Pointless CEO Pay Ratio Rule Is Pointless

August 6, 2015 0 Comments

This is also what happens when you allow just anyone to write, draft and propose laws for our financial sector. As a result, you get this rather pointless and silly CEO Pay Ratio rule, as a requirement for the Dodd-Frank Act of 2008.

Some small background into the fact, as a response to the 2008 financial meltdown, Dodd-Frank implement rules aimed at updating the regulation of the financial services industry, which also includes several unrelated executive compensation and corporate governance requirements. One of these requirements involves a mandated pay ratio (Section 953 (b) ), which requires companies to disclose the ratio of the median employee pay to CEO pay.

The SEC just approved this rule today, I can’t wrap my head around why anyone would believe this law would be a good idea, or even necessary for the purposes of stabilizing our financial sector. Now companies will have to collect information regarding their employees, which can range from different pay systems across dozens of countries with different wages and benefit laws, and of course adjust them for currency differences.

It’s not as if this information is available to the Human Resource/Payroll department at the click of a button. Wages and benefits are fluctuating in the economy, every single day, so you can imagine the amount of resources a single company has to devote to such a mundane task.

From the WSJ:

Securities regulators Wednesday approved a final rule requiring companies to disclose the pay gap between chief executives and rank-and-file employees, putting in place a contentious proposal sought by activist investors to pressure companies on executive pay.

The five-member Securities and Exchange Commission voted 3-2, with the panel’s two GOP members opposing the measure. It requires companies to disclose median worker pay—the point on the income scale at which half their employees earn more and half earn less—and compare it with CEO compensation.

The SEC’s action marks the culmination of years of heated and often partisan debate over the measure, which is required by the 2010 Dodd-Frank law. The vote likely won’t be the end of the fight over the issue. Corporations or trade groups such as U.S. Chamber of Commerce are expected to consider challenging the requirement, possibly in court.

The pay-ratio requirement has been a major flash point in part because it injects corporate disclosure into the hot political debate surrounding income inequality and CEO pay.

Supporters, including Democrats on Capitol Hill and labor unions, believe the measure could help pressure corporate boards at firms with large pay gaps to rein in compensation of top executives. They also say the ratio disclosure will provide shareholders with pertinent information on how their money is being spent.

The rule “should provide a valuable piece of information to investors and others in the marketplace,” as well as details “about how a company manages human capital,” said Democratic SEC Commissioner Kara Stein. “As investors increasingly focus on corporate governance and executive compensation issues at public companies, the pay ratio disclosure will provide another metric that is useful on many fronts, such as say‐on‐pay votes.”

This is probably the most inane rationale for the adoption of a financial rule that I have ever read in my entire life… It’s even more laughable that regulators are touting this as if there was some demand from the investment community for companies to disclose this information to the public.

The fact of the matter is there was never any demand for this sort of information from people who invest in stocks. It also makes zero sense from a investment standpoint. Public companies would be burdened by the cost of complying with this rule. That hurts the bottomline, which hurts overall Earnings Per Share (EPS).

More importantly, the rule doesn’t provide information to shareholders. I can’t really see investors using the ‘CEO Pay Ratio’ for anything useful. If anything, it’s probably the most useless metrics I have ever seen.

It’s no different from the Price-to-Sales (P/S) ratio investors use as a valuation metric for stocks. It’s there, and people use it but it doesn’t really tell you all that much about the company. Sales are not profits. It’s just the accumulated revenue overtime. The problem with dividing the market price of a stock with the sales is that the sales are supported by debt and equity. This completely ignores profitability, which might be nice if you’re not making any more, but imagine if I started selling $20 dollar bills for just $19 dollars. I would make plenty of sales, but I would go broke doing it. But hey, as long as my investors are looking at price-to-sales, my business is a pretty good investment. This is basically what the CEO Pay Ratio entails. It ignores other useful information investors can formulate their investment decisions from and concentrates that information on something immaterial.

It’s really no big secret that Corporate Executives are paid significantly more than the average work. It’s also true, in some cases, that executive compensation is disproportionate to their overall performance; however, calculating pay ratios fails to correct this, even less than the “say-on-pay” rule the SEC adopted. What makes this even worse is the fact that this rule was supposed to be non-binding. From the “say-on-pay” experiment, we have learned increasingly that shareholders want the Board of Directors to handle matters regarding executive compensation. During this time frame, since the adoption of “say-on-pay,” executive compensation has increased to their highest levels yet.

On top of this, the overall sentiment on this new rule is negative, at least amongst investors and directors. According to an opinion survey released in 2013 by the NYSE Governance Services, Corporate Board Member and Pay Governance LLC, and executive compensation advisory firm, only 18% of directors this new rule will actually improve Corporate governance. So, it goes without saying, although most people understand the pay system and their relationship to excessive CEO compensation, most people feel that it will improve governance.

More importantly, all of this tripe about CEO compensation is rooted in ignorance. For example, our friends at the American Federation of Labor and Congress of Industrial Organizations, better known as the AFL-CIO, is perpetuating erroneous information, which claims that U.S. CEO-to-worker compensation ratio is 331:1. This misinformation was disseminated by the usual idiots suspects, involving Democrat Presidential Candidate Hillary Clinton and the left-leaning economic think tank, the Economic Policy Institute. Even the Austrian-leaning financial blog Zero Hedge, for whatever reason, decided to promote this statistical fallacy. Although the website can be very conspiratory, they usually post some very good stuff, which is very disappointing. Somehow, I expected better…

Sure, while its true that some CEOs of certain publicly traded companies have a pay ratio much greater than the average worker; however, this does not reflect the vast majority of companies in the United States. The AFL-CIO did an analysis of the CEOs of 350 companies in the S&P 500 in 2013. From these companies, it concluded that the CEO-to-worker pay ratio is actually 331:1, higher than the developed world and up 200 times from 20 years ago.

Now, it doesn’t take a financial expert to understand that the S&P consist of 500 of the largest companies in the world, made up by a Free-Float Capitalization Weight (okay, it probably takes an expert to understand the last bit). While the S&P 500 represents large, publicly-traded, multinational corporations, and are considered the bellwether for the U.S. economy, it is hardly a representation of all corporations, publicly-traded companies, or CEO compensation.

There are 5.8 million corporations in the United States. Between the NYSE, AMEX, NASDAQ, and the thousands of stocks that are trading OTC, there could be over 11,000 publicly-traded companies operating in the United States. Simply put, no amount of reasoning can allow anyone to take 350 of the largest companies in the world, community their CEO/employee pay ratio and conclude that all U.S. CEOs are paid this insane amount of money.

Looking at annual wage data from the BLS Occupational Employment Statistics, you can gather a different picture of compensation for not just corporate executives, but all other occupations in the economy. OES looks at 22 major occupations, 94 minor occupations, broad occupations and 821 detailed occupations. So, needless to say, you’re getting a pretty good idea of what type of jobs you’re looking for when you browse the data.

According to that data, among 246,240 chief executives, the average annual salary was $180,700. This may not sound like much, but this also includes incentive pay & benefits such as annual incentives, long-term incentives, company benefits, bonuses, which is usually apart of executive compensation packages as I have mentioned before. The only part of compensation packages that are not included in the OES are severance pay.

Considering that the average annual salary for all occupations is $47,230, this makes the true CEO/Employee pay ratio closer to 3:1, not 331:1.

When it all comes down to CEO compensation and excessive pay, there is more to this issue than people love to explain. Most people don’t understand how executive compensation work and what consist of an executive pay package. I doubt anything about this new CEO Pay Ratio rule is going to change anything regarding excessive pay at some of the largest corporations in the world. This ruling isn’t really about giving information to shareholders, nor is it about informing the general population. Instead, it gives those with an agenda the ability to shame corporations to support their inequality narrative.

I’m really not sure why this is even in Dodd-Frank to begin with, but let’s just chalk it up to another one of those regulatory mishaps of those of us in power should really learn from by now.

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