After years of delay, the Securities and Exchange Commission approved a sensible final rule on Wednesday that will force publicly traded companies to reveal how the pay of chief executives compares with that of typical employees.
The new “pay ratio” rule, part of the Dodd-Frank financial reform law, requires companies to compute and disclose the ratio of chief executive pay to the median pay of employees, while skillfully addressing complaints from corporate America that doing so would be a costly logistical nightmare. For instance, it allows statistical sampling to compute median pay, which will make the calculation easier for companies with many employees in differing locations.
The rule also addresses corporate concerns that are clearly political, while upholding the law’s purpose, which is to expose the gap between pay for the top boss and pay for everyone else. For instance, companies with large and generally low-paid foreign workforces are understandably worried about large pay gaps. The rule lets companies exclude a small share of their foreign workforce, generally up to 5 percent, a compromise that will not alter the ratio substantially.
Similarly, the rule lets companies report the ratio every three years, rather than every year, as was previously proposed. That is not ideal, but once pay-ratio information starts to become available, shareholder demand for consistent and timely disclosure is likely to lead to more frequent updates.
Unfortunately, the rule does not take effect until 2017, which means the first disclosures will appear on securities filings in 2018. That is a lot of time for opponents to try to derail the rule, especially if Republicans, who have consistently opposed the pay-ratio disclosure, take the White House in the next election.
Still, they would be fighting a rule whose time has come. Shareholders were recently granted the right to cast advisory votes on executive pay; the pay-ratio measure will inform those votes by providing a benchmark to gauge whether executive pay is excessive. It will also provide a counterweight to current practice, which is simply to compare an executive’s pay with that of other chief executives in the same industry. That method has contributed to ever upward spiraling executive pay: CEO compensation is currently about 300 times that of typical workers, compared with 30 times in 1980.
Company-specific ratios will also help shareholders evaluate the effect of skewed pay policies on company performance. What are the consequences for morale and turnover? Is a company courting reputational harm by paying its chief lavishly while paying its workers poorly?
The vote on the five-member SEC was divided on partisan lines. The two Republican commissioners who opposed the pay-ratio rule have also opposed other recent executive-pay proposals, including one on “pay versus performance” that would detail how executive pay tracks company results, and one on “clawbacks” that would require executive bonuses to be revoked if the financial reports on which they were based turned out to be wrong.
The pay-ratio rule will need to be carefully policed, by regulators and shareholder activists, to guard against noncompliance and manipulation. Properly enforced, it can give shareholders information that can help foster much needed change in corporate norms.