Why CEO-to-Worker Pay Ratios Matter to Investors

Daniel Pedrotty is the Director of the AFL-CIO Office of Investment. This post is based on an AFL-CIO briefing paper available here.

Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires public companies to disclose the ratio of compensation between their CEO and their median employee. The Securities and Exchange Commission will propose regulations to implement this requirement later this year. In this briefing paper, the AFL-CIO Office of Investment argues why CEO-to-worker pay ratios matter to investors.

First of all, changes in CEO-to-worker pay ratios are a useful measure of growing CEO pay levels. In 1980, BusinessWeek magazine estimated that the top executives of the largest U.S. companies made 42 times the pay of factory workers. In 2010, the gap between CEO pay at S&P 500 companies and the median U.S. worker had soared to 343 times, according to the AFL-CIO’s Executive PayWatch website.

Secondly, CEO-to-worker pay ratio disclosure will help reduce CEO pay levels. Existing disclosure rules encourage setting CEO pay levels based on “peer group analysis” that has contributed to CEO pay inflation. Pay ratio disclosure will encourage Boards to also consider the relationship of CEO pay to other company employees. Companies with high pay ratios will have to explain and justify their ratio to their shareholders.

Thirdly, high CEO-to-worker pay ratios can hurt employee morale and productivity. Employees of public companies already know how much their CEO makes relative to their own pay. Academic studies have shown that large pay disparities within a company can hurt employee teamwork, loyalty, and drive. Disclosing the median pay of employees will provide valuable information about employee compensation practices.

There is no one-size-fits-all answer for the ideal ratio of CEO-to-worker compensation. Rather, disclosure of CEO-to-worker pay ratios will permit investors to compare the employee compensation structures of companies over time and to their competitors. Such disclosure will provide valuable information about which companies are investing in their human capital, an increasingly important contributor to shareholder value.

The AFL-CIO’s briefing paper Why CEO-to-Worker Pay Ratios Matter For Investors is available here on the AFL-CIO’s website http://invest.aflcio.org.

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