January 11, 2022
Pay Ratio: Complex “Median Employee” Calculations Leave Investors With a Bad Taste
Liz blogged a couple of months ago about how investors are starting to assess pay ratios as part of the say-on-pay analysis. According to a recent study by a group of B-School profs (Alam, Ghosh, Ryan Jr. and Wang), the best way for companies to come out favorably on these types of voting policies is probably to make real changes to CEO and/or employee pay, versus taking steps that could be viewed as “gaming the calculation” of the median employee. The study analyzes these three questions:
(i) Do discretionary choices in the methods used to estimate the pay ratio allow firms to influence the reported pay ratio without making real changes to CEO or employee pay?
(ii) Do investors react differently to pay ratio disclosures based on the choice of method employed?
(iii) Do firms strategically use these discretionary choices when facing social pressure toward income equality?
The professors conclude that companies disclose lower pay ratios when using “more complex methods to identify the median employee” – and companies “headquartered in a state with stronger aversion toward income inequality” are more likely to choose these more complex methods, presumably in response to societal pressure. At the same time, the study shows that shareholders react negatively to those complex methods. That’s consistent with another study that Liz blogged about a couple years ago.
Compensation committees will need to stay aware of these perceptions and pressures. It will be a juggling act to set competitive executive compensation while also balancing pressure to minimize inequality. While the outcome of those decisions will vary by company, human capital oversight and potential increases to workforce compensation are shaping up to be hot topics for almost everyone again this year.
– Emily Sacks-Wilner