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Why the SEC's CEO Pay Rule Matters

Lenore Palladino

Yesterday, the Securities and Exchange Commission finally approved a rule mandating that public companies regularly reveal the compensation gap between their chief executives and the rest of their workforce. Once the first data points from the rule are available in 2018, they will provide workers, investors, and the public a real look at how corporations value an hour of their CEO’s time, versus a rank-and-file employee. 

The disparity between CEOs and their workers has soared over the last fifty years: according to excellent work by our friends at the Economic Policy Institute, the gap has grown from $20: $1 to $300: $1. A Demos report showed this pay inequality is even worse in the fast food, where the CEO-to-worker gap has soared to $1000-to-$1.

Importantly, psychological researchers have found that “Americans drastically underestimate how wide that wealth gap has become,”(1) a misperception that the rule’s data will hopefully fix. The rule originated in Dodd-Frank over five years ago. Major industry pushback delayed the rule’s passage, and may have weakened the formulas that specify what needs to be included in a CEO’s officially-calculated compensation package—for example, are the private jet memberships included? What about the country club membership? Businesses won the ability to rely on a statistical sample of staff compensation, rather than a robust accounting of all staff salaries. Judging from the language of one Commissioner, opposition from corporate America continues to be robust: opposing the rule, SEC Commissioner Daniel Gallagher said that the rule was “pure applesauce,” and “the most useless of our Dodd-Frank mandates.

Although the stated purpose of the rule is to assist shareholders in assessing where the compensation of their chief executive sits relative to similar companies in order to increase investor “say on pay,” by making the point of comparison to their workforce—rather than to similarly- situated executives—the rule will put into stark relief the pay gap and allow employees to see where their salary sits relative to a representative median worker within their firm. 

What can’t be overlooked, and what the rule does not address, is that it’s not just the ratio between CEOs and employees has shifted so drastically, but how the overall compensation of CEOs has shifted away from salary-based pay and towards stock ownership, increasing the incentives for CEOs to act like an investor rather than a corporate manager. According to William Lazonick’s research, a CEO’s base salary today accounts for just 3-7% of their total compensation, while the rest is a combination of performance- and equity-based pay.

It’s not just that CEOs make $300 dollars an hour, and Jill in the corporate office makes $1. It’s that Jill is taking home a salary, in the form of, basically, cash, whereas the CEO gets their compensation from an ownership share in the firm itself in the form of stocks or stock options, tied to the performance of the company’s stock. It’s this incentive structure that has caused CEOs to care more about the short-term movements of their companies’ stock—and to take actions like buying back shares of stock simply to bump up the price, rather than investing in innovation within the firm—thus driving up their own compensation (and widening the pay gap) as well as the value of their corporate stock, even if no substantive productive activity within the firm has improved. This trend is at the heart of the financialization of America's economy, and needs to be addressed head-on. While raising wages for low-paid employees is necessary, it is by no means sufficient to reduce the pay gap and end destructive short-termism within corporate America. 

So, transparency about the CEO-to-worker pay gap is good. Actually reducing the disparity between the compensation of CEOs and their employees would be better. Reforming CEO compensation packages so that they aren’t driven by short-term increases in stock price, but are instead attuned to building long-term corporate value that would lead to shared prosperity, would be best of all.