The CEO-worker pay ratio: worse than useless

The annual release of data required by the SEC on the pay ratios of CEOs and the median worker at their company is out.

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The data show that Nike CEO Mark Parker makes a heck of a lot more than a typical Nike employee. The estimated ratio of Parker’s annual total compensation ($9,467,460) to the median annual total compensation of all Nike employees ($24,955) was 379 to 1 in fiscal year 2018.

Comcast CEO Brian Roberts did even better in 2018. His compensation package ($35.003,000)compared with Comcast’s median employee’s compensation ($82,205) resulted in a CEO pay ratio of 426 to 1.

As expected, the release of the data is spurring all sorts of overheated grievances.

“Look at all the overpaid, greedy CEOs.” “The facts are in. Inequality is destroying America. This proves it.”

There’s no question that CEO compensation has been escalating.

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The problem is the comparative CEO-worker data generated in response to the Dodd-Frank Wall Street Reform and Consumer Protection Act and implemented by the SEC is seriously flawed, misleading and unreliable and its collection a colossal waste of businesses’ time and money.

Passed in 2010 during the Obama administration, the pay ratio requirement took effect in 2017. Ostensibly, the purpose was to ensure that the devastating 2008 financial crisis wouldn’t be repeated, to increase the transparency of executive compensation and to provide investors with another piece of information to consider when determining whether the compensation of their CEO is appropriate.

“This simple benchmark will help investors monitor both how a company treats its average workers and whether its executive pay is reasonable,” said Sen. Robert Menendez (D-NJ), who introduced the pay ratio provision in the Dodd-Frank Act.

But the numbers really say nothing useful about how a company treats its workers or whether the CEO’s pay is reasonable.

That’s partly because the real motive of the pay ratio advocates was to give the left a tool to propel its inequality agenda. The proponents wanted to promote envy and class warfare, to argue that the once-great America as a land of opportunity is vanishing and that more aggressive government intervention guided by liberal principles is necessary.

As SEC Commissioner Michael S. Piwowar said in a dissenting statement on the pay ratio rule when it was approved, “Today’s rulemaking implements a provision of the highly partisan Dodd-Frank Act that pandered to politically-connected special interest groups and, independent of the Act, could not stand on its own merits. “

“The bottom line is that this is one of the sillier and more pointless disclosures that I have ever seen,” David Yermack, a professor of finance at NYU’s Stern School of Business, told The Atlantic.

Nike, for example, spelled out all sorts of qualifiers in disclosing its pay ratio figures:

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“The SEC rules for identifying the median compensated employee and calculating the pay ratio based on that employee’s annual total compensation allow companies to adopt a variety of methodologies, to apply certain exclusions, and to make reasonable estimates and assumptions that reflect their compensation practices. As such, the pay ratio reported by other companies may not be comparable to the pay ratio reported above, as other companies may have different employment and compensation practices and may utilize different methodologies, exclusions, estimates, and assumptions in calculating their own pay ratios.”

The ridiculousness of the whole exercise is illustrated by some of the sharp swings in some companies’ ratios from 2017 to 2018, as the Wall Street Journal recently reported.

Shipbuilder Huntington Ingalls  Industries Inc. and potash producer Mosaic Co.reported, for example, that the typical worker got half as much in 2018 as the year before. At Honeywell International Inc.,the data showed the typical worker’s compensation was 33 percent higher in 2018 than 2017.

The fact is, every company calculates the pay ratio differently, partly because the SEC rule gives companies wide leeway in identifying median workers.

Some year-to-year ratio fluctuations reflect acquisitions or spinoffs that revamp a company’s workforce. Others are attributable to whether the median employee has a traditional pension plan, or new ways of identifying that middle employee.

Companies don’t have to account for independent contractors if they don’t set their pay, for example, so, a company with a highly paid CEO and loads of low-paid independent contractors can massage its numbers to look better.

Companies can also manipulate the numbers by identifying their median worker in a variety of ways.

“To identify the median employee, the rule would allow companies to select a methodology based on their own facts and circumstances,” the SEC rule says. “A company could use its total employee population or a statistical sampling of that population and/or other reasonable methods. A company could apply a cost-of-living adjustment to the compensation measure used to identify the median employee.”

The pay ratio numbers also can fluctuate when there are different types of businesses. For example, at Goldman Sachs, an investment banking, securities and investment management firm where most employees are highly educated and highly paid professionals, the pay ratio figure will obviously be lower than at McDonalds where most employees are less educated and earn modest wages.

Businesses that employ a lot of part-time or seasonal workers, or that employ a lot of foreign workers in countries with comparatively lower wages, will also have high ratios.

Then there are the compliance costs borne by companies collecting and submitting the data. “The SEC total initial cost of compliance for all 3,571 registrants affected by the Section 953(b) requirements is expected to be approximately $1,315 million, “ the SEC  said in the Final Rule in 2015.

To top it all off, the disclosures required by the SEC rule do little to help investors make decisions on trades. Not only is the pay ratio calculation based on wildly different data used by different companies, but CEO-worker pay ratios are not especially reliable indicators of how a company will perform.

It’s not that reporters and editorial writers don’t know the pay ratio numbers are pretty much worthless and politically motivated. It’s just that a story that gives them a chance to rail about inequality is too much to miss.

As Stanford University Professor Joseph Grundfest said when the SEC rule was finalized in 2015, “Ultimately, the ratios that companies will disclose in their SEC filings will not be grist for meaningful debate so much as fodder for shocking headlines. Individually, factoids about executive compensation can be truly, deeply bananas, and some media outlets capitalize on that.”

Portland’s pay ratio surcharge – more lunacy

Occupy Wall Street protesters demonstrate in Portland

Protesters demonstrate in Portland.

Given the unreliability of the pay ratio numbers, Portland’s pay ratio tax is a farce, too, just another tool to raise revenue.

In December 2016, the Portland City Council voted to impose a surtax on CEO compensation that would be added to the city’s business tax on publicly traded companies whose chief executives earn more than 100 times the median pay of their employees.

The surcharge was set at an additional 10 percent in taxes if their CEO’s compensation is greater than 100 times the median pay of all their employees and 25 percent if the pay ratio is greater than 250 times the median.

The city initially figured the surtax would generate about $2.5 to $3.5 million per year.

Only Commissioner Dan Saltzman showed wisdom in voting against the proposal by then-Commissioner Steve Novick.

As noted earlier, Portland’s tax is based on unreliable data and will fail miserably in meeting Novick’s hope that it “would prod corporate America back to equitable pay scales.” The tax is surely irritating to businesses, but it’s not likely to change their compensation practices.

Moreover, even if some shamed companies reduce their CEO’s pay and spread around the cut, it won’t mean much to other employees.

For example, The Kroger, Co which owns Fred Meyer, reported its CEO W. Rodney McMullen’s pay was $11,534,860in fiscal year 2018, which Kroger said was 547 times its median worker’s pay of $21,075.

Even if Kroger reduced its CEO’s pay to $1 million, and distributed the rest equally to Kroger’s 453000 employees, they would each see an annual raise of just $25.46.

In other words, the surcharge is just another way to pad the city’s coffers.

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