The SEC’s New Pay-Ratio Disclosure Rule
After the financial meltdown of recent years, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act. One of the goals of the act was to improve accountability and transparency in the financial system. A brief sectionb in the lengthy bill requires a publicly held company to disclose the ratio of the total compensation of its chief executive officer (CEO) to the median compensation of its workers. For instance, if the annual pay of the median employee is $45,790 and the total compensation of the CEO is $12,260,000, then the pay ratio is 1 to 268. Otherwise stated, the CEO makes 268 times more than the median income for employees.
Five Years in the Making For five years, the Securities and Exchange Commission (SEC) hesitated to adopt a disclosure rule as mandated by the Dodd-Frank act. The SEC received almost 300,000 comments and issued its own comments on the proposed rule.c The commissioners indicated that they were unsure what potential economic benefits, “if any,” would be realized from making this information public. The SEC has estimated that the regulation will cause companies almost 550,000 annual paperwork hours, plus about $75 million per year to hire outside professionals. Dealing with the New Rule The new rule is 1,800 words long, and managers initially may find it difficult to implement.
Fortunately for them, the SEC realizes that it can only ask for “reasonable estimates” of the CEO-worker pay ratio.
The CEO’s measured compensation includes salary, bonuses, stocks and options, incentive plans, and other compensation. In theory, calculating this amount is fairly straightforward.Calculating the median income of the company’s labor force is more difficult. Note that the median income is not the average income of employees.
Rather, the rule requires the company to identify a “median” employee as the basis for comparison.The rule does give companies flexibility in determining how to identify this median employee. Statistical sampling can be used, for instance. And the rule states, “Since identifying the median involves finding the employee in the middle, it may not be necessary to determine the exact compensation amounts for every employee paid more or less than that employee in the middle.” The rule also permits companies to make the median employee determination only once every three years.
Business Questions
1. Why might the new SEC pay-ratio disclosure rule cause certain businesses to eliminate low-wage workers?
2. How might the new SEC pay-ratio disclosure rule help shareholders
