this new rule. My fear is that not only will it not be useful, but that it will also backfire and result in even greater pay inequity.

If this happens compensation professionals on all areas of the spectrum will once again look clueless or complicit (neither sounds good to me.)

Thoughts?

[Tony Bergmann-Porter]

Well, to not look clueless or complicit would require the leadership of SHRM and WorldatWork to take a non-politically-correct stance on the topic. Good luck with that...

[John Bushfield]

Absent some seismic shift in the equity markets coupled with an adjustment to the business model driving compensation practices, I fear greater pay inequity, or the perception of greater pay inequity, is inevitable. The incentive to derail that train is simply not there otherwise.

Unfortunately, the very nature of their craft puts Comp pro's at the front of the complicit/clueless line, and are easy targets for blame. SHRM leadership is an oxymoron; a non-politically correct stance on this topic would take some original thinking, and a willingness to take a risk, neither of which appear to exist in that organization.