Back at the start of the month, the Securities and Exchange Commission decided to adopt a brand new metric that is causing quite a bit of controversy. Companies are now required to publicly declare the pay gap between the CEO and the median compensation of the employees at the firm.
In a time when we are well aware of the growing gap between the rich and the poor, a metric that measures how much money the top of the company is making in relation to the common worker promises to be an eye opener.
Data hasn’t been released yet and won’t until 2017, but the move has sparked a furious debate over why this metric would or would not benefit investors.
Differing Opinions
The new mandate from the SEC is proving to be a lot more controversial than the SEC probably expected and both sides of the debate are determined to maintain their stance.
Some shareholders seem to think it is a very positive development. Anne Simpson, the Director of Global Governance at Calpers, which manages public pension assets that exceed $300 billion, said the move comes as a “chink of light in a cloudy subject.” Simpson believes that it is becoming increasingly important that we have this conversation in public. The pay gap can reveal a lot about the pay structure and the fundamental culture at a company and this information could prove to be valuable for potential shareholders.
Such information, she argues, would let money management companies such as Calpers ask questions of management when the ratio is surprisingly high. They can force the management into action to reduce the gap if need be, making the company more equitable to its talented workforce.
However, many others seem to be more ambivalent to the new measure, such as Kerrie Waring of International Corporate Governance Network. Waring believes the new mandate could be useful, but only very marginally. She maintains that the total shareholder returns (TSR) metric already gives a lot of information about CEO compensation and the new pay-ratio would be very easy to manipulate.
Other countries, such as the United Kingdom, do not require such a metric. In general, money managers around the world explain that figuring out the median wage and the CEO earnings is a simple back-of-the-envelope calculation. They do not see the need for such a metric.
Patrick McGunn from the Special Council at Institutional Shareholder Services, says that the new data would likely not be used by most since the calculations might hinder the process. He says there are so many moving parts in any given company, and calculating the exact nature of compensation could be very complex in some industries. Sometimes comparing the data with peers from a group of companies may be difficult and inaccurate, which wouldn’t lead to any further clarity for investors.
What Does This Mean For Investors?
This move by the SEC could be seen as either an unnecessary regulatory burden on corporations or a move in the right direction for shareholder rights. There is no arguing that more information is generally better, as we move towards a culture that demands transparency in corporate and political affairs.
The way a CEO’s pay stacks up against the median worker could be a very helpful measure for someone who is evaluating a possible investment. At the very least, it would allow retail investors and analysts to understand the culture at a company and how egalitarian the workforce is there. Companies with better ratios could also be rewarded for their part in helping combat the issue of economic inequality, much the same way Corporate Social Responsibility is treated now.
On the other hand, comparing the side-by-side data of multiple companies could be difficult and even misleading. A multinational company that has a workforce primarily based in emerging nations, where wages are lower, could skew the results of the data. And comparing between different sectors or even different competitors in the same industry could prove to be such a challenge that many investors may avoid using the metric in their analysis at all.
Then there is the issue of costs, as companies may have to bear an additional cost to collect the relevant data. This could be an issue considering the already significant costs of complying with current market regulations. In response to this concern, the SEC has stated that the companies that will need to make these announcements will only be required to update earnings data once every three years. However, it’s still being debated whether the pay-ratio could change enough within a year to warrant a more frequent update cycle.
The reality is that neither investors nor publicly traded companies will know the true significance or impact of this new mandate until the first set of data is released and dissected in the media in 2017. But the volume of the response of both supporters and opponents makes it clear that this is not something that will be ushered in without a lengthy public debate.