As SEC Adopts CEO Pay Ratio Rule, What Will It Mean For Investors And Workers?

The Securities and Exchange Commission adopted a “pay ratio” rule Wednesday that will force publicly traded companies to disclose a comparisons between what top executives earn and the salaries of workers. The vote will bring to life a few controversial lines written into the Dodd-Frank financial reform law in 2010 that have existed in a state of suspended animation amid resistance from major corporations and business trade groups. But it’s unclear whether the rule will serve to shame companies into adopting more equitable pay regimes or align the interests of corporate shareholders with those of workers.

The commission’s final vote won’t go unopposed. More fighting is likely on the way, as one of the SEC’s two Republican commissioners has already predicted a possible court challenge. Supporters of the rulemaking, however, say it will carry substantial weight. Investors and the public have known for years what top executives earn. Never, though, have companies had to spell out a multiple of what the boss earns compared with the wages of the median employee.

“It’s going to be a big number. It’s going to disrupt the operations of the company,” says Charles Elson, a critic of rising CEO pay and expert on corporate governance at the University of Delaware.

The requirement, slipped into the Dodd-Frank law at the 11th hour, was never the type of metric that investors were clamoring to know. It is instead, Elson says, meant to “shock the employees to demand change. It’s designed to create dissension.”

The provision came about at a time when many were concerned that run-away CEO compensation contributed to the financial crisis. (The Dodd-Frank law also gave shareholders a non-binding “say on pay” vote to tell companies whether they’re for or against the CEO’s compensation amount).

The SEC’s proposal to flesh out the pay ratio — first released in September 2013 — has taken place against the sharpening national debate over income inequality and stagnant worker wages. Whereas inflation-adjusted CEO pay at the 350 largest companies by revenue skyrocketed 997 percent between 1978 and 2014, the annual salary of a “typical” worker (i.e. not a supervisor) grew only 10.9 percent, according to a recent analysis by the Economic Policy Institute, a left-leaning think tank in Washington, D.C. The CEO-to-worker pay ratio, the study found, grew from 20-to-1 in 1965 to 303-to-1 in 2014. The ratio hit a peak of 376-to-1 in 2000.

Elson says the new disclosure requirement could staunch the trend. “I think it’s going to force companies to refigure CEO pay, and realign it for how pay is constructed for the rest of the organization,” Elson says.

From an investor standpoint, the disclosure will offer shareholders an additional data point by which to identify potential concerns, according to Timothy Smith, a senior vice president at Walden Asset Management. The socially responsible investment manager, together with its parent, Boston Trust, has $8 billion in assets under management. "For an investor, this is not about the embarrassment factor," says Smith. "It's saying, moving forward, we believe companies should be paying attention to trends in compensation for executives and compensation for workers."

Pegging CEO paychecks to what others in the company earn would indeed signal a marked shift in how boards of directors usually determine those salaries. Boards often rely on “peer groups” — what CEOs earn at other companies — to gauge what their own leader should make. In theory, this provides boards with an objective standard to judge pay, and they can choose to compensate their chief executive below, at, or above a given benchmark.

In reality, though, both boards and CEOs often believe (or want to believe) that their CEO is worth more than what his peers are making. “The comparison to everyone else means there’s just this pressure to make the number higher and higher,” says J. Robert Brown, a professor at the University of Denver Sturm College of Law.

This also puts a company’s board of directors in an awkward position when the chief executive comes to them and asks for a raise. ”That’s a hard argument to turn down to your CEO: We don’t think you're worth what these other CEOs are worth,” Brown explains.

The new pay ratio rule, however, could give board members an out — a solid excuse to temper the CEO’s pay if they want to avoid a ratio that looks, well, bad on paper. “It provides the compensation committee with an incentive to pay less in [executive] compensation in order to have a good ratio,” says Brown. "I think that’s where it will have an effect.”

Opponents of the rule however, contend that it won’t move the needle either way on pay — not up for workers, nor down for chief executives. Companies pay their workers according to the demands of the market, just as boards pay their CEOs “what they believe is appropriate and consistent with the market to get the best talent possible to manage the company,” says Timothy Bartl, president of the Center on Executive Compensation, research and advocacy group for human resource officers.

The regulation “will not result in pay changes,” Bartl says. What it will do, he argues, is divert time and resources away from areas that actually matter to investors. “There will be a cost to it, and that cost will result in companies paying attention to things that don’t have significant impact” to shareholders, Bartl says.

Heather Slavkin Corzo, director of the AFL-CIO office of investment, notes that compensation across all levels of the company effects employee morale and productivity. If workers are "not motivated by their compensation," she says, "then it has an impact from an investor perspective.”