CEO Pay Ratio: The Great Challenges Boards Will Face

ceo pay ratio

A recent study by Stanford University’s Rock Center for Corporate Governance revealed two important insights about CEO pay:

  • Americans, on average, are outraged about how much CEOs get paid.
  • Americans grossly underestimate how much CEOs make.

According to the study, the typical American estimates CEO pay to be within the $1 to 5 million range, which is in fact only a fraction of actual compensation packages. As companies prepare to disclose the CEO Pay Ratio in 2018 (as mandated by Dodd-Frank), boards and management are becoming rather nervous about the potential backlash.

At their 8th Annual Global Ethics Summit, Ethisphere hosted an excellent panel (now available as a podcast) about the Pay Ratio; they discussed the feedback companies are receiving from institutional investors, preparations companies are taking, and the predicted effects. Below, we’ve gathered a few major insights from the 30-minute podcast.

Listen to the Podcast Here:

Operational & Opportunity Costs

This panel explores the impending costs and logistical hurdles associated with the CEO Pay Ratio. Panelists describe the difficulties companies will have as they attempt to set up the Pay Ratio, since identifying and tracking down information will prove a great challenge for many.

Carey Roberts (Chief Compliance Officer & Corporate Secretary, Marsh & McLennan) outlines the operational cost, as well the opportunity cost, that boards will face. While transparency is central to the company culture at Marsh & McLennan, Roberts worries that the time, energy, and resources associated with the CEO Pay Ratio will divert the board’s attention from the things investors have cited as more important (i.e., focusing on strategy, shareholder capital return, etc.).

We’ve had a lot of discussions with [ our institutional investors ] around our pay practices… What we’ve heard from them is that they don’t think this ratio will be helpful or interesting because of the size of our company and how different pay practices are around the world.
— Carey Roberts, Marsh & McLennan

Ratio Estimates

According to the panelists, the CEO Pay Ratio will vary widely and by industry. At the upper end, they expect to see some ratios in the “very high hundreds” (e.g., 800-900 to 1). Following the panel, we spoke with the executive pay experts at Meridian Compensation Partners for additional insights.

“We are seeing a wide range of estimates,” said Meridian partner, Jane Romweber, “from around 50 (for a utility with a highly paid engineering workforce) to around 1000 (for a large retailer with many part-time employees whose pay cannot be annualized).”

All else being equal, larger companies will have higher ratios, as CEO pay depends to a certain extent on company size while median employee pay does not.
— Jane Romweber, Meridian Compensation Partners

Panelists also discuss how different types of companies (e.g., utilities vs. financial services) will be affected.

Projected Backlash

Exacerbated by media coverage, companies expect disclosure of the CEO Pay Ratio to cause significant internal challenges. Panelists described an impending predicament, where companies will need to go on the offensive and disclose even more information in order to present the pay ratio in the appropriate context.

Service industries will have the greatest challenge providing this context given their global scale and preponderance of part-time and seasonal workers. Panelists also discuss the projected impact of the Pay Ratio on Say on Pay.

The Danger of “One Size Fits All”

Tim Olson (Senior Corporate Counsel & Corporate Secretary, NorthWestern Energy) offers a unique perspective, as his company has been disclosing the CEO Pay Ratio for the last seven years. On why NorthWestern Energy has disclosed the ratio since 2009:

It was one of the many tools that our compensation committee used to set executive pay. For us, it was telling that complete story. Then with Dodd-Frank, we got backed in this corner saying, ‘Well now we need to explain it more.’
— Tim Olson, NorthWestern Energy

Using NorthWestern Energy as a talking point, the panelists discuss the dangers of treating all companies the same when it comes to pay ratio calculation.

Don’t miss Ethisphere’s full podcast series here.