Pay Ratios, Commissioner Aguilar and the Concerns with Voluntary Implementation

In late February, Commissioner Aguilar gave a highly useful talk on the need for, and importance of, "robust disclosure" to allow shareholders to effectively exercise their voting rights.  The talk recommended that companies make expanded disclosure in a number of important areas.  Specifically, with respect to compensation ratios, Commissioner Aguilar noted that: 

• risks relating to compensation go beyond the immediate incentives of a particular compensation plan or policy. The relative pay of different classes of employees, such as the ratio between CEO compensation and median pay, can also create risks to an enterprise, including the risk of employee, customer, and shareholder discontent. Decisions regarding executive compensation may also affect succession planning and related risks. Companies should consider whether additional disclosure is necessary to enable stockholders to assess such risks and the manner in which any such risks may be affected by a company’s compensation policies and practices.

The recommendation was not limited to ratio disclosure.  He also called for "enhanced disclosure in the proxy statement regarding the relationship between executive compensation actually paid and a company’s long-term performance."

The recommendation had all the appearances of an uncontroversial uuterance.  After all, he only called for voluntary disclosure.  Moreover, it was a potential example of private ordering.  Companies could decide on a case by case basis whether disclosure of compensation ratios should occur.  

Yet the suggestion did cause controversy.  The Center on Executive Compensation found fault with the proposal.  In a letter to Commissioner Aguilar, the Center expressed "disappointed that your statement urged companies to voluntarily disclose a pay ratio in proxies this year."  The basis for the disappointment other than opposition to pay ratio disclosure ("The Center continues to opposed the pay ratio requirement because the calculation of the median compensation of all employees globally using the statutorily mandated SEC definition of compensation is unjustifiably complex.") was that "most investors are not asking for pay ratio information, and where shareholder proposals have been offered on the pay ratio, support from shareholders has typically been less than 10 percent."  The letter also took the position that companies making the disclosure would have to "explain in the future why the voluntarily disclosed ratio differs from the calculation fo the ratio mandated by the statute, as implemented through SEC rules." 

These are weak arguments.  First, it is highly unlikely that companies making voluntary dislcousre would have to make any additional explanation in the future once a rule was in place.  When the SEC updated compensation disclosure requirements in 2006, companies had no obligation, either under the rules or under the antifraud provisions, to go back and update prior compensation disclosure.  The market knew that one standard existed after 2006 and one before.  Whenever the SEC adopts pay ratio disclosure rules, the same will be true.

Second, the statement that  "most investors" do not want this information is questionable (how can anyone charaterize what "most investors" want) but largely beside the point.  Congress has mandated the disclosure so it has to happen.  Companies that begin ratio disclosure early will start to put inplace the interneal process needed to compute the amount.  Morevoer, in considering what shareholders want, the test is not "most" but reasonable.  Materiality is anything important to a reasonable shareholder.  There are plenty of reasonable shareholders seeking this information.  

Opponents of ratio disclosure are right, however, to be concerned with Commissioner Aguilar's suggestion.  To the extent that a number of companies make the requisite disclosure, it will show that the disclosure can occur in a cost effective manner.  It will eliminate the loudest argument of opponents:  That disclosure is too expensive and therefore should not be required.