Cafe Classic: CEO Pay Ratio, Unintended Consequences?

Editor's Note:  With Pay Ratio reporting around the corner, we go back in time with Dan Walter to four years ago when it was first being discussed as a possibility. 

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, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture and considered a leading expert on equity compensation issues. Dan has written several industry resources including a recent Performance-Based Equity Compensation issue brief. He has co-authored ”Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives” and other books. Connect with Dan on LinkedIn. Or, follow him on Twitter at @Performensation.

Comments

[Charles]

Yeah, it's true. CEOs are really squeezing the employees to obtain the maximum productivity and profit for the company. However, employees' payment is not up to the extent of their efforts. CEOs cannot enjoy their status without the contribution from their employees. And in my opinion, employees should be paid a share of the company. I'm working for an academic writing company, https://www.essayschief.com and get payment on the basis of works completed.

[Tricia]

I suspect the CEO pay ratio disclosure rule will not change top executive pay practices. Most companies enjoy favorable Say-on-Pay results. Some industries might outsource their staff to a third party to achieve a better pay ratio. You can avoid including low-skilled, lower paid workers from your pay ratio if they are really employed by another company. I think that is what I fear most from this rule.

[Brian Pittman]

Yeah, It's true.
Great Post! Thanks for sharing with us. very informative post.
100% right. Well said.

[Dan Walter]

CEO pay is a very tricky topic. Some research has shown that the largest contributor to CEP Pay increases is the growing size of companies as a whole. The bigger the company is, the more someone earns to run it. But, big companies don't need to pay non-executive positions any more just because of their size.

It is unlikely that Pay Ratio will have an impact on voting. That is, unless, a scandal or two occurs where pay ratio problems also correlate.

[Karen Kervick]

Are CEOs concerned about the public knowledge of their pay ratio? Their pay currently is out there but having it scrutinized by the employees in this way, do you think it will be a motivating factor if the employees view the ratio unfavorably? If so, what do you think most CEOs would do? Offer to lower their pay or work to increase the employee compensation?

[Dan Walter]

Great question Karen,

I think that small minority of CEOs are concerned about the perception of their employees. Most are concerned about their own perception of pay relative to the people they measure themselves against.

If a company has a materially different CEO pay ratio to its close peers, it is possible they may make changes, but I do not expect that will happen often (if at all).

[Karen Kervick]

So it will be up to the employees or public to shame the CEOs who have a wildly excessive ratio into making a positive change - one way or the other. I would love to see more "do the right thing" on their own.

Of course these days we are so preoccupied and overloaded with info, employees may not even notice or see what the ratio is.

I forget the specifics of the pay included in the employee average rate, but that rate could also be skewed due to some high level earners, so it will be he lowest paid employees who will need to stand up and be heard if they feel the CEO pay is excessive.

[Dan]

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[Lesley Morgan]

So how about TMRs for CEOs and the rest of the C-suite, administered by Boards of Directors and reportable in financials? Instead of dollar amounts, tie ratios (made up of salary, perks, etc.) to min, midpoint, and max. Allow geographic and industry differentials (or whatever is deemed to make sense by whomever does the deeming). Just like we do for employees, but this time, for the C-suite.

And not following the TMRs would have tax consequences for the company and for the C-suite position holder. Maybe overages could be clawed back and distributed to the employees pro rata.

Yes, administering this would be a bureaucratic nightmare, but that describes a lot of programs that attempt to ensure fair and respectful behavior.