SEC Proposes Rule for Pay Ratio Disclosure (with Lofchie Comment)

The SEC voted (3-2) to propose a rule that would require public companies to disclose the ratio of the compensation of its CEO to the median compensation of all of its employees around the world, including employees at subsidiaries, and temporary, seasonal and part-time workers. The disclosure is required pursuant to Dodd-Frank Section 953(b) ("Executive Compensation Disclosures"). The proposed rule would not prescribe a specific methodology for companies to use in calculating the a pay ratio; rather, companies themselves would determine the median annual total compensation of its employees appropriate to the size and structure of their businesses.

SEC Commissioner Luis A. Aguilar issued a statement to provide context for the proposed rule, stating that it is an "important step to comply with the Dodd-Frank Act's requirements for better disclosure and accountability regarding executive compensation decisions at public companies," though also noting flaws in the rule. Commissioner Kara M. Stein also issued a statement regarding the rule, stating that, while pay ratio disclosure is an important issue, the proposed rule may not necessarily be the right approach.

Commissioner Daniel M. Gallagher submitted a dissenting statement to the rule, voicing his opinion that it is "yet another Dodd-Frank mandate having nothing to do with the SEC's mission and everything to do with the politics of not letting a serious crisis go to waste."

Lofchie Comment: I recommend reading the dissenting statements by Commissioners Gallagher and Piowar (linked below). Even by the standards of someone who has been reading new derivatives rules for the past three years, this rule proposal (while mandated by statute) seems utterly wasteful and potentially destructive. The proponents of the statute seem to believe that the market will favor companies that report a low ratio of CEO pay to the pay of the median employee; I don't know why that would be the case. If it were, then I would worry that companies might seek to reduce the number of their lesser-paid employees, either by outsourcing work to non-affiliates outside the United States, or by mechanizing work even when it might not be cost-efficient to do so. And what happens if companies that have a high CEO-to-average employee pay ratio outperform their peers? Would that indicate that pay inequality should be increased? (Logically, I would expect companies with a high ratio of CEO pay to outperform their peers because the CEO will be better paid for outperformance. Obviously, that means the high ratio is the result, rather than the cause, of the outperformance, but it also means that the numbers may demonstrate the exact opposite of what the proponents of this rule would like to see.)

See: SEC Proposed Rule; SEC Press Release. See also: SEC Commissioner Aguilar's Statement; Commissioner Stein's Statement; Commissioner Gallagher's Statement; Commissioner Piwowar's Statement.