Will New Pay Ratio Disclosure Lead to “Public Infamy?”

Doing background reading as we prepare for new pay ratio disclosure I ran across a wonderful Alexander Hamilton quote: “Public infamy must restrain what the laws cannot.”

This Hamilton quotation was cited to make a corporate governance point in “Money for Nothing: How the Failure of Corporate Boards is Ruining American Business and Costing Us Trillions.” That book on executive compensation, by John Gillespie and David Zweigate, was published in 2010, well before one could imagine that a biography of Hamilton would be turned into a hip-hop Broadway hit. Now with the man and the musical all the rage there’s a new opportunity to consider Hamilton’s wisdom. The quotation comes from letter written in the late 1700s in a reference to a financial scandal of the time in which board and CEO malfeasance resulted in the financial collapse of the Society for Establishing Useful Manufacturers.

I was revisiting “Money for Nothing,” as well as Sam Pizzigati’s excellent “Greed and Good: Understanding and Overcoming the Inequality That Limits Our Lives” and “The CEO Pay Machine” reviewed here because the new compensation disclosure of pay ratio between the CEO and that of the median worker at the company begin with proxies filed in early 2018. The information on CEO pay is not new to shareholders, but the ratio will highlight a remarkable differential, and likely incite some public infamy. Here’s some context.

This discussion of how much leaders should be paid in comparison to their workers is an old one, as pointed out by former compensation consultant Graef Crystal, “Plato told Aristotle no one should make more than five times the pay of the lowest member of society. J.P. Morgan said 20 times. Jesus advocated a negative differential — that’s why they killed him.”

Note that these leaders were not advocating for disclosing a pay ratio but for setting one. Eleanor Bloxham, a long time governance observer noted that, “Back in 1977, Peter Drucker wrote that CEO pay should be no more than 25 times average worker pay. In a 1984 essay, he updated that to say that no more than 20 times average worker pay was appropriate.”

Others proposed ratios for pay suggest comparisons not to worker’s wages but to other financial data points. Edgar S. Woolard Jr., Chairman and CEO of DuPont from 1989 to 1995, once suggested limiting CEO’s pay to 1.5 times what the executive running the company’s operating units received.

For much of American history pay at the top grew approximately at the same rate as that of the worker. That, as many of you know, changed remarkably in the past quarter century now at nearly 300:1 in the United States.

In a powerful speech given at Trinity Church the former Vice Chairman at Merrill Lynch, then CEO of the Federal Reserve bank in New York called for an end to excessive CEO pay, and questioned the extraordinary increases. William J. McDonough noted, “I am old enough to have known both the CEOs of 20 years ago and those of today. I can assure you that we CEOs of today are not 10 times better than those of 20 years ago.”

Nor did they work ten times as many hours. Graef Crystal separately pointed out that the increase wasn’t related to supply and demand. Nor are they several times more valuable than the CEOs in other developed countries where pay ratio is estimated to be much lower (12:1 in Germany, 11:1 in France in 2012 according to David Bowles.)

Shareholders and citizens were not pleased. Articles on compensation excesses became frequent. Public infamy did place restraints on some element of pay (perquisites on the whole are less egregious than they once were).

But pay continued to go up.

In 2011, under provisions 951 of the Dodd-Frank Act Wall Street Reform and Protection Act, shareholders first gained the right to vote on pay packages. When a significant number of shareholders vote against packages boards listen. As I noted in a series of blog posts I did this summer, many companies made changes in practices and others reduced pay following high levels of opposition to pay packages. The total disclosed compensation (TDC) of Salesforce Chairman & CEO Marc Benioff declined from $39.9 million for FY 2015 to $13.1 million for FY 2017. After Honeywell heard from shareholders a preference that long-term performance awards “be share-based instead of cash” they made changes that resulted in a TDC decline of 47%. CEO pay as disclosed in the proxy statements declined by 40% at Regeneron and Vertex after low levels of shareholder support. Many other companies made smaller changes.

The utilization of this tool is one thing we study in As You Sow’s annual report “The 100 Most Overpaid CEOs: Are Fund Managers Asleep at the Wheel?” In a few months we’ll be releasing our fourth report on how mutual and pension funds vote on excessive packages and while many funds have markedly increased levels of opposition to packages over the past four years, there still remain some who appear to approve almost automatically.

The voting tool would be more effective if more shareholders voted less obligingly with management. The average level of support on pay proposals at S&P 500 companies is well over 90%.

Another provision of the Dodd Frank act also signed into law July 2010 was section 953b, which calls for the ratio disclosure. Corporations and their lobbyists fought this disclosure with every tool in their arsenal. The rule making dragged on until the SEC finally passed a version of the rule in 2015. (There are other element of Dodd-Frank that were never finalized and may never be.) Republicans in the House had promised legislation to overturn it even before the 2016 election meaning that there is a chance that this information will only be available for one year.

While pay increased exponentially at some companies, there were others who chose to keep deliberate limits. Often these are companies weave larger social issues into their missions and many continue to maintain the caps to this day. Dr. Bronner’s, a soap company, notes on its website that it “caps the total compensation of the highest-paid employees and executives at five times that of the lowest-paid position.”[AB1] [RLW2]

Ben & Jerry’s ice cream began with a cap on executive pay of no more than five times that of lowest paid employee in its early days. As the company grew, the ratio increased to seven and then 17 to one, which it held until the company was bought by Unilever in 2000.

Whole Foods began with a salary ratio of eight to one in the 1980s, and raised to 14 before the company went public in the early 1990s. The company increased the multiplier again to 19 times average workers’ pay in 2006.

Sometimes the fact that these ratios moved upward over time is used contend that a defined ratio is difficult to maintain. As a counter point I’d suggest reading John Mackey’s essay “Why sky-high CEO pay is bad business” which appeared in the Harvard Business Review in 2009. He noted that having a cap had not presented a problem to the company. “Whole Foods has never lost to a competitor a top executive that we wanted to keep since the company began more than 30 years ago.” He also explained that employees cared about pay equity issues and that Whole Foods found that a smaller gap made for a happier workforce with better performance results.

Whole Food’s 2007 proxy statement explains that the company keeps compensation “not so high that it creates a negative perception with our other stakeholders.”

There’s plenty of negative perception about CEO pay packages in general, however. According to a 2016 survey by Stanford’s Rock Center on Corporate Governance found that nearly three-quarters of those surveyed thought that CEOs were paid too much relative to what workers received.

As noted before, CEO pay has continued to rise sharply in the years since Mackey said a pay cap was not an impediment to hiring. Perhaps greed and executive entitlement have increased markedly since 2009. Still, it is worth recalling that an arbitrary limit of 17:1 was not a problem less than a decade ago as you see ratios of over 170:1 in 2018. I expect to see an astonishing range of data come out on pay ratios this year. The SEC has given companies broad discretion on how to calculate the data, and broadened it even more with additional interpretive guidance in September. Because the data will be variable it will make it more difficult to compare company to company, within industry, or by size. That may backfire on those that hoped to add complexity to cloud data comparisons. The overall ratio will stand out even more glaringly.

Perhaps public infamy — which should be focused on the directors who design the packages, the shareholders that approve them, as well as the executives themselves — may yet restrain what this disclosure will now clearly illustrate. In 2015, SEC Commissioner Gallagher, in his opposition to the rule wrote of “perceived income inequality” in the same tone that others in his party write of “purported climate change.” In both of these matters, numbers don’t lie.