CEO-Worker Pay Ratio Rule Under Attack

A bill in Congress threatens to throw a veil over critical information on CEO pay.

By Sarah Anderson

The Dodd-Frank financial reform bill mandates that public companies disclose the ratio of total compensation of the CEO to that of the median of all their employees.

Rep. Nan Hayworth (R-NY) has introduced a bill to repeal this disclosure rule before the Securities and Exchange Commission can write the regulations necessary to enforce it. The bill has already passed a key House subcommittee and could be voted on the floor by the end of the month.

Corporate lobbyists have been complaining that the reporting requirement (Section 953b of Dodd-Frank) will be overly costly to fulfill and provide no real benefit to investors. It’s hard to buy the argument about cost.  Companies are required to collect and maintain their employees’ compensation data for accounting and tax purposes. 

In comments to the SEC, we at the Institute for Policy Studies (IPS) also argue that shareholders have a material interest in the pay ratio data. Citing a large body of academic literature, we lay out three reasons why extreme pay differentials tend to undermine enterprise effectiveness: 

1.  They lead to lower morale and higher turnover rates that undermine productivity.

John Mackey, CEO of Whole Foods, limits his cash compensation to no more than 19 times the average for workers at his firm. “Because of the yawning gap between the leaders and the led, employee morale is suffering, talented performers’ loyalty is evaporating, and strategy and execution is suffering at American companies,” Mackey wrote for the Harvard Business Review. “Employees really do care about this issue, and a smaller gap makes for greater solidarity, and as a result better performance, throughout the workplace.”  A Notre Dame report found that senior executives at companies with wide management pay gaps are twice as likely to exit as senior executives at companies where pay was more equally distributed.

2.  They reinforce rigid corporate hierarchies that discourage workers from being creative contributors to enterprise success. 

Peter Drucker, the father of modern management theory, pointed out in the early 1980s that in any hierarchy, every level of bureaucracy must be compensated at a higher rate than the level below. The more levels, the higher the pay at the top. This gives CEOs a personal interest in maintaining rigid hierarchies that are disempowering for workers. Drucker’s solution was to limit executive pay to no more than 20 times the compensation of their employees.  A landmark Brookings Institution report by David Levine supported this general view, stating “large differences in status can inhibit participation.”

3.  They reinforce a “celebrity CEO” culture that is not conducive to high executive performance. 

Jim Collins, a former scholar at the Stanford Graduate School of Business, spent five years trying to determine “what it takes” to turn an average company into a “great” one. He eventually identified 11 firms that had successfully generated off-the-charts stock returns over 15 years. Not a single one had a high-paid CEO.  A celebrity CEO, Collins wrote, turns a company into “one genius with 1,000 helpers.”

Our nation’s long-term economic health will depend, in large part, on the productivity of our enterprises. The new CEO-worker pay ratio requirement, if allowed to go into force, could significantly enhance that productivity — and, as a result, U.S. competitive capacity.

About Sarah Anderson

Sarah Anderson directs the Global Economy Project at the Institute for Policy Studies.

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