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Dodd-Frank Regulation Could Curb CEO Pay Excesses

Apr 26th 2016
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Section 953(b) of the Dodd-Frank Act, which takes effect next January, will require firms to disclose the ratio of the CEO’s compensation to the median pay of company employees. But will revealing that ratio shame companies into scaling back how much the head honchos make?

A study in the spring issue of the American Accounting Association’s Journal of Management Accounting Research indicates that, yes indeed, revealing that pay ratio is likely to also reveal a few red faces.

“Given that companies are concerned about whether investors, employees, and the public perceive their CEO pay and employee pay to be fair, our results are consistent with the argument by supporters of Section 953(b) that pay-ratio disclosures may be better able than current CEO pay disclosures to shame companies into restraining CEO pay,” the study states.

What’s more, the study, authored by associate professors Khim Kelly of the University of Waterloo and Jean Lin Seow of Singapore Management University, reveals that the CEO-to-employee pay ratio, compared to only pay among CEOs, has a big effect on the perception of salary fairness – you think? – and also indirectly impacts investors.

Kelly notes that CEO-to-employee pay ratios have grown from 20-1 50 years ago to 80-1 25 years ago, and current estimates range from 200-1 to 300-1.

“It stands to reason that confronting investors with ratios approaching these will make an impression, and our research suggests it does,” Kelly said in a prepared statement.

The professors’ study involved a group of MBA candidates who were asked to judge a fictional company based on CEO-to-employee pay ratios. Those who were told of the CEO-to-employee pay ratios were far more likely to regard the CEO’s pay as unfair, and the more they viewed it as unfair, the less likely they considered the company as a good investment.

The study notes that the investment angle is key because Section 953(b) critics say it allows the US Securities and Exchange Commission to interfere in income inequality issues rather than investor protection.

The professors believe their findings will interest management accountants because they’re involved in executive and lower-ranking employee compensation, and how wage levels compare among similar companies. Management accountants also decide on proportions of part-time and full-time employees, temporary and permanent employees, and business locales – which affect median employee pay and pay ratios.

Further, compensation and location decisions are included in required disclosures about CEO and median employee pay and pay ratios.

Still, let’s face it. While companies may have to justify how their pay structure is fair, investors and employees expect the top boss to earn more, right? The issue here, then, is that “it is less likely that our participants are reacting to the mere disclosure that the CEO is paid more than the median employee and more likely that they are reacting to the pay ratio being higher than industry,” the study notes.