The Advisors' Blog

– Liz Williams, US Compensation Research, & Natalia Weaver, ISS Corporate Services

The concept of “pay disparity” took a step forward in 2013 when the SEC proposed a new rule, as mandated by Dodd-Frank, which will require most U.S. public companies to disclose the ratio between the “actual” compensation paid to their CEOs as a multiple of the median level of compensation paid to all other employees. Although the proposed rule incorporates considerable flexibility for companies to determine “all employees” median pay, it did not quell debate about the value of pay disparity measures to investors and the public. Academic research continues to be mixed on the issue, including the value of other disparity measures, such as the ratio between pay to the CEO versus the next highest paid executive or the average of all other named executive officers (NEOs).

Initial disclosures of the new pay disparity ratio will likely begin in proxy statements published in 2016, but both investors and issuers have already begun to give it serious consideration. To help investors anticipate how the new pay disparity measure might look, ISS undertook an analysis using data from the Bureau of Labor Statistics (BLS) Current Employment Survey, which contains the monthly and annual average hourly wage for all US employees by sub-industry, industry and sector (not seasonally adjusted). The BLS data classifies industries using the North American Industry Classification System (NAICS); ISS estimated average employee wages by industry and applied these to comparable Global Industry Classification System (GICS) categories in order to compare them to disclosed CEO pay data for S&P 1500 companies and project how the future pay disparity ratios may appear. Additionally, ISS analyzed CEO and NEO pay data within the S&P 1500 universe, to pinpoint ratios between the top executive and other NEOs.

Our research identifies several key findings:

– Based on BLS data, the median ratio of CEO-to-average-employee pay rose significantly during the study period, from 64.3 in 2009 to 87.7 in 2012; however the median in 2009 likely reflects a temporary decline in CEO pay in the wake of the financial crisis, and the ratio climbed more modestly (from about 80 to 88) after that.

– The escalating ratio stems from increases in CEO pay. Median reported pay for S&P 1500 CEOs rose about 30 percent from 2009 to 2012, compared with an increase of less than 6 percent for average annualized employee wages generally. As noted, the biggest jump in CEO pay occurred from 2009 to 2010 (about 21.3 percent), following some decline in 2009; the largest increases in annual employee wages came between 2010 and 2012 (2 percent each year).

– Across all industries, the bottom 50 percent of ratios are notably more concentrated than the upper half, indicating much more variation in CEO-to-average-employee ratios for companies with higher pay disparity.

– There is clear disparity in both the distribution of ratios and median ratios among different industries: Software & Services and Semiconductors, for example, demonstrate both relatively low median ratios as well as lowest overall ranges of CEO-to-employee-pay ratios. Conversely, companies in industries such as Retailing, Food, Beverage & Tobacco, and Household & Personal Products exhibit both relatively high median ratios and some of the highest ratios across all industries.

– While most industries maintained fairly stable median ratios over the period, a few (e.g., Food & Staples Retailing and Consumer Services) experienced significant increases from 2009 to 2012.

– In contrast, median ratios between CEOs and the next highest paid named executive officers (NEOs) across all S&P 1500 companies showed steady albeit limited growth from 2009 to 2012 (from 1.9 to 2.06), with the same trend in all indexes (S&P 500, Midcap, and Smallcap).

– There is also much less variation seen across industries for CEO-to-next-highest-paid-NEO pay disparity than exists with respect to CEO-to-average-employee pay, and generally more even distribution of ratios within industries according to this analysis. In this case, Diversified Financials had the lowest median ratio in 2012 (1.47), while the Materials industry had the highest (2.44)

– Similar results are found when comparing the ratio of CEO pay to the average other NEOs’ pay levels.

Based on the BLS data used in our analysis as a proxy for company-specific pay ratios that will emerge when the new rule takes effect, investors will need to view the ratios in appropriate context within industries, and may find it most useful to monitor changes at the company level or within close peer groups, rather than across firms generally or even within the same broad industry. Notably, concerns raised by both academics and investors in recent years regarding companies’ use of peer benchmarking to set top executives’ pay may intensify if the gap between CEO and median-employee pay continues to outpace changes in disparity between CEO pay and that of other NEOs.