The Pay Ratio Rule and the Effect of Disclosure

The SEC this week approved the pay ratio rules, required under the Dodd-Frank Act. Details can be found in the SEC’s adopting release and press release. The rules require disclosure by public companies of the ratio of the compensation of its CEO to the median compensation of its employees. My topic today is not the finer points of the rules, which are not really relevant to my practice – the “smaller reporting companies” that I represent are exempt from the disclosure requirements – but on the policy underlying the rules.

There is no debate over the fact that, over the past few decades, the average pay ratio has gotten far larger, i.e., top executives now receive far more in compensation than the average employee, as compared to the state of affairs during the 1950s and 1960s. If you accept that executive compensation is out of whack, as I do (though that is in part a political judgment), the question becomes the best way to address it. By introducing the pay ratio disclosure concept, the drafters of Dodd-Frank adopt the Justice Brandeis view that “sunlight is the best disinfectant,” that disclosure of the pay gap will embarrass companies and lead stakeholders to push them toward fairer pay structures.

However, although I wouldn’t say I’m in favor of opacity and non-disclosure, it’s fair to question whether requiring this disclosure will have the desired effect. Greater public dissemination of compensation information has not resulted in reduction of compensation; quite the opposite. The publication of law firm profit figures by the American Lawyer magazine has fueled the sense among partners that there are greener pastures elsewhere, leading to high guaranteed pay packages. Agents for free agent athletes cherry pick examples of other highly paid players – and everyone now knows what they’re paid – to negotiate higher pay for their clients. And getting back to public companies, the SEC has for years required detailed compensation disclosure for senior executives, and the result has not been embarrassment and retrenchment, but the hiring of compensation consultants that use the public data to justify ever more generous pay packages. Walmart shareholders are already well aware that the CEO is paid far more generously than a median worker; calculation and disclosure of the ratio will have no impact on their willingness to vote in favor of “say on pay” proposals or to retain directors who approve generous pay packages.