Securities Disclosure As Soundbite: The Case of CEO Pay Ratios

Abstract

This Article analyzes the history, design, and effectiveness of the highly controversial CEO pay ratio disclosure rule, which went into effect in 2018. Based on a regulatory mandate contained in the Dodd-Frank Act of 2010, the rule requires public companies to disclose the ratio between CEO pay and median worker pay as part of their annual filings with the Securities and Exchange Commission (SEC). The seven-year rulemaking process was politically contentious and generated a level of public engagement that was virtually unprecedented in the long history of the SEC disclosure regime. The SEC sought to minimize compliance costs by providing firms with maximum methodological flexibility, expressly foregoing any effort to ensure data comparability across firms. The sizable pay gaps highlighted by the newly reported pay ratios attracted extensive attention from the media and various non-corporate constituencies, fueling public outrage, motivating new proposed legislation, and reinforcing concerns over pay inequity and economic inequality. At the same time, the pay ratio’s role in investor decisionmaking remains uncertain. We suggest that the pay ratio disclosure rule represents a unique approach to disclosure, which we term disclosure-as-soundbite. This approach is characterized by (1) high public salience — the pay ratio is superficially intuitive and resonates with the public to an extent much greater than other disclosure, and (2) low informational integrity — the pay ratio is a relative outlier in terms of certain baseline characteristics of disclosure, meaning that the information is lacking in accuracy, difficult to interpret, and incomplete. We find that in its current formulation, the rule is ineffectual and potentially counterproductive when viewed as a means of generating useful and reliable information for investors, or influencing firm behavior on matters of worker and executive compensation. The pay ratio is more successful in fomenting or contributing to public discourse on broader societal matters relating to pay inequity and economic inequality, though the quality of the underlying information likely limits the quality of the discourse. Given the low probability of legislative action in this area in the near term, we propose that the SEC should seek to improve the rule’s informational integrity by mandating a narrative disclosure approach that provides information about median worker pay and the resulting pay ratio with more context, nuance, and explanation. This would be consistent with the format of existing disclosure requirements relating to executive compensation, and it would represent a positive move away from the disclosure-as-soundbite approach. A related and broader question about the need for disclosure of non-executive compensation and human capital management practices deserves further academic study.