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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  1. Mike
    Posted Monday, August 15, 2011 at 1:52 pm | Permalink

    Your point about high ratios having an impact on team morale and drive is absolutely correct. Amazing job of pointing that out.

  2. Louis Fischetti
    Posted Friday, October 28, 2011 at 1:41 pm | Permalink

    I believe disclosure of this information should be made widely available to the public at large. This will allow the consumer to decide which companies and brands to support, using the market to help curb inequality. Left unchecked and unnoticed, it’s natural for excesses to happen. Rather than the government trying to get into the compensation fairness (which is subject to the whims of politics), let society determine what is ‘too much’ and vote with their wallets.

  3. Barbara Lond
    Posted Friday, January 27, 2012 at 3:01 pm | Permalink

    Publiishing ratios will not demonstrate how organisations are utilising their human capital. Publishing data for example on the kinds of jobs people hold and job level,would (by gender and ethnicity). There’s much research from occupational segregation showing that white men predominantly occupy upper echelons in organisations. There is similar discussionninnthe UK about ratios. There are many issues to consider as well as ratios to engender faith in investing in human capital. I am constantly surprised that no-one recognises these. Either people don’t understand, don’t want to know, or don’t care. Future leaders, our younger leaders, will hopefully have more impact, as they seem to have their eyes open more. I believe we are on the brink of a new wave of thinking needed to run organisations, and rhetoric will simply not work. Diagnosing and understanding the,complex issues and making relevant interventions, for example new leadership and role competences embedded intelligently into organisations by experts in organisational and behavioural change, will work, as much research shows. Simple changes can make a differences as for example procedural justice and psycholocal contract research shows, and many organisations in my experience, don’t do any or enough research to understand the the issues first.

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