Pay Ratio Finally Passes

On August 5, SEC commissioners finally approved implementation of the pay ratio rule. Shareholders will now see a ratio between the pay of CEO and median employee. As Larry Mishel of EPI noted, “The delay shows the power of corporate lobbyists, but the finalizing of the rule is a win for the American people.” As I’ve said before this data will provide insight into which companies view employees as resources and  which see them only as costs. Obviously, corporations cannot function without the services of employees.

Here’s a quote from the Darden Restaurant proxy issued on August 5, the same date the rule was adopted.

“The Board believes that our success depends in large measure on our ability to attract and retain highly qualified officers, employees and non-employee directors who are motivated to put forth maximum effort on our behalf and on behalf of our shareholders.”

Shareholders would agree with this statement. It is almost a truism; yes, of course, qualified employees are good to have. Boards of directors constantly trumpet the need to incentivize executives to inspire the best performance. In the last six months the word “motivate” has appeared in the proxies of 3,000 companies, explaining the rationale for a compensation plan. I looked at a number of proxies – that’s what led me to Darden – and the language was generally consistent.

Companies universally acknowledge the need to attract and retain officers and executives. To Darden’s credit, in the quote above, the board mentions employees. But without the pay ratio, it is difficult to know whether this is a matter of philosophy or simply language. After all, talk is cheap, and according to some press reports, so is Darden. The company, which owns the Olive Garden and other restaurants, has been criticized for its reliance on a sub-minimum wage pay for waitresses. The presumption that the difference between $2.13 and state minimum wage will be made up in tips has not been proven.

The pay for Darden CEO Edgar Lee increased by more than 50% between 2014 and 2015 (though is position has evolved from COO to interim CEO to CEO). The cash bonus component quadrupled from the prior year. Frustrated shareholders last year, led by hedge fund Starboard Value, replaced the entire board of Darden. The new board has disclosed in the proxy some changes in compensation, including eliminating an individual performance rating component of its bonus plan.

Corporations and their lobbyists have fought this disclosure with every tool in the arsenal, and Republicans in the House have already promised legislation to overturn it. The opposition was not because it gives insight into how much executives are paid; shareholders already have that data. The resistance to the pay ratio rule is about disclosing median employee pay and the comparison. In contrast with rationale for high CEO pay it suggests more than a little hypocrisy: as if the only people motivated by money are millionaires.

No sophisticated investor will expect the ratio at Darden to be the same as that of a Wall Street bank. But comparing within industry, and comparing over time, will tell investors a great deal.

As SEC commissioner Luis Aguilar said in his statement, “The hope, quite simply, is that this information will better equip shareholders to promote accountability for the executive compensation practices of the companies that they own.” In addition to shareholders, others may also find this information of use. For example, a recent Harvard Business Review article describes a study in which consumers expressed a preference for purchasing items at companies with a lower ratio.

Two commissioners voted against the statement. In his opposition statement, Commissioner Daniel Gallagher writes of “perceived income inequality” in the same tone that others write of “purported climate change”. He describes the commissioners as mimes creating imaginary boxes; and changes in the rule are rearranged deck chairs (not sure what the Titanic is in this metaphor) and the rule as pure applesauce.” He suggested that a much more limited version of the rule could be issued, “in the year 2020 or so.”

Luckily for shareholders, the other commissioners focused on policy rather than politics. They heeded the drafters of Dodd Frank and the quarter million individuals who wrote in support of this rule. The information may not appear in proxies until 2018 (though we hope early adopters will include it sooner), but it will come.