SEC ruling: Will it shrink the wage gap or lead to fairer CEO pay?

We all know that the CEOs of most major companies make a lot more money than the average worker, but now the Securities and Exchange Commission (SEC) wants us to know exactly how much more.

On Wednesday, the SEC ruled that after five years of delays, an important provision of the 2010 Dodd-Frank Act will be enacted. The provision compels public companies to disclose the ratio between their chief executive’s annual salary and the median employee pay. But while equality advocates say the ruling will allow activists and shareholders to pressure large companies into narrowing the pay gap, others say that it misses the point entirely. Instead of focusing on the ratio between CEO earnings and those of employees, critics say, the SEC should look at whether CEOs are really getting paid what they are worth.

“It really depends on performance, not on ratio. No one ever says Bill Gates gets paid too much at Microsoft. They won’t say that because he built the company,” says Robert Pozen, senior lecturer at the MIT Sloan School of Management and senior fellow at the Brookings Institution, a moderate Washington think tank.

“If a company was in really big trouble and a CEO came in and turned it around, they get paid really well for doing that. I don’t know anyone who disagrees with that. I think people are concerned when CEOs get paid a lot when the company isn’t really doing very well,” he continues. 

Publicly traded US companies are already required to disclose their CEOs' salaries, and some already disclose the ratio of CEO compensation to rank-and-file worker pay, though they don't use the "median" figure the SEC now requires, analysts say.

Still, many have criticized the SEC's method, pointing out that companies can exclude up to 5 percent of their foreign workers and use sampling to estimate the figure, instead of tallying data from all of the company payrolls.

Mr. Pozen, meanwhile, says that the SEC calculations are a poor reflection of what a CEO is actually compensated.

“A lot of this is computational," he notes. "For instance, if a company grants a CEO $20 million of restrictive shares [on the condition] that they meet certain revenue targets, it gets reported as a big number. But it’s not clear this is actually going to happen. Maybe these performances will be met and maybe they won’t. What we should be looking at is actual pay," rather than compensation packages.  

Moreover, he says, many of the companies subject to the SEC's ruling have workers in many different countries. And some have far more than others, meaning the wage makeup of the workforce – and how it compares to the general working conditions in the countries where those workers reside – can vary greatly from company to company.

“I think there is a lot of methodological debate about what the proper way is to get an average or median worker. The SEC has decided you can exclude only 5 percent of your foreign workers. But multinational companies have people throughout the world, and many of these countries are in very different wage situations. You would not expect, for example, a factory worker in Vietnam to make what a factory worker would make in the US,” he says.

Wage conditions in Poland, Australia, or Vietnam, then, are taken into account in the SEC's calculations, but they aren't necessarily relevant to the inequality fight in the US. 

Still, equality advocates say that the ruling is necessary to narrow the gulf between worker and employee salaries, which has widened approximately ten-fold in the last 65 years. According to Labor Department earnings statistics calculated by the Associated Press, a chief executive made about 205 times the average worker's wage last year, compared with 257 times in 2013.

“We need many more policies that change corporate governance, that change our tax policies towards corporate pay, that raise marginal income tax rates. But I think this is one piece of the puzzle,” says Lawrence Mishel, President of the Economic Policy Institute.

“Companies already provide information in their proxy statement about what the CEO makes. But it adds a dimension. CEOs make a lot of money, and people don’t know how to put numbers in context, so one large number is no different than another very large number. So it could be that the ratio puts the number in context.”

While most observers are unsure whether the ruling will succeed in changing how companies pay their employees, many say this obligatory disclosure has the potential to be an important tool for shareholders and others who weigh in on CEO salaries. In 2011, after the financial crisis sparked outrage over the inflated paychecks of the country’s top CEOs, the SEC gave shareholders of public companies the right to register their opinion about an executive’s pay in a non-binding vote. Still, the ratio disclosure could help highlight the biggest discrepancies, advocates say.

“The Economic Policy Institute notes that C.E.O. pay has risen even faster since 1979 than overall pay for the top 0.1 percent. And if that’s right, then you can imagine subtle regulatory changes like the new disclosure rules mattering. If boards are overpaying C.E.O.s because they are selfish or stupid, exposing their pay practices to the light of day might make some difference,” wrote Neil Irwin for the New York Times.

There are concerns, however that the rule could prompt the most effective CEOs to move to privately-owned companies that could pay them more without fear of scrutiny, a result which could lead to a talent drain for publicly owned companies.

“If boards do respond to public pressure and slash C.E.O. pay, publicly traded companies could see an exit of top talent toward privately held companies that don’t face similar disclosure rules, potentially making some of America’s biggest and most important firms less well run as a consequence,” added Mr. Irwin for the Times.

The gap between CEOs' pay and that of the average worker narrowed slightly last year, after average wages grew more than CEO pay did. Nevertheless, the average salary differs from the median used in the SEC's rule, which is calculated as the point at which half the company's employees earn more and half earn less.