Cafe Classic: CEO Pay Ratio, Unintended Consequences?

Editor’s Note:  With Pay Ratio reporting around the corner, we go back in time with Dan Walter to four years ago when it was first being discussed as a possibility. 

The dreaded CEO Pay Ratio Disclosure is almost here! The SEC has proposed the rules for the regulation required by Dodd-Frank. Companies have railed against this rule as being complex, expensive and more hyperbole than helpful. Activists have clamored for the rule to help expose the lack of link between CEOs and those who work at their companies.

I have gone into potential issues in prior posts here at the Comp Café and other places. I won’t rehash some of the obvious and commonly stated concerns in this posting. But, I will point out a potentially disastrous unintended consequence.

The rule was written as a last minute addition to the Dodd-Frank Bills, by U.S. Sen. Robert Menendez, D-N.J. A stated goal of the rule was to slow the increase of executive pay by showing the gulf between compensation separating CEOs and their average workers. The idea is that people will see the enormous gap between some CEOs and their staffs and rain down hellfire on those companies until they reduce CEO pay. That result seems unlikely in all but the most egregious and extreme cases.

Let’s talk about a possibility that hasn’t yet been raised.  What if investors do the opposite of what is hoped by the new rule’s benefactors? Investors are pretty single-minded in getting the best return for their investment. They worry about things like keeping costs low and profits high. Investors like when their investments spend money below the level of their peers while providing returns above them.

What if a major investor sees that their company’s CEO to Employee Ratio is 150:1 while a competitor’s is 250:1.  And, what if both CEOs make about the same amount of money and provide the same returns? Will the investors call for a lowering of their CEO’s pay? Not likely. Will they demand their company’s CEO be paid higher simply to make the ratios more similar? Again, extremely unlikely. OR, will they ask why the average staff member at the companies they invest in is paid so much more than at the competition? Will the compensation department be asked to explore ways to reduce pay for the rank and file with the goal to get pay ratios in line with “market data”?  Hmm… Maybe.

While I hope this won’t be the case, it would not surprise me if it happens.  Remember, you read it at the Compensation Café first!  What are your thoughts about the eventual impact of disclosing pay ratio?

Dan Walter, CECP, CEP is the President and CEO of Performensation. He is passionately committed to aligning pay with company strategy and culture and considered a leading expert on equity compensation issues. Dan has written several industry resources including a recent Performance-Based Equity Compensation issue brief. He has co-authored Everything You Do In Compensation is Communication”, “The Decision Makers Guide to Equity Compensation”, “Equity Alternatives and other books. Connect with Dan on LinkedInOr, follow him on Twitter at @Performensation.

This post originally appeared on Compensation Cafe
Author: Ann Bares