Will Transparency in CEO Compensation Have Unintended Consequences?
Summing Up: The Dodd-Frank legislation requiring companies to compare CEO compensation with rank-and-file pay will have little or no impact on executive compensation levels, say Jim Heskett's readers. (Online forum has closed; next forum opens November 4.)
The Dodd-Frank legislation provision requiring the publication of the ratio of CEO compensation to that of the average compensation level of all employees in public companies will have little or no impact on CEO compensation levels. That's the conclusion of a majority of respondents to this month's column.
Several thought that the provision could have the desired effect. Yedendra Chouksey said, "What is open to public glare does restrain proclivity for 'insanely generous' self-rewards… So, why not try it and hope for some better discipline in (the) top executive reward system?" Ajay Kumar Gupta put it this way: "I believe revealing compensation ratio(s) will help inculcate values, honesty, and accountability in the organization."
Others were less sanguine. Zach Allen described it as a "futile effort … there is a mystique associated with being a CEO. Often the CEO is portrayed as 'the only person in the world who could do this job'… You can thank the financial press for this mystique." In pointing out the futility of the effort, Rebecca West commented that "the current exclusionary process of creating CEOs feeds into an elitist culture among executives that begin to view themselves as 'untouchable.'" Gerald Nanninga added, "If CEOs create a lot of wealth at their company and share it with enough people, they can get away with making themselves extremely wealthy… A few silly ratios won't change that." Paul Jackson pointed out, "There is already available in proxy statements what the compensation is. It's supposed to be public knowledge, except few of the public learn of it, and few investors, apparently, get upset." Ravindra Edirisoorlya said that "the market for CEOs decides the pay of CEOs." Kamal Gupta put it this way: "Investors care two hoots about it as long as the company is doing well and rewarding them well."
There was concern that the legislation might actually have the opposite effect of what was intended. Tom Dolembo commented, "Publicity will have the opposite effect … the information will support and raise current levels." Guy Higgins commented, "Recall that CEO compensation began to balloon only when the CEOs could see each other's comp packages and began thinking, 'I'm better than that doofus.'"
Ulrich Nettesheim raised a question for further thought: "Does increasing transparency and visibility of the ratios help increase the ability for shareholders and boards to make better choices?" He commented, "One of the best agents to advocate for the right level of pay will be CEOs themselves … informed individual judgment with a hefty dose of transparency goes a long way to doing the right thing." What do you think?
Early in the Gulf of Mexico oil-rig explosion and leak disaster, BP agreed to activate a camera fixed on the source of the leak. Some people believe that simple act produced such a vivid, constant reminder of the enormity of the leak that it hastened actions that would otherwise have taken longer and been much less effective in stopping the leak and dealing with the cleanup.
Now comes a little-publicized provision of the Dodd-Frank legislation designed primarily to encourage Wall Street reform. In addition to the disclosure of the annual compensation of the CEO, the bill requires organizations with publicly held stock to disclose the median total annual compensation of all employees and the ratio comparing these two amounts. The intent is clear. It is to provide a periodic reminder to shareholders and others of the reasonableness of CEO compensation. We can expect a deluge of stories comparing the compensation ratios for various CEOs. Reporters won't even have to do the math behind the stories.
As a former director of companies operating in various parts of the world, I can report from experience that differences in philosophy concerning compensation, say between Europe and the U.S., pose real issues. Not only do European CEOs and board members regard U.S. levels of CEO compensation as bordering on insanely generous, they are wary of such things as stock options and other elements of U.S. pay packages. This can pose a real problem when senior executives are moved back and forth between continents.
There are legitimate questions concerning the Dodd-Frank provision. The first is measurement. As we have learned from the detailed explanations of top five executive pay packages required recently for public companies, the amounts shown in those reports can be highly misleading. For example, what are we to make of "out-of-range" compensation resulting from the excellent performance of the company? Or option awards that are intended to cover several years? Or options related to multi-year performance that happen to be cashed in a given year? Second, does this kind of transparency matter? There is little indication that investors pay much attention to the detailed compensation information that is readily available now.
Then there is the implicit assumption that a lower ratio of CEO to average compensation has a beneficial effect on an organization's performance. Presumably, the thinking is that greater equity in pay leads to a healthier culture (for example, in organizations like Whole Foods Markets and the Ben and Jerry's division of Unilever that actually set low limits on the ratio) that in turn accounts for some amount of added performance.
So the resulting questions are: Will moral suasion through such measures as the Dodd-Frank bill affect CEO compensation? Does it matter? What do you think?