SEC’s CEO Pay Ratio Rule Starts in 2018: Could It Help Fix the Wage Gap?

SEC’s CEO Pay Ratio Rule Starts in 2018: Could It Help Fix the Wage Gap? Hero Image

It’s been over 50 years since the Equal Pay Act was passed, and we’re still talking about income inequality. With daily reminders of the gender and racial pay gap, misclassified employees, and the growing number of workers who rely on food stamps to survive despite working a full-time job, it’s hard not to talk about it.

But while we have this valuable conversation as a society, we often underestimate one of the most shocking forms of pay disparity: the difference in pay between CEOs and their workers.

Everyone knows that Chief Executive Officer is a highly compensated role, and rightfully so. No one would deny it’s a hard job. A CEO is the highest ranked executive in an organization, the person in charge of an organization’s day-to-day operations, and the public face of the company during a public relations crisis.

Most Americans don’t realize the shocking difference of income between CEOs and their employees, and how this disparity in pay has been growing astronomically since the 1970s…

But most Americans don’t realize the shocking difference of income between CEOs and their employees, and how this disparity in pay has been growing astronomically since the 1970s — despite the stagnation in the average worker’s salary.

That’s about to change. Starting in 2018, the U.S. Securities and Exchange Commission will require publicly traded companies to disclose the median of the annual total compensation of all its employees except the CEO, the annual total compensation of its CEO, and the ratio of these two amounts. While information on CEO pay is already accessible online, this law will be the first to require companies to disclose a clear, certified ratio of CEO-to-worker pay for the public to see.

But will disclosure actually change anything? Today, Morgan & Morgan labor & employment attorney Christina J. Thomas will talk about what the new CEO pay disclosure rule could mean for workplace equality in America and the steps that lawmakers, attorneys, and even some CEOs are taking to bridge the gap.

Americans Still Underestimate the CEO-to-Worker Pay Ratio, Despite the Data

The CEO pay disclosure rule is part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was passed by Congress under the Obama administration in 2010 in response to the financial crisis of 2008. It’s designed to increase transparency about executive compensation among publicly traded companies.

CEOs are making more than 350 times the average worker’s wages.

Although access to corporate financial reports is already just a Google search away, many people don’t realize just how easy it is to find these documents and look up information about the companies they work for.

“Most Americans don’t know how to look up a SEC Form 10-K,” said Thomas. “Every publicly traded company has one of those, and they’re all filed with the SEC. They’re public documents, and they’re intended to protect shareholders, but they can also benefit employees.”

Here are the facts:

CEO pay has grown 90 times faster than the average worker’s pay since the 1970s, according to a 2015 paper by the Economic Policy Institute. The CEO-to-worker ratio was 25:1 in the ‘70s. Now, it’s above 300:1 in many companies. The average worker’s wages has stagnated, while CEO pay has grown drastically over the decade.

Americans believe CEOs make approximately 30 times what the average worker makes, when in reality CEOs are making more than 350 times the average worker’s wages, according to a 2015 study conducted at Harvard Business School.

Clearly, the information on CEO and worker pay exists, but it’s not being published in a clear way that benefits the public, hence the reason so many Americans believe the CEO-to-worker pay ratio to be much smaller than it actually is.

That’s what the SEC is aiming to change.

CEO pay has grown 90 times faster than the average worker’s pay since the 1970s…

“We know that large corporations are already collecting data on employee pay, because they’re using it to calculate minutiae for the purpose of profit margin,” Thomas said. “The SEC has made it clear that the data that is already being collected needs to be utilized in a way that provides information to the public — such as stockholders, employees, and small business owners — that makes economic opportunity equal for all.”

“If an employee knows how much more their CEO is making than the average worker, that could empower people to get together or potentially unionize,” added Thomas.

High CEO-to-Worker Pay Ratio Linked to Low Job Satisfaction, Low Shareholder Returns, Low Approval Rating

Sacrificing workers’ wages and benefits for the sake of business may actually not be so great for the bottom line, it turns out.

High CEO-to-worker pay ratios can hurt employee morale and productivity, cause high employee turnover and lower job satisfaction, and can result in a lower quality product, according to Steven Clifford, a former CEO and author of The CEO Pay Machine.

“Many studies have concluded that high CEO-to-worker-pay ratios lower morale and company performance. To me, this is as surprising as studies that reveal that the Pacific Ocean is actually full of water,” said Clifford in an excerpt from The CEO Pay Machine. “Will news that the boss made $102 million raise or lower morale with UnitedHealth Group employees? Will McKesson employees be more or less motivated upon learning that their CEO made $145 million? You don’t need a PhD to answer correctly.”

High CEO-to-worker pay ratios can hurt employee morale and productivity, cause high employee turnover and lower job satisfaction…

All of this, Clifford believes, harms American industry and curbs economic growth.

Beyond employee satisfaction, companies with high CEO-to-worker pay ratios also had lower shareholder returns over a five-year period compared to companies with low CEO-to-worker pay ratios, according to a CtW Investment Group study of S&P 500 companies.

Another study, which was conducted by professors at University of Utah, Purdue University, and University of Cambridge, corroborated CtW Investment Group’s findings. The study analyzed the CEO pay and company performance of 1,500 major companies between 1994 and 2013 and found that the 150 companies with the highest-paid CEOs had the worst company performance. The authors of the study attributes this negative correlation between higher-than-average CEO pay and poor stock performance to overconfidence.

“Overconfident CEOs receiving high excess pay undertake activities such as overinvestment and value-destroying mergers and acquisitions that lead to shareholder wealth losses,” the study said.

As a result, companies with high CEO-to-worker pay ratios may also turn off potential investors.

“If I’m looking for a place to put my money, I’m going to look for the companies that have a plan that includes long-term sustainability, not just short term gains. Workforce retention — and adequate pay — is a big piece of that puzzle,” Thomas said.

In addition to low shareholder returns and poor worker retention, the highest-paid CEOs often tend to get the worst approval ratings from workers, according to a 2016 study by career website Glassdoor that looked at 800 publicly traded companies.

While gender, age, and education of the CEOs had little impact on CEO approval ratings, highly paid CEOs tended to have significantly lower CEO approval ratings. But perhaps most notable, the Glassdoor study found that strong company culture can partially lessen the negative effect of high CEO pay on approval ratings.

How Some CEOs Are Tackling the Issue of Income Inequality in Their Own Companies

Clearly, a high CEO-to-worker pay ratio can hurt long-term employee retention, approval, and shareholder confidence.

CEOs can either ignore this information and pursue short-term goals to temporary bolster company performance and stocks, or they can utilize the data disclosed to the SEC — which they have likely already gathered internally — to make meaningful changes over the long haul that help to retain talent.

Contrary to popular belief, these changes can go far beyond just raising employee wages. There are tax-deductible, ancillary services employers can provide that are shown to buttress the median wage rate, increase employee retention, and improve company culture.

Thomas listed some examples: In-house daycare or preschool services, continued education and tuition assistance, free gym membership, ridesharing or public transportation subsidies, homebuyer loan assistance, and more.

There are some great examples of corporations and CEOs who are aware of these trends of income inequality and are actively attacking them, says Thomas.

Aetna Raised Wages, Added Benefits for Lowest-Paid Workers

In 2015, Aetna CEO Mark Bertolini made a move that separated him from the many CEOs who get rich quick by slashing costs to improve company performance for the short term.

After discovering that his company’s lowest paid workers were forced to turn to Medicaid and food stamps to make ends meet, Bertolini spent tens of millions of dollars on his company’s workers, according to Fast Company.

“The people out there that live in the real world need our help,” explained Bertolini.

Aetna raised the company minimum wage to $16 an hour, and added benefits including helping employees repay loans, lowering out-of-pocket health insurance costs for its lowest-paid workers, and establishing a wellness program that rewards workers up to $300 a year if they get at least seven hours of sleep each night.

While expensive in the short-term, investing meaningfully in employees can reduce the high costs associated with employee turnover, which is more common for low-paid workers. Bertolini also believes that by investing in his company’s workers, they will provide a better experience for Aetna’s customers, leading to higher revenue and shareholder value in the long-run.

McDonald’s Boosted U.S. Sales by Improving Worker Wages, Benefits

The fast food industry is infamous for having some of the worst CEO-to-worker pay ratios out of all sectors of the U.S. economies, but McDonald’s CEO Steve Easterbrook took steps to buck the trend in 2015 by raising the average wages for workers at the U.S. locations it owns to $10 per hour.

McDonald’s also added a paid vacation package for employees who have worked with the company for over a year and created its “Archways to Opportunity” program designed to provide assistance to employees pursuing education, according to Fortune.

McDonald’s quarterly sales increased in 2016 after years of declining sales following the implementation the wage increase and benefits…

While this raise technically only affected 10 percent of McDonald’s workers, as the majority of McDonald’s restaurants are franchised, many McDonald’s franchisees likely raised wages in their own restaurants as well in response.

Several franchisees reported feeling pressure to raise employee pay after McDonald’s wage announcement, according to Business Insider.

So far, it’s working. McDonald’s quarterly sales increased in 2016 after years of declining sales following the implementation the wage increase and benefits, according to Business Insider.

McDonald’s CEO attributes it to the wage investments, which he believes improved worker retention and customer satisfaction scores.

“The improvements we made to our compensation and benefits package to employees in U.S.-company operated restaurants, along with expanding Archways to Opportunity, have resulted in lower crew turnover and higher customers satisfaction scores,” Easterbrook said in a statement discussing the company’s quarterly results.

By retaining good workers, McDonald’s enhances the service it provides to its customers and drives up sales, while still helping to improve the lives of its employees.

What the CEO Pay Rule Could Mean for Labor & Employment Cases

While many companies are beginning to improve wages and working conditions for their employees of their own volition, others companies continue to allow workers’ wages to stagnate while CEO pay grows.

Some even deny their workers their lawful wages and rights under the guise of “protecting the bottom line.” This is where labor & employment attorneys like Christina J. Thomas come in.

“If a company is publicly traded, the first thing that I do before I file a lawsuit is pull their most recent annual or quarterly report to see what their profits are,” said Thomas. “Almost every case that I have involves an employee who wasn’t getting paid correctly, or was fired for some unjust reason, and the company’s excuse typically has to do with a business justification. ‘This employee wasn’t productive enough, they didn’t sell enough, they didn’t make enough widgets…’ that’s always their defense.”

In these cases, the CEO-to-worker pay rule can help to bolster labor & employment cases on behalf of workers who were unjustly fired, retaliated against, or denied proper wages due to “business costs” by clearly showing the company’s profits and CEO compensation package in comparison to the average worker.

“For example, if my client gets sexually harassed in the workplace and she complains about it and gets fired, and the company comes back and says, ‘We didn’t fire her because she complained, we actually fired her because she wasn’t productive, and we have these standards of productivity,’ I’m going to argue to the judge that the jury needs to understand what the ‘standards of productivity’ mean in the larger context of the corporate culture,” said Thomas. “And that includes CEO pay and median wage rates for all workers.”

“As an employment lawyer, I’m looking at it from this perspective: We have these goliath corporations that are saying that they’re trying to do right by their stockholders and pay out dividends, but really there are just a few people at the top who are getting all the cash, and the workers are suffering as a result,” she added.

The CEO pay ratio data that companies will have to disclose to the SEC starting next year may become a valuable tool for helping attorneys like Thomas to tell their clients’ stories to the judge and jury.

What Cities and States Are Doing to Address the CEO-Worker Pay Gap

Beyond the courtroom, changes may be coming to the local and state level, as officials look to surtaxes as a way to remedy the CEO-to-worker pay gap in their own backyard.

Portland, Oregon became the first city in the country to charge a 10 percent surtax on companies with CEOs earning more than 100 times the median pay of average workers.

Portland, Oregon became the first city in the country to charge a 10 percent surtax on companies with CEOs earning more than 100 times the median pay of average workers after adopting the tax ordinance in late 2016, according to The New York Times.

“If other jurisdictions follow Portland’s lead in enacting policies based on the Securities and Exchange Commission disclosure, shareholders may realize that extreme chief executive officer to median worker pay ratios reduce their profits and, with this result in mind, make changes to their pay structure,” the ordinance reads.

The tax is estimated to generate between $2.5 and 3.5 million annually for the city’s general fund, which would help to pay for basic public services including housing, police salaries, and more, according to Portland city officials.

Since the tax law went into effect in Portland, other cities and states have looked into passing similar measures. For example, Rhode Island and Minnesota have both proposed similar legislation to the Portland pay ratio surtax, according to Bloomberg.

“If a corporation doesn’t want to pay the surtax, they don’t need to — they can simply lower their outrageous CEO compensation, or increase their employees’ salaries,” said Rep. Aaron Regunberg in a statement introducing H. 5141, Rhode Island’s proposed surtax bill.

Connecticut, on the other hand, went a step further and proposed a corporate income tax rate of five percent for companies with a CEO pay ratio of 25:1; 7.5 for pay ratios between 25:1 and 100:1; 10 percent for pay ratios between 100:1 and 250:1; and 25 percent for companies with a pay ratio of over 250:1, according to Bloomberg.

Only time will tell if Portland’s surtax will be an effective method of tackling pay inequality, and if other cities or states will successfully follow in suit.

Demand for Pay Transparency & Fair Wages Growing: How Will CEOs Act?

The SEC’s imminent pay disclosure rule, efforts by CEOs to stem the wage gaps within their companies, and state-implemented surtaxes on companies with large CEO-to-worker pay ratios are all part of a greater movement towards pay transparency, and with it fair wages and benefits that allow all workers to live with dignity.

As pay transparency and liveable wages are increasingly expected by workers and shareholders alike, it will become harder than ever before for corporations and their CEOs to hide — and to justify — enormous wage gaps.

Ultimately, how corporations use the information disclosed to the SEC to manage their business won’t just impact the quality of their workers’ lives: it’ll be vital to the success of their company.

“Which companies will survive the waves of social media wrath we see happening every day in this country? The ones who take a proactive approach to income inequality, or the ones who try to hide their business strategies in the boardroom?” said Thomas. “To me, the answer is obvious.”

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