The Conference Board Governance Center Blog

Dec
05
2013

CEO-to-Worker Pay Ratios Are Material To Investors

By Brandon Rees, Acting Director, Office of Investment, AFL-CIO

A long overdue executive pay provision of the Dodd-Frank Act will finally go into effect in the near future. As required by Section 953(b), the Securities and Exchange Commission has proposed rules to require public companies to disclose the median pay of all employees, and the ratio of pay between the median employee and the CEO.

The SEC has received over 100,000 comments that are overwhelmingly in support of this disclosure provision. Investors who have come out in favor of the rule include pension plans such as CalPERS and NY State Common, socially responsible investors including Walden and Trillium, and international investors like Railpen and Amundi.

Many of these investors’ letters express concern that existing CEO pay practices are flawed. At most companies, CEO pay levels are set based on a peer group analysis of what other CEOs are paid. While the CEO’s final payout may vary based on performance, the targeted amounts are based on these peer group studies.

The problem is that peer group benchmarking leads to CEO pay inflation. Not every CEO can be paid above average, yet no company wants its CEO to be “below average.” Some companies explicitly target their CEO’s pay above the median, while others cherry-pick their peer group with higher paid. Year after year, the average rises.

While peer group data is relevant for setting CEO pay levels, it shouldn’t be the only factor taken into consideration. Pay ratio disclosure will encourage board of directors to consider the relationship CEO pay levels relative to other employees. Investors will also use pay ratios as a metric to evaluate the appropriateness of CEO pay packages.

Why are these pay ratios material to investors? High levels of CEO pay relative to other employees can reduce company performance. Employees are well aware of how much their CEO is paid. Employee productivity, morale, and loyalty suffer when workers see that the CEO is taking more while those same workers do more for less.

In contrast, a reasonable pay ratio sends a positive message to the workforce that the contributions of all employees are valued. Accordingly, the Council of Institutional Investors recommends that compensation committees consider “the relationship of executive pay to the pay of other employees” as a factor when setting executive pay.

Pay ratio disclosure will help investors allocate capital to companies based on human capital considerations. There is no one-size-fits-all answer for the ideal ratio of CEO-to-employee compensation. Rather, disclosure will permit investors to compare the employee compensation structures of companies over time and to their competitors.

Lastly, pay ratio disclosure will help constrain further growth of CEO pay levels. Over the past two decades, average CEO pay at large U.S. corporations has increased at twice the rate of average worker pay. Had CEO pay grown at the same rate as worker pay, the average large company would have paid its CEO $5 million less in 2012.

Pay ratio disclosure gives investors an additional metric to consider when voting on “say-on-pay” votes and other executive compensation matters. This is important because the siren song of high pay can tempt CEOs to take on excessive risks. That’s why pay ratio disclosure is integral to the Dodd-Frank Act’s executive pay reforms.

About the Guest Blogger:

Brandon Rees, Acting Director, Office of Investment, AFL-CIO

Brandon Rees, Acting Director, Office of Investment, AFL-CIO

Brandon Rees is the Acting Director of the Office of Investment for the American Federation of Labor and Congress of Industrial Organizations (AFL-CIO). Brandon Rees joined the AFL-CIO Office of Investment in 1997. He received his B.A. in Economics and J.D. from U.C. Berkeley.

 

 

 

 



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