Saturday, April 13, 2013

Whatever Happened to the CEO Pay Ratio?
Fred Whittlesey
Compensation Venture Group

I just returned from the Conscious Capitalism 2013 Conference. There was scant discussion of compensation other than occasional references to the CEO pay ratio. Then I spent a few hours catching up on email and links to the endless stream of online commentary on compensation and there it was. The CEO Pay Ratio.

It’s amusing to me that almost 3 years after the passage of Dodd-Frank Act which requires the disclosure of the CEO Pay Ratio – the ratio of a company’s CEO pay to the median pay of that company’s employees - some commentators (I resisted the temptation to link) are just now writing about all of the complex technical implementation difficulties with the CEO Pay Ratio disclosure requirement. I addressed that in a WorldatWork Journal article in July 2010 and there’s been ample coverage since. It’s a tired issue, covered extensively and now repetitively.

The definitional and implementation complexities are indeed overwhelming and over-debated, no doubt the reason for the SEC’s continued avoidance of the issue. (The SEC seems to have decided in response that the best way to avoid missing deadlines, which they have repeatedly done with respect to Dodd-Frank requirements, is to stop setting deadlines, which they have done. As many of us know, a project without a deadline is a project that may never be completed.)

But while the SEC has not acted, it has not stopped their discussing it. In February of this year, SEC Commissioner Aguilar in a speech touched on this issue, identifying it as a risk management and disclosure issue: 

“...risks relating to compensation go beyond the immediate incentives of a particular compensation plan or policy. The relative pay of different classes of employees, such as the ratio between CEO compensation and median pay, can also create risks to an enterprise, including the risk of employee, customer, and shareholder discontent.”

But the populist anti-pay movement is extending beyond the C-suite. On April 1, 2013 (why does any organization issue any significant information on that day?) the IRS issued proposed regulations for Section 162(m)(6). Section 162(m) is the “million dollar cap” (cap that is not-a-cap) on CEO pay. Subsection 6 now imposes a new “cap” of $500,000 on ALL employees of certain health insurance providers. It’s an extremely complex rule but an extremely simple concept – legislators and regulators worldwide are looking for opportunities to impose constraints on highly-paid people. So far, we have on the list CEOs, bankers, and healthcare insurance employees. More to come, to be sure.

In the US, we’re focused on Dodd-Frank and the SEC, but the movement is global. In Switzerland, citizens voted for additional limits on executive pay, beyond the recent approval of strict say-on-pay rules. As Broc Romanek noted, in his blog, “The Young Socialists, the youth wing of the left-leaning Social Democratic Party of Switzerland, have collected more than 100,000 signatures--the threshold needed to call a vote--in support of a referendum to limit executive salaries to 12 times those of a company's lowest-paid employee. The campaign, dubbed the 1:12 Initiative for Fair Pay, is named for the organizers' belief that no one in a company should earn more in one month than the lowest-paid employee makes in a year. “

In the meantime, those in the US more concerned with the concept than the regulatory details have forged ahead, much as other organizations and companies have done with the Pay for Performance requirement which the SEC has similarly failed to determine. For example:

· Whole Foods Markets states in their 2013 proxy discusses their salary cap by saying “we have placed a cap on executive and other leadership members’ salaries and equity grants…in an attempt to balance our competing objectives of fairness to all stakeholders.” They publish a table showing that the cap is a multiple of 19 times the average annual wage since 2008.

· DuPont in their 2013 proxy discloses the concept of a “pay equity multiple” comparing CEO pay that of other executives which is roughly 3x.

Interestingly, there are several large companies that in the past disclosed positions described as “internal pay equity” which no longer do so. It is a difficult concept to manage.

Outside the US, a longer-term example of the concept exists in Mondragon Corporation in Spain which determines pay ratios between executives and other workers that range from 3x to 9x, averaging 5x. Mondragon has been in business for over 55 years, and has more than 80,000 employees working for more than 250 companies.

Paraphrasing Arlo Guthrie in Alice’s Restaurant, if one person does it they’ll think he’s really sick; if two people do it in harmony, they’ll think they’re (censored) and they won’t take them; if three people do it they may think it’s an organization; and if fifty people a day do it, they may think it’s a movement. The CEO Pay Ratio is a movement, and one to watch. With or without the SEC.

The problem with most of these ratios, though, is that they only capture base salary or granted pay; the real story is in realized pay. Next week I will be quoted in another article in the Boston Globe citing CVG’s research that a CEO was granted approximately $5 million in pay in 2012, but actually realized over $16 million that year. The big story is that he has accumulated an estimated future $83 million over his tenure at this company including 3 different pension plans, a deferred compensation plan, and the outstanding equity awards still unvested or unexercised.

Some would say that pay levels like this are not “fair”. I always tell clients (and the media) that I never use the “F word” when discussing compensation because I don’t know what “fair” is.

What I do know is that if suppliers are being pressured to lower prices, customers are paying higher prices, employees’ pay is stagnant relative to inflation, employee ownership plans have been axed because of institutional shareholders’ and proxy advisers’ arbitrary policies, and the impact on society and community is of concern in a company that provides tens of millions of dollars of compensation to a CEO running an auto-pilot business…in a capitalistic free-market society the collective stakeholder groups - suppliers, customers, employees, the community - will change things.

That society can wait for a misguided Congress to legislate irrational laws that securities regulators balk to implement, or the society can wait for its youth to trigger still more legislation. Or that society can awaken to some conscious, rational approaches to paying executives, board members, and employees that rebalance the current stakeholder hierarchy where shareholders rule at the expense of all other stakeholders. We have collectively allowed the latter to occur and now have the opportunity for the former.

Conscious Compensation ® raises these questions and proposes solutions to supportConscious Capitalism © and the progress of global society. The CEO Pay Ratio dialogue is the door to making progress on this. Don’t be fooled by the consultants, like me, who in the course of our professional roles debate the mechanics of such a concept. Just like granted pay, realized pay and accumulated pay, the regulated Pay Ratio requirement may make be complicated and make no sense, but the concept is not an Arlo Guthrie organization, it is an Arlo Guthrie movement. 

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