Corporate Governance and the Problem of Executive Compensation: The International Response to the Compensation Problem (Pay Ratios)

We have a few more posts on the issue of executive compensation but will wrap up this week with some final thoughts.

Congress in Dodd-Frank has taken a number of approaches to executive compensation.  They include mandating say on pay for all public companies and imposing additional procedural requirements on the compensation process used by listed companies.  In addition, Congress mandated additional disclosure.  Different from the usual requirements, Congress went beyond the computation of executive compensation and required the disclosure of a comparative metric.  The SEC must adopt rules that require the disclosure of pay ratios.  In effect, companies had to reveal the ratio between the compensation paid to the CEO and that paid to the median employee.  See Section 953 of Dodd-Frank. 

The metric provides another basis for determining the reasonableness of compensation.  It is also company specific.  The metric, therefore, gives shareholders a mechanism for assessing the fairness of the amount paid within a particular company.  Changes in the metric from year to year may also provide valuable information on the relative fairness of CEO compensation.   

So far the rule has remained dormant.  The provision is merely included in a long inventory of unfinished business under Dodd-Frank.  The SEC's inaction has a number of likely explanations.  The Rule has generated considerable opposition.  Companies do not like it.  Likewise, some on the Commission staff appear to have taken an excessively narrow perspective of the agency's rulemaking discretion in the implementation of the provision.  See Dodd-Frank, Compensation Ratios, and the Expanding Role of Shareholders in the Governance Process

At the same time, Congress did not impose a mandatory deadline for the rule.  Given the pressure on staff resources, attention has likely shifted to other rulemaking endeavors such as those imposed under the JOBS Act.  Nonetheless, at least one commissioner has expressed disappointment in the slow pace associated with this and other governance rules mandated by Dodd-Frank.  

While the merits of pay ratios has been vigorously debated in the US, the approach has received favorable attention abroad.  The High Pay Commission supported disclosure of ratios.  As the Report noted:


The publication of a pay ratio would allow closer scrutiny of the pay gap in companies.  The Commission particularly feels that this those who would excel at engineering become engineers, but equally that those who would become good doctors or teachers are not deterred by the gap in rewards. Rawls in A Theory of Justice determined that reward should be based on the difference principle: that any difference in reward should be based on whether it will assist the poorest in society. Thus rewarding executives more – to ensure the best people seek the role – can be seen as a fair distribution of resources to an extent.

Delay on this rule is unfortunate.  One of the main advantages of the rule will likely be inside the board room.  Directors will have greater incentive to take a hard line on compensation that skews the ratio.  While CEO use of the corporate aircraft for personal trips is hard to deny from a legal perspective, it may be easier to turn down if it results in negative shift in the ratio.  As long as the rule remains dormant, however, this benefit will not arise. 

J Robert Brown Jr.