The CEO pay ratio disclosure rule in the United States (US), adopted as part of the Dodd-Frank Act of 2010, was the first of a kind. Applying to publicly-held companies, it requires disclosure of the annual total compensation paid to the CEO, the annual total compensation paid to the median employee, and the ratio between the two. The rule became effective for the 2018 proxy season, and US companies are now entering the second round of pay ratio reporting. Though the idea of a pay ratio can be traced as far back as Plato, never before have companies been required to calculate and report such a statistic.
Pay ratios are becoming a global phenomenon. Since 2010, US-style pay ratio disclosure rules have also been adopted in the United Kingdom (UK) (with effect from 2020) and India (with effect from 2013), and have been mooted in Australia and at the EU level. Israel has adopted a law limiting the deductibility of CEO pay for firms in the financial sector to 44 times the pay of their lowest-paid worker. A failed 2013 referendum in Switzerland sought to cap companies’ pay ratios at 12:1. And in the UK, politicians have proposed using pay ratios to set caps on pay for government workers and contractors.
We analyse the US experience with pay ratio reporting in an article entitled ‘Securities Disclosure As Soundbite: The Case of CEO Pay Ratios’, which is forthcoming in the Boston College Law Review. Based on a last-minute addition to the Dodd-Frank Act, the pay ratio rule generated significant controversy during the lengthy Securities and Exchange Commission (SEC) rulemaking process. Companies and their executive compensation consultants spent years and considerable resources preparing to comply with the rule. Once the pay ratio figures started arriving in 2018, they captured public imagination in ways that the typically long and technical corporate disclosure documents never do. The sizeable pay gaps highlighted by the data have led to extensive media coverage, fuelling public outrage and reinforcing concerns over pay inequity and economic inequality. Progressive politicians have cited the pay ratio data when proposing new business regulation bills. The city of Portland, Oregon imposed a penalty business tax on firms whose pay ratio exceeds 100:1. Similar measures have been proposed in states from California to Illinois to Massachusetts, and at the federal level. The pay ratio disclosure mandate has survived multiple repeal efforts since 2010, and it looks unlikely to go away in the near term.
Our examination of the history, design, and normative impact of the US pay ratio disclosure rule suggests that it reflects a unique approach to securities disclosure, which we term disclosure-as-soundbite. This approach is characterized by high public salience—the pay ratio is superficially intuitive and resonates with the public to an extent much greater than other disclosure; and by low informational integrity—the pay ratio is a relative outlier in terms of certain baseline characteristics of disclosure. The accuracy of the information is questionable because of the broad ways in which the SEC defined the underlying inputs, median worker pay and CEO pay, along with the methodological flexibility it granted firms in making the relevant calculations. Each firm’s pay ratio also presents a challenge of interpretation, and hence comprehensibility, because of the absence of objective pay ratio benchmarks and the lack of comparability among different firms’ ratios. Finally, the SEC rule requires firms to disclose only numbers, without explanation or context, which renders the information incomplete in what we believe are important ways.
We find that in its current formulation the US pay ratio disclosure rule is ineffectual and potentially counterproductive when viewed as a means of generating useful and reliable information for investors, or influencing firm behaviour on matters of worker and executive compensation. The pay ratio is more successful in fomenting or contributing to public discourse on broader societal matters relating to pay inequity and economic inequality, though the quality of the underlying information likely limits the quality of the discourse. Based on this analysis, we propose that the SEC should seek to improve the rule’s informational integrity by mandating a narrative disclosure approach that provides information about median worker pay and the resulting pay ratio with more context, nuance, and explanation. This would be consistent with the format of existing disclosure requirements relating to executive compensation, and it would represent a positive move away from the disclosure-as-soundbite approach.
Since UK-listed companies will be required to report pay ratios starting in 2020, it is worth noting that the UK pay ratio disclosure rule is not an exact replica of the US rule. The UK rule requires firms to relate CEO pay to the pay of not one but three different employees—the median employee, the 25th percentile employee, and the 75th percentile employee, and to report three pay ratios. In addition, the UK rule defines three consistent methodologies for calculating the ratio and requires firms to identify which methodology they have followed. The UK rule also calls for narrative disclosure on ‘whether the company believes that [the CEO-to-median worker pay ratio] is consistent with the company’s general employee pay, reward and progression policies and, if so, why’. This approach can be expected to result in disclosures that have higher informational integrity. It remains to be seen, however, whether this will be enough to render the UK pay ratio experience qualitatively different from the US one. One thing is certain: whereas in the past the annual corporate reporting season generated a discussion of CEO pay alone, the discussion will now also cover the pay of rank-and-file workers and the CEO pay ratio.
Steven A. Bank is the Paul Hastings Professor of Business Law at UCLA School of Law.
George S. Georgiev is an assistant professor of law at the Emory University School of Law.