Why Pay Ratio Disclosure Will Create More Problems Than it Will Solve
8/13/2015
Why will disclosing the ratio of CEO pay to the median pay of employees is pointless, costly and has the potential to backfire:
- The ratio does not tell us whether a CEO has been successful at his/her job. The CEO’s contribution is measured by the value the CEO has provided to its shareholder. A CEO Pay/TSR ratio will make more sense
- It will encourage companies to let go of lower paid employees and increase capital investments (at best) or increase outsourcing, potentially to foreign firms to improve the ratio. While under certain circumstances these moves may be seen as positive, they do not serve one of the main purposes of the rule which is to reduce inequality
- As with other pointless regulations, management will spend valuable time managing the ratio instead of operating the firm, distracting them from creating value
- Excluding 5% of foreign employees in the calculation is completely arbitrary and will (again) encourage companies to outsource some of the jobs to foreign firms making things potentially less transparent (increased transparency is another main objective of the new rule)
- It will be impossible to know what constitutes a “good” ratio. Benchmarking a firm’s ratio against other firms (even those in the same industry) is not appropriate given various issues such the level international exposure, level of automation, and other strategic or cultural decisions
- In addition, the ratio will tend to be “lumpy” given that the long-term component in most variable compensation plan only pays once in 3 or 5 years, making it harder to compare not only across companies but also historically within the firm