SEC Pay-Ratio Rule is Kiss of Death for Low-Wage Workers

The Securities and Exchange Commission finally approved a rule stemming from that 2010 Dodd-Frank Act that requires corporations to disclose the pay gap between their employees and the company’s CEO.  

Supporters of the rule argue that shareholders should know how the company spends its money, including on CEO salaries. Investors need full information in order to make sound investment decisions. But CEO salaries are already public information.

The real reason for the pay-ratio rule is that it can be used to pressure corporations with a large pay gap to rein in CEO bonuses. This means that the intention of the rule is more about addressing income inequality than protecting investors. Republican SEC Commissioner Daniel Gallagher criticized the rule, explaining, “Addressing income inequality is not the province of the SEC.” He called the rule an example of “social policy masquerading as disclosure requirements.”

But even if addressing income inequality was within the purview of the SEC, the rule would still be bad policy.  The amount of money spent on executive salaries has little to do with the profitability of a company. In fact, some CEOs earn high levels of compensation even when the company does not perform well. 

Pay ratios are often misleading. Outliers on either end of the calculation can distort the usefulness of the ratio. A very successful company may compensate its CEO millions of dollars annually, but it may have foreign workers who only make a few dollars per hour. However, the company may still be paying these workers well over the average income for their country. The company’s high pay ratio projects a negative image onto the company, when they are merely successfully doing business.

The rule would allow companies to exclude only 5 percent of their overseas workers from the pay-ratio calculation. Foreign workers generally make much less than their American counterparts, which distorts the already misleading pay ratio.

There is no reason why executive salaries should be comparable to those of low-skilled workers. CEO salaries are high because executives are highly valued by their companies. If they were paid less, another company would offer them higher salaries to change companies.

Wall Street Journal contributor Richard Floersch explains, “Compensation is, or should be, an integral part of a business strategy, devised to incentivize executives to accomplish that strategy.” Pay is not only about retaining well-performing executives in the short-term, but it is also about cultivating a long-term company culture and business strategy. A report by the compensation and data analysis firm Equilar, Inc., found that over 70 percent of the total compensation for S&P 500 executives was in the form of long-term incentives, rather than bonuses for short-term performance.

Many journalists, including New York Times columnist Paul Krugman, distort the data when they compare the large salaries of CEOs to their employees by only including the largest companies. For example, the AFL-CIO published a report claiming that the average CEO-to-worker pay ratio is 331:1. But their research only included 500 of the largest companies. There are nearly 270,000 CEOs in the nation, each leading companies of varying sizes. According to the Bureau of Labor Statistics, the average chief executive earns $180,700 annually. The average worker makes about $46,440 per year. So the average pay ratio is closer to 4:1 than to 300:1.

Regulations similar to the pay ratio mandate have backfired in the past. The 1993 law limiting the deductibility of senior executive compensation to $1 million resulted in many companies increasing CEO salaries to $1 million. The intended wage ceiling became a wage floor.

The new rule could also hurt the very workers it is intended to help. The rule states that “independent contractors or ‘leased’ workers are excluded from the definition [of an employee] as long as they are employed…by an unaffiliated third party.” Companies may stop hiring low-income workers, or contract out their low-skill work, in order to improve their public image by decreasing their pay ratios. Low-skilled workers are then worse off because they have fewer employment opportunities.

With the July employment numbers showing that job creation is slowing, Congress and federal agencies should repeal burdening regulations that make doing business more costly and difficult. Income inequality should be addressed, not by limiting what top income earners make, but by encouraging investment and entrepreneurship, which will create jobs and boost economic productivity for all Americans.

Jonathan Nelson is a contributor to Economics21. Follow him on Twitter here.

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