Controlling CEO Pay

How Will It Play Out?

The SEC recently established a new rule requiring most companies to disclose the ratio of CEO pay to that of their average employee. “Fifty years ago, chief executives were paid roughly 20 times as much as their employees, compared with nearly 300 times in 2013,” according to a study cited in The New York Times.

The rule in no way dictates what the pay should be, but it gives investors a window into the compensation practices of publically traded firms. The new rule is designed to help investors compare pay scales in companies. But it also promotes awareness of growing income inequality. Thomas Piketty, the French economist whose best-selling book helped fuel a global debate on income inequality, notes “higher wages for top earners in corporate America had been among the main drivers of the widening income differences in the United States.” He added in an interview last year: “The system is pretty much out of control.”

On the other hand, as The Times noted, “Representatives of corporations were quick to assail the new rule . . . saying that it was misleading, costly to put into practice and intended to shame companies into paying executives less.” It is probably all of those things – but that does not mean it is a bad idea. How will it play out?

Gretchen Morgenson at The Times looked into it and found a number of experts on who thought the rule might actually succeed in curbing “over-the-top pay.” The numbers, easy to grasp and probably shocking to many, could possibly galvanizing employees as well as state governments to act. Even so, the official ratios probably will underestimate the true extent of the disparity as the numbers will not include pensions and supplemental retirement plans – which most executives and almost no other employees enjoy.

Investors won’t care, and the large mutual funds, like Vanguard and Fidelity will “vote their clients’ shares routinely in support of lush pay practices whether they like it or not.” As Morgenson notes, “These voting policies help keep corporate boards clubby and executive pay aloft.”

So the new rule is unlikely to be effective by itself, without significant efforts to influence public awareness. That may well occur as the presidential campaign heats up.

But a more immediate effect, according to The Wall Street Journal is that “businesses will spend more time explaining to employees at all levels how they set pay.” When lower level employees know what the averages are in their companies, as a result of the rule, they can and no doubt will agitate for increases.

That’s the real issue, shining a light into the black box of corporate compensation. Charles Elson, Director of the Center for Corporate Governance at the University of Delaware, commented that the “pay ratio was designed to inflame the employees.”

That is no doubt what so profoundly agitates the U.S. Chamber of Commerce and other corporate lobbying groups who are opposing the rule. “When they read that number, employees are going to say, ‘Why is this person getting paid so much more than me?’” Elson speculates: “I think the serious discontent will force boards to reconsider their organizations’ pay schemes.”

So in the end, the new rule may not mean that CEOs will get paid less, but that other high level employees will end up getting more. Paradoxically, that will increase the cost of management and, no doubt, widen that gap between the rich and poor.