– 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.
– Broc Romanek, CompensationStandards.com
On Tuesday morning, I got this press release announcing that ISS had been sold by MSCI to Vestar Capital Partners to the tune of $364 million. Drats! Fooled again by a rumor in the mass media as I had blogged last week about another likely purchaser due to a WSJ article.
The transaction is expected to close in the second quarter. ISS will operate independently and the current ISS executive team will remain in place. Here’s a Reuters’ article…
– Broc Romanek, CompensationStandards.com
When I saw these two headlines recently, I assumed they were talking about the same study:
1. PBS’s “A new study: How overpaid CEOs tank their firms”
2. Forbes’ “Big Company CEOs Just Aren’t Worth What We Pay Them”
But I was wrong, they were respectively related to these two new studies:
1. “Performance for Pay? The Relation Between CEO Incentive Compensation and Future Stock Price Performance” with an abstract of:
We find evidence that CEO pay is negatively related to future stock returns for periods up to three years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of excess pay earn negative abnormal returns over the next three years of approximately -8%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results appear to be driven by high-pay induced CEO overconfidence that leads to shareholder wealth losses from activities such as overinvestment and value-destroying mergers and acquisitions.
2. “Are Top Executives Paid Enough? An Evidence-Based Review” with an abstract of:
Our review of the evidence found that the notion that higher pay leads to the selection of better executives is undermined by the prevalence of poor recruiting methods. Moreover, higher pay fails to promote better performance. Instead, it undermines the intrinsic motivation of executives, inhibits their learning, leads them to ignore other stakeholders, and discourages them from considering the long-term effects of their decisions on stakeholders. Relating incentive payments to executives’ actions in an effective manner is not possible. Incentives also encourage unethical behaviour. Organizations would benefit from using validated methods to hire top executives, reducing compensation, eliminating incentive plans, and strengthening stockholder governance related to the hiring and compensation of executives.
– Broc Romanek, CompensationStandards.com
Recently, Corp Fin Director Keith Higgins provided a status update on the Four Horsemen rulemakings from Dodd-Frank during a February PLI panel on governance. I wasn’t there but I understand that this was the gist:
– As noted in the SEC’s reg flex agenda posted in December, the SEC intends to adopt a pay ratio rule & propose the other mandated rules in 2014. Whether that really happens depends on the Commissioner’s own workload, but the Corp Fin Staff will be ready to make this happen if they want.
– On the pay ratio proposal, there were 127,000 comment letters, of which 900 were “unique” letters (not “form” letters). Some of the comments were general, such as stating that data privacy would be an issue without specific information. The bulk of detailed comments dealt with non-US employees.
– The clawback & hedging/pledging proposals probably will be easier than the pay-for-performance proposal. The biggest challenge for the clawback proposal will be the no-fault aspect. The pay-for-performance proposal is a challenge because the statute mandates disclosure of compensation “actually paid” without describing what that is. The Corp Fin Staff has been looking at voluntary disclosure of “realized” and “realizable” pay – but does not think those are good models because they are all over the map (and are sometimes criticized for leaving out important components of pay).
– Broc Romanek, CompensationStandards.com
As noted in its Form 8-K, Hologic is the 2nd company holding its annual meeting in 2014 to fail to gain majority support for its say-on-pay with only 34% voting in favor (down from 65% last year). Hat tip to Karla Bos for pointing this out!
Poll: How Many Companies Will Receive a “Failed” Say-on-Pay Vote in ’14?
With 74 say-on-pay failures in ’13 – more than most folks predicted in last year’s poll – what will this year bring? Please take part in this anonymous poll:
survey services
– Broc Romanek, CompensationStandards.com
As noted in this WSJ article: “Investor adviser Institutional Shareholder Services Inc. is set to change hands for the third time in seven years, according to people familiar with the matter, amid debate about the firm’s sway over governance in corporate America.
Insight Venture Partners, a New York private-equity and venture-capital firm that was an early investor in Twitter Inc., is the likely winner of an auction of ISS run by current owner MSCI Inc., people familiar with the matter said Monday. Terms of the potential deal and its timing couldn’t be learned. People close to the sales process had said earlier that ISS could fetch around $300 million, which would be considerably less than it has sold for in the past.”
And here is a Fortune article about how the new owner would manage ISS’ conflicts…
– Broc Romanek, CompensationStandards.com
This memo from Aon Hewitt relates to this teaser: “For those who thought the movement to rein in executive pay may be losing steam, the recently released tax reform discussion draft provides a reality check. Among the hundreds of various tax breaks that would be reduced or repealed to help pay for recommended tax rate cuts, are several proposals related to executive compensation that could (if enacted) serve as a catalyst to reduce executive pay levels at for-profit and tax-exempt organizations.” Here are other memos that I have posted on the bill…