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Thursday, November 14, 2013

The "Pay Ratio Provision" in the Dodd-Frank Act: Legislation to Repeal It in the 113th Congress

Gary Shorter
Specialist in Financial Economics

Section 953(b) of the Dodd-Frank Consumer Protection and Wall Street Reform Act (Dodd-Frank Act; P.L. 111-203), known as the “pay ratio provision,” requires the Securities and Exchange Commission (SEC) to write rules to implement a requirement that public companies disclose the ratio between the total compensation of a company’s chief executive officer (CEO) and the median compensation of all other employees. On September 18, 2013, the agency released proposals to implement the pay ratio provision. A firm will be able to choose its own methodology to calculate worker median pay, including statistical sampling.

Supporters of the provision, including its sponsor Senator Robert Menendez, argue that the public company data on CEO-worker pay disparity that will result from the provision will pressure corporate boards to be more restrained in pay packages to CEOs. The strategy can be seen as a measure to address what some describe as a board/CEO dynamic that can result in perceived excessive compensation for CEOs: board members may feel beholden to the CEO, who may also serve as board chair. Research consistent with this notion of insufficiently independent boards exists. Other research, however, appears to be consistent with the view that public company CEOs operate in a generally competitive marketplace in which the value that they give to shareholders is fairly compensated.

Other supporters of the pay ratio provision, including consumer groups, labor groups, and pension funds, also claim that disclosures that will result from the provision will help to inform investor decision making, including on whether a CEO’s compensation is reasonable given a firm’s overall worker compensation picture. If a corporate disclosure adds value to the investing process, it is said to provide material information. Materiality is central to the SEC’s adoption of disclosure regulations, including the compensation disclosure rules that it has issued over the years. The SEC has observed that the usefulness to investors of the company-specific pay ratio data in the pay ratio provision cannot be quantified.

Critics of the pay ratio provision, including the U.S. Chamber of Commerce, human resources groups, and other business-related groups, counter that the value of corporate disclosure data is linked to the ability of investors to use it to compare various firms. A principal concern is that this comparative value of the ratios will be undermined. An additional concern is that the provision will mislead investors who try to compare the CEO-worker pay ratios from domestic firms in industries with differing levels of worker pay and from domestic firms without a global workforce relative to domestic firms with global workers who are paid at varying wage levels in different currencies.

There is also some concern that the pay ratio provision is likely to result in substantial compliance challenges and costs, especially for large multinational or multi-segmented firms with decentralized payroll systems. Some estimates are that implementation costs for some companies could be in the millions of dollars. The SEC acknowledged that such firms would be likely to face greater compliance challenges and costs. In the aggregate, the proposal estimated that firms would spend about $72 million over a three-year period to comply with the pay ratio provision with large, multinational firms likely facing the greatest costs.

H.R. 1135 (Huizenga) would repeal the pay ratio provision, Section 953(b) of the Dodd-Frank Act. H.R. 1135 was ordered to be reported by the House Financial Services Committee on June 19, 2013. This report will be updated as events warrant.

Date of Report: October 28, 2013
Number of Pages: 24
Order Number: R43262
Price: $29.95

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