Meet the little ratio that is driving corporate America crazy.
Tucked into a corner of the three-year-old law reforming the U.S. financial system was a small provision: It required publicly-traded companies to reveal how the pay of the chief executive compares to the average earnings of the firm’s employees.
This relatively minor rule – now being finalized by U.S. regulators – has inspired a major pushback from big corporations. They say the number is difficult to compile, costly to calculate and meaningless for investors – and as a result, they’re seeking to dilute or postpone the requirement.
The ratio “is merely an effort to achieve social objectives unrelated to investment decisions,” said David Hirschmann of the U.S. Chamber of Commerce, in a letter submitted to regulators earlier this month.
The regulation’s supporters, including pension funds and other socially-minded investors, disagree. They argue disclosing the ratio can help rein in excessive executive pay and put a spotlight on the compensation framework within a single company.
In recent months, the two sides have clashed in submissions to the U.S. Securities and Exchange Commission, which is expected to issue the final regulation next year. The regulator has received more than 600 detailed comments on the rule from trade associations, major corporations, pension funds, unions, lawyers and academics (and more than 120,000 form letters from ordinary citizens expressing their support for the rule).
The rule on the pay ratio taps into a broader discussion surrounding income inequality in the U.S., where the top earners have seen their compensation swell over the last thirty years while the pay of average workers has stagnated. On average, chief executives of companies in the Standard & Poor’s 500 Index earn 204 times more than the typical employees in their industry, Bloomberg News calculated earlier this year.
Charles Elson, a corporate governance expert at the University of Delaware, said he wasn’t a fan of the new requirement at first, calling it a “cheap thrill” rather than essential information for investors. But he now believes there could be positive consequences.
“The rule is going to force companies to make a disclosure and you’re going to get some big numbers,” he said. “It will force boards to look holistically at pay” – instead of only focusing on how executives are compensated compared to their peers at other companies.
The Center for Executive Compensation, the advocacy arm of the human-resources trade group for America’s largest companies, has made its opposition clear. Timothy Bartl, the president of the Center, called the rule “excessively burdensome, especially to global companies, relative to the scant or non-existent benefits.”
Mr. Bartl said the center’s members are multinationals that operate, on average, in 34 countries with 46 different HR systems. In a recent survey of its members, all of them said they saw “no purpose for calculating” the ratio, he said. When asked whether any of their 10 largest investors had asked for such information, the respondents all said no.
Some investors, however, feel differently. Canada’s NEI Investments, for instance, which manages $5.5-billion in assets, submitted a letter to the SEC commending it for its efforts.
“There are people who are very concerned about whether [the ratio] is very difficult to calculate. There are also people who are concerned that the number is going to look bad,” said Michelle de Cordova, NEI’s Director of Corporate Engagement and Public Policy. She added with a laugh: “If you are genuinely concerned that it is going to look bad, maybe it is bad.”
NEI has also engaged with Canada’s major banks to push them to incorporate some kind of internal comparisons into their reporting on executive compensation. It remains unclear if or how they will do that, but Ms. de Cordova will be watching closely. “We are certainly looking for some disclosure that allows us to understand senior executive pay in the context of the company as a whole,” she said.
Reporting a CEO pay ratio is not unheard of in corporate America – indeed, a handful of companies already do so willingly. Whole Foods Market Inc., the grocery-store firm, established an internal limit where no executive’s cash compensation can exceed 19 times the average wage for employees. The process of calculating where those limits fall is a “relatively straightforward process that takes a few days,” a Whole Foods executive told The Wall Street Journal last year.