Fair Game
By GRETCHEN MORGENSON
It is a confounding truth about outsize executive pay — all past attempts to rein it in have failed.
So why does anyone expect a different outcome from the Securities and Exchange Commission’s new rule requiring disclosure of the gap between what a company’s chief executive is paid and what its rank-and-file workers earn?
I put that question to some experts on executive pay; several of them gave intriguing reasons to be optimistic that this rule may actually do something to curb over-the-top pay.
Their thinking goes like this: Because the rule will generate an easily graspable and often decidedly shocking number, it may energize a cadre of new combatants in the executive pay fight. And because these newcomers — company employees, state governments and possibly even consumers — will most likely be more vocal on the matter than institutional investors have been, the executive pay bubble might actually start to deflate.
“The pay ratio was designed to inflame the employees,” said Charles Elson, professor of finance and director of the John L. Weinberg Center for Corporate Governance at the University of Delaware. “When they read that number, employees are going to say, ‘Why is this person getting paid so much more than me?’ I think the serious discontent will force boards to reconsider their organizations’ pay schemes.”
The rule, which passed the commission on a 3-to-2, party-line vote, has been five years coming. Under the Dodd-Frank law, the S.E.C. had to come up with a regulation requiring large public companies to calculate the difference between what their top executives receive in compensation and the median pay level for their other employees.
The new rule goes into effect on Jan. 1, 2017, over strenuous opposition from the U.S. Chamber of Commerce and other corporate lobbying groups. But there was also support for the rule from investors, individuals, academics and advocacy groups. More than 287,000 letters poured into the S.E.C. after it proposed the rule in September 2013.
The companies’ pay ratios haven’t been calculated yet, but everyone acknowledges that many will be astronomical. A 2014 study by Alyssa Davis and Lawrence Mishel at the Economic Policy Institute, a left-leaning advocacy group in Washington, showed that chief executive pay as a multiple of the typical worker’s earnings zoomed from an average of 20 times in 1965 to almost 300 in 2013.
Some companies’ ratios will be far greater than that.
And yet, Brian Foley, an independent compensation consultant in White Plains, said the way the S.E.C. was requiring companies to calculate the rule would probably understate the true pay gap. That’s because the calculation, which relies on what is known as the summary compensation tables in the annual proxy statement, does not include the total amounts executives have built up in their pensions and supplemental retirement plans.
“The pension numbers baked into the summary compensation table are only year-over-year improvements and don’t begin to capture how much the C.E.O. has on the table in terms of retirement money compared to how much the troops typically have on the table,” he said.
The S.E.C. has always contended that the rule will help inform shareholders, especially as they ponder how to vote on companies’ pay practices.
But Mr. Foley doesn’t think investors will pay much attention to the new rule. Neither does James Reda, managing director of executive compensation consulting at Arthur J. Gallagher & Company. “It is not clear how institutional investors or their advisers will use the pay ratio, if at all,” he said. “However, it is conceivable that labor pension funds may use the number to consider an investment in a company.”
The fact is, few institutional shareholders appear to be distressed by excessive pay levels at companies whose shares they hold. A tally by the Shareholder Forum of the most recent votes on pay practices at companies in the Standard & Poor’s 500-stock index shows a median support level from shareholders of 94.9 percent this year.
This complacency could have a lot to do with the rising stock market. But it almost certainly does not reflect the views of 95 percent of investors. What it does reflect is the practice of large mutual fund companies like Vanguard and Fidelity to vote their clients’ shares routinely in support of lush pay practices whether they like it or not. These voting policies help keep corporate boards clubby and executive pay aloft.
Although institutional investors will probably continue to look the other way on executive compensation, the disclosure of a pay gap may encourage other stakeholders to act differently. That’s the view of Sarah Anderson, global economy project director at the Institute for Policy Studies, a left-leaning organization in Washington.
“It makes a lot of sense to bring the C.E.O. pay ratio out of the shareholder realm and into the consumer’s,” Ms. Anderson said. “There’s also interest at the state level to take this indicator of C.E.O.-to-worker pay and incorporate it into tax policy and procurement policy.”
She cited a 2014 bill proposed in the California Senate that would have raised the state’s corporate income tax to 13 percent from 8.84 percent for companies that pay their top executives over 400 times the median pay of their workers. That bill also would have lowered the tax rate to 7 percent on companies with a top-executive-to-worker pay divide of less than 25 to one.
The bill did not pass with the two-thirds majority it needed, but one of its co-sponsors is working to move it forward, Ms. Anderson said.
In January, five Rhode Island senators introduced a bill setting preferences for how state contracts are awarded, giving a leg up to businesses that have relatively low pay ratios of 25 to one.
A companion bill may be introduced in the Rhode Island House of Representatives in the next session.
It’s possible, too, that some consumers, disturbed by the disparity between a corporate chief’s pay and that of lower-level workers, will change their shopping habits to favor companies whose pay is fairer. If institutional investors won’t vote with their feet on this matter, perhaps consumers will.
“Everybody is outraged about C.E.O. pay, but people feel they can’t do anything about it,” Ms. Anderson said. “What I’m hoping is that this will give people something to do about it that’s concrete.”
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