Companies Must Disclose Ratio of CEO Pay to Median Employee Pay

August 7, 2015
Sally Abrahamson

The SEC voted on Wednesday to require public companies to disclose the ratio of their CEOs’ compensation to the median compensation of its employees. The new rule, which was approved by a 3 to 2 vote, stems from a mandate included in the Dodd Frank Wall Street Reform and Consumer Protection Act.

The Dodd-Frank act, which was enacted in 2010 in the wake of the 2008 financial crisis, introduced new regulations and oversight targeting the financial industry. It also included several provisions addressing executive compensation both in the financial industry and beyond. Among those were mandates for nonbinding shareholder approval votes on executive compensation packages (i.e., “say-on-pay”), compensation committee independence, and disclosure of executive pay versus performance. The ratio disclosure rule is the latest of these to achieve SEC enforcement status.

Critics call the new rule nothing more than a shaming tactic and argue that compliance will be costly and time-consuming. (It should be noted that the rule will not apply to certain smaller companies and emerging companies). Supporters of the rule are hopeful that it will give shareholders a clearer picture of the compensation practices and priorities of the companies in which they are invested.

This not the first time that those who would wish to reform executive compensation practices have championed a measure intended to arm shareholders with more information about executive compensation. Indeed, the pay ratio rule is merely the latest in a long series of efforts to curb executive compensation by providing shareholders with greater transparency1.

One might expect that such measures, particularly when combined with say-on-pay voting rights, might have the effect of leading shareholders to call for reduced compensation levels for high-ranking executives. So far, however, this has not been the case. Despite the fact that Americans have become increasingly conscious of income inequality issues in recent years, shareholders have rarely voted against the executive compensation packages submitted for their votes. Instead, the packages are frequently approved by a landslide.

It remains to be seen whether pay ratio disclosures will change the status quo. Even if they do not, however, the rule may not be without impact. Since employers will be compelled to disclose the median pay of its rank-and-file employees, commentators have speculated that some employees may be motivated to question their own position within the range of employee compensation at their companies. For example, an employee whose pay is below the median may demand to know why she is paid less than her peers. Given that many employers maintain spoken or unspoken policies that discourage discussions of pay among employees (despite the fact that such policies are generally unlawful), the information employees may glean as a result of the pay ratio rule could give rise to some shake-ups – or at least some headaches for employers.

[1] Executive compensation disclosures were first required in their modern form in 1982, providing for certain information to be presented in a tabular format. Changes made in 1992 (adding the requirement of a narrative, among There changes) and 2006 (overhauling the presentation of, and expanding the requirements of, executive compensation disclosures), and further changes since then, including pursuant to the Dodd-Frank Act, were meant to provide shareholders with more complete, understandable information on executive compensation.

(*Prior results do not guarantee a similar outcome.)