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Bates Research  |  08-07-15

SEC Rules on CEO Pay Disclosure

This Wednesday, the SEC approved a rule requiring that public companies disclose the ratio of CEO pay to median employee pay. The rule is actually mandated by the Dodd-Frank Act, but the Commission has spent the last five years fine-tuning the terms of the rule. The rule itself allows for some flexibility in how companies designate ”median employee” (the ratio’s denominator), such as conducting a statistical sampling of employees rather than surveying all of them, and excluding some foreign employees from their calculations. The rule passed by a narrow 3-2 margin, with the Commissions' two Republican members voting against it. In its current form, the rule itself contains exclusions for many types of companies, such as foreign private issuers and registered investment companies, so not everyone will have to comply with the new requirement. For those that do have to comply, the ratio is not a required disclosure item until they file financials for the fiscal year beginning in 2017.

Passage of the final rule comes at a time when income inequality is a hotly debated topic. Based on Harvard survey results, people within the United States estimated that CEOs should be paid roughly 6.7 times more than the average worker. When asked how much they thought CEOs were actually being paid, survey results indicated a ratio of roughly 30 to 1. In reality, the ratio is currently around 354 to 1. Management guru Peter Drucker once warned that anything above 20 to 1 would "increase employee resentment and decrease morale". The U.S. had hit 40 to 1 already by the 1980's, with a high watermark of 400 to 1 at the time of Drucker's death in 2005.

While the new rule, and the information it makes more readily available, may generate further outcry against income inequality, that is not the SEC's stated goal. The Commission’s view is more pragmatic, noting that the ratio will allow shareholders better insight into the comparative value they are getting from company management, allowing them to make better informed decisions when voting (especially on pay issues).