By Cydney Posner
In this DealBook column, the NYT's DealProfessor takes issue with the sorry tendency of Congress to address any problem with disclosure – transparency – rather than attacking the problem head on, often with unintended adverse consequences. Here the argument is exemplified by Dodd-Frank's internal pay equity disclosure provision, reportedly soon to be implemented with SEC regulations, with a slap at the elaborate conflict minerals disclosure provisions. The author contends that the internal pay equity disclosure provision was adopted as an easy-sounding fix to address the problem of soaring executive compensation and increasing income inequality, but will actually cost some companies millions in compliance costs and achieve nothing.
According to the author, the motivation behind the provision, which requires all public companies to disclose median total compensation for all workers compared to CEO total comp, was "to shame companies that had excessively high executive compensation to either pay their chief executives less or their workers more. The provision also comes in light of the increasing income disparity between the two. Pay for chief executives has risen to 277 times the average workers' pay, from 20 times in 1965, according to the Economic Policy Institute."
But while the brief provision (at only 140 words) seemed like a simple fix, in his view, "[c]arrying out the law may well result in costs that are just as obscene as the pay it is disclosing." As is widely known, there been many complaints about the difficulty of performing the necessary calculations covering all forms of compensation for all employees, especially when the company is multinational and has a large number of employees overseas.
In addition, he contends, these "added costs of the pay disclosure would be bearable if there was evidence it would do anything. But, like the disclosure requirement for conflict minerals, the evidence is mixed that the expense is worth it. In fact, he maintains, compensation disclosure in general has largely failed to achieve its objectives: "instead of empowering shareholders, it has allowed executives to see what others are paid. This has led to a ‘Lake Wobegon' effect in executive compensation, pushing each chief executive to demand to be paid ‘above average,' and the result has been ever-increasing compensation. It is not clear how the new disclosure required by Dodd-Frank would change established trends. Companies that already disclose executive pay are not going to suddenly change their ways. And as Daniel M. Gallagher, a former S.E.C. commissioner, asked, what is the benefit to investors? It's not only that it is likely to have no effect, the information provided might actually be misleading. If global employees are included, the ratio will be exaggerated by relatively low-paid employees in less-developed countries. The end result is that companies are likely to spend millions for something that is likely to do nothing."
Is the rule just "cheap regulation," he asks, which is "more about being able to show that you are doing something, anything about a problem without actually fixing it"? But to the extent that it is a legitimate effort by "politicians who are justifiably trying to address income inequality," why not "meet it head on, rather than through these indirect methods that only seem to cause more trouble"? Opting for an apparently easy fix like "more disclosure can sometimes have unintended and costly consequences. There are also no easy answers to hard problems. While [e]xecutive compensation may be excessively high and income inequality a real problem,… that seems beside the point."
Of course, even those that agree with the author's general proposition might argue that, in this case, the concept underlying the provision was not entirely flawed; given that the AFL-CIO were, the author notes, strong advocates of the provision, perhaps in this case, the disclosure requirement was designed to generate the political sentiment necessary to address the issue more directly. Arguably, the problem is more justly attributable to Congress' detailed and overly inclusive drafting, which mandated exactly how the compensation should be calculated and for whom. Indeed, the prescriptive nature of the statute has largely stymied any efforts by the SEC to streamline the analysis required. In 2011, Rep. Barney Frank sought to amend the provision by requiring that the compensation ratio information be provided only annually and, with regard to the employee compensation calculation, by limiting the calculation to only cash compensation and only domestic employees. (See my article of 6/24/11.) That effort went down to defeat on a straight party-line vote, as House Republicans opted instead for a bill to repeal the provision entirely as part of The Burdensome Data Collection Relief Act. (That bill was has been reintroduced in the 2013-2014 session.) Reportedly, the SEC will adopt a statistical sampling methodology that should simplify the requirement to some extent; however, the author suggests, if the SEC adopts watered-down rules, it could result in litigation seeking to strike the provision altogether. Of course, based on recent trends, it may well lead to litigation regardless of what the SEC adopts.