The Securities and Exchange Commission voted 3-2 along party lines this week to approve a final implementation requiring large companies to disclose how much more their CEO makes compared to the median employee. The requirement was included in the Dodd-Frank Act passed into law in 2010, but the SEC did not make its first enforcement proposal until 2013. The SEC has received more than 280,000 public comments in favor of the rule in the two years since then.
Opposed by pro-business groups and Republicans as an unnecessary and expensive sop to fuel witch hunts against corporations with highly-paid CEOs, the measure was supported by unions and social justice groups to highlight to shareholders the inequality between CEO compensation and worker pay. While growing income equality between “the 1%” and the average American worker is well-documented, some economists worry that boiling the subject down to a single number does nothing to help discussion of the matter.
What is the CEO Ratio Disclosure Rule?
Starting in fiscal year 2017, public companies with annual gross revenue over $1 billion must include the ratio between CEO compensation and that of the “median worker” in their annual financial reports. (CEO compensation is already reported.) This ratio must be recalculated at least every three years.
This measure does not limit CEO pay in any way. It simply requires companies to disclose the median salary of their workforce, and compare it to the CEO’s pay.
Who Is Exempt?
- Private companies
- Registered investment companies
- Foreign companies
How Is It Calculated?
Corporations can actually calculate the median employee pay by using the pay of all employees, or it can “statistically sample” its workforce to estimate the number. This measurement must be made sometime in the final three months of the company’s fiscal year, which will allow some companies to avoid counting seasonal workers that would drag the median number down.
What About Foreign Workers?
For companies with overseas operations, up to 5% of their foreign workforce can be excluded from the calculation. In addition, a “cost of living multiplier” can be applied to the salaries of foreign workers, to reflect their domestic purchasing power compared to the US.
For example: If a foreign worker is paid half the wages of a U.S. worker, but has the same domestic purchasing power, his wages will be adjusted to equal the U.S. worker’s.
What Are the Concerns?
While some express concern that this measure could spark an increase in CEO pay, as some CEOs demand to be paid better compared to others, a more likely concern is employee disgruntlement when they compare their pay to the median salary for the company as a whole, or competitors’ pay scales. This may lead to a lot of headaches for middle management, as many employees demand better wages.
Another concern is possible lawsuits over the accuracy of the ratio number, since it is included in the company’s annual report. Others say that this legally-required accuracy will discourage “cooking” the ratio so that CEO compensation doesn’t look so bad.
Opponents say that abiding by this regulation will cost far more than the SEC estimates. The U.S. Chamber of Commerce, which has fought against implementing the law, is all but certain to launch a lawsuit, and the corporate lobbying group Center on Executive Compensation declared the rule useless, except for unions, certain pension funds, and social activists “to drive their own narrowly-tailored agendas.” Republican members of Congress have vowed to take action to strip the measure from Dodd-Frank.
Supporters of the measure say that it gives investors another data point when deciding whether to invest in a company, and reflects the executive board’s policy towards running the company. Unions and social advocacy groups will use the information to highlight income disparity in attempts to gain concessions for higher wages. “Activist investors” who look to wring the most from their stake in a company, will demand explanations if a company’s performance for shareholders does not match the CEO’s paycheck.
How Much Are CEOs Paid, Anyway?
The Economic Policy Institute notes that: “From 1978 to 2013, CEO compensation, inflation-adjusted, increased 937 percent, a rise more than double stock market growth and substantially greater than the painfully slow 10.2 percent growth in a typical worker’s compensation over the same period.”
While CEO pay has ballooned compared to worker pay pay (growing from 20x worker pay in 1965 to 296x in 2013), it actually has been worse in the past.
No matter which side of the argument you are on, it’s obvious that this new requirement of disclosing the ratio of pay between the CEO and the median worker will ignite the controversy over stagnating wages and income equality. Most of the added corporate expenses, though, may be from dealing internally and externally with the fallout from the release of this data, rather than compiling it.