It didn’t require microscopic examination of the Securities and Exchange Commission’s pay ratio rule to find the gaping holes in it.
Proposed in September, the SEC’s rule was yet one more attempt to rein in runaway executive compensation packages. The pay ratio essentially is a comparison of a public company’s median employee compensation to that of its CEO.
Problem was, there were no teeth in the rule. Call it a guideline at best. The rule leaves it up to the company — i.e., the CEO and others in the C-Suite — to determine how to calculate median compensation of employees and total compensation of the CEO.
“This proposal would provide companies significant flexibility in complying with the disclosure requirement while still fulfilling the statutory mandate,” SEC Chair Mary Jo White said, pointing out the elephant in the room.
The CEO pay rule popped up a few years ago during the latest frenzied gnashing of teeth over CEO comp packages. The issue emerged in other lands as well; Swiss voters were asked this fall to limit executives pay to 12 times that of junior employees. However, the campaign failed after 65 percent of Swiss voters rejected the idea in November.
In the U.S., the usual suspects were behind the ratio: unionists, social activists, liberal politicians. But as the rule’s weaknesses become ever more apparent, even they are losing hope that it will work as intended.
There were other caveats that undermined the rule’s potential for restraint besides the “flexible” approach. But the fact that it does not “prescribe a specific methodology for companies to use in calculating a ‘pay ratio’” and dictates that “instead, companies would have the flexibility to determine the median annual total compensation of its employees in a way that best suits its particular circumstances” basically gutted its influence.
Worse, some of those who were supposed to care about the ratio — especially investors in a company — didn’t. A Towers Watson survey in October revealed that corporate executives and comp pros were completely unconcerned about how the public, investors or board members responded to the ratio. They just saw crunching the numbers as a big pain.
Now that the 60-day comment period has come and gone, a chorus of critics is raising an outcry about the futility of the rule.
The Huffington Post has served as a platform for several salvos against the rule. Av Sinensky, an exec comp attorney, offered up a list of four reasons the ratio won’t work:
- It’s all about disclosure, not enforcement, and no one cares about toothless tigers any more.
- The methodology, as mentioned above, is so flexible as to be meaningless.
- The latent effect may be that CEOs will look at the crunched numbers and decide they need a raise.
- The crunching of the meaningless numbers will take time and money away from something less meaningless.
“Not surprisingly, this proposal – like some of the other rules implemented under Dodd-Frank – will do little to accomplish the desired effect of narrowing the gap between employee compensation and executive compensation. If anything, it may have the opposite effect,” opines Sinensky.
The Motley Fool recently weighed in as well: “The only way such a CEO-to-worker pay ratio could help rein in outrageous CEO pay is if investors pay close attention to the numbers and only invest in companies that keep compensation rational. In a list of qualities investors look for, like a potential growth story or value, the CEO-to-worker pay ratio will likely be far from the top.
“And, especially for large-cap companies, the extra millions that go into the CEO’s pocket can be rounding errors on the final profit. For such companies, looking cheap when hiring might seem much worse than an outrageous pay ratio.”
The HR Policy Association, in an article summarizing the various holes through which large trucks could be driven, said: “In the proposed rule, the SEC was already very skeptical as to whether or not the pay ratio provided any value to investors. It will be interesting to see how the SEC addresses the conflict in the light of the ongoing debate regarding Congress’s forcing the Commission to wade into social-oriented rulemaking.”
Despite the obvious limitations of the pay rule, many a CEO weighed in during the SEC’s comment period, which ended Dec. 2.
A letter submitted by the Business Roundtable just before the closing bell summarized the Big Business community’s views of the ratio rule.
First, the Roundtable’s letter alluded to the overall absurdity of the rule.
“The disclosures required by the proposed pay ratio rules will depend on issues having nothing to do with a company's performance, as the Commission acknowledges in the proposing release,” the group wrote. “Moreover, the proposed disclosure will exacerbate the growing length of required disclosures that make it difficult for investors to identify the material information that is relevant to their investment and voting decisions.”
While quibbling about whether foreign employee comp should be included in the calculations, the BR made a larger point about the sheer effort involved in gathering and crunching data for this quixotic quest.
“Given the amount of data necessary to be considered and the significant number of estimates, assumptions and judgment calls necessary to produce the ratio, we believe it will be impossible for chief executive officers and chief financial officers to verify the information sufficiently in order to be able to make the certification the proposed rules would require,” the letter stated.
Yet, as it now stands, the numbers-crunching must go forth. Unless someone doesn’t want to do it and face — no sanctions.