Fairness is in the Eye of the Investor: CEO Pay Ratio Voluntary Disclosures and Investor Reactions

Abstract

Since 2018, the Security and Exchange Commission (SEC) has required firms to disclose the ratio of their Chief Executive Officer's (CEO's) and median employee’s pay. Due to the uncertainty surrounding the ratio's interpretation, some managers use voluntary disclosures to complement and clarify their mandatory disclosures. We document this behavior by manually inspecting the proxy statements of all firms in the S&P 1500. We predict and find that a firm's propensity to provide voluntary disclosures increases in the magnitude of its pay ratio. Drawing on equity and signaling theory, we predict that investor reactions will be significantly more impacted by the voluntary disclosure behavior of firms whose pay ratios are in the middle of the distribution. Investors rely more on the voluntary disclosures of middle ratio firms because the magnitude of their ratio provides an ambiguous signal of pay fairness, relative to low or high ratios. We find empirical support for this prediction, and we find that investor responses are strongest among firms with high institutional ownership, which we attribute in part to the demands of institutional investors for increased human capital management disclosures.