Quack Corporate Governance: Dodd-Frank's Executive Comp Disclosure Rule

Roberta Romano famously referred to Sarbanes-Oxley as "quack corporate governance." Much the same can be said of the new Dodd-Frank bill, as well.

Case in point: Section 953 requires that each reporting company’s annual proxy statement must contain a clear exposition of the relationship between executive compensation and the issuer’s financial performance. It further requires disclosure of “the median of the annual total compensation of all employees of the issuer,” except the CEO, the CEO’s annual total compensation, and the ratio of the two amounts.

The cognoscenti have known for some time that this requirement will be hugely burdensome:

[It] means that for every employee, the company would have to calculate his or her salary, bonus, stock awards, option awards, nonequity incentive plan compensation, change in pension value and nonqualified deferred compensation earnings, and all other compensation (e.g., perquisites). This information would undoubtedly be extremely time-consuming to collect and analyze, making it virtually impossible for a company with thousands of employees to comply with this section of the Act.

Now the word is getting out more generally. Today's Financial Times relates that:

US companies face a “logistical nightmare” from a new rule forcing them to disclose the ratio between their chief executive’s pay package and that of the typical employee, lawyers have warned.

The mandatory disclosure will provide ammunition for activists seeking to target perceived examples of excessive pay and perks. The law taps into public anger at the increasing disparity between the faltering incomes of middle America and the largely recession-proof multimillion-dollar remuneration of the typical corporate chief. ...

The rules’ complexity means multinationals face a “logistical nightmare” in calculating the ratio, which has to be based on the median annual total compensation for all employees, warned Richard Susko, partner at law firm Cleary Gottlieb. “It’s just not do-able for a large company with tens of thousands of employees worldwide.”

Disclosure is not free. The question always must be whether a dollar of corporate expense in generating the disclosure produces more than a dollar in value to investors. Section 953's costs will be enormous. The benefits to investors seem slight. Instead, as with so much of Dodd-Frank, the many benefits will flow to anti-corporate social activists who want to use the data for their own purposes.

Update: Usha Rodrigues comments:

Brandeis' sunlight works best when it's pretty clear that the darkness is hiding something. The classic example is related party transactions: if a company has to disclose whenever it engages in a transaction with its executives, the market will either punish it for engaging in management-enriching activity at the expense of the shareholders, or it will be less likely to engage in that activity in the first instance.

It's not at all clear that disclosure of CEO/average employee pay ratios will trigger the same reaction. On the contrary, the history of executive comp regulation by disclosure has taught us that disclosure can result in an arms race as executives demand pay packages at least as good or better than that of their peers. Even the most populist of shareholders will generally agree that you have to pay CEOs more than the average employee, and the intrafirm ratio seems like an odd metric for determining how much is too much. If a company has low-wage employees (e.g., Wal-Mart) the ratio will be higher than if it's a company with high-wage employees (a bio tech firm); does that mean the Wal-Mart CEO is being paid "too much"? Even more problematic for populist reformers, the FT article points out an unintended consequence of the new regulation: it favors companies that outsource or even off-shore jobs, since those low-wage earners won't be counted in the median employee pay numbers. Ooops.

Comments

[David]

I have a hard time believing that large and medium companies don't have this information already available. I work for a mid-size company (2500 employees). All of this information (minus change in pension value) is available to every employee via a portal to bswift.com that indicates my total compensation is $123,475.87 (on a salary of $81,333.91).

[David Welker]

While such disclosure may or may not be worth it, the idea that this is "impossible" to comply with sounds like extreme exaggeration.

This is why we have computers. Enter all the compensation for each employee in the system (something that should be done anyway in any good accounting system) and have a program create a report. That isn't rocket science. Do companies now really go about business not knowing how much they compensate their employees now? If so, that sounds like just bad accounting. If they already have that information, I don't see why it should be so hard to take that information and use a computer program to create the disclosures that are required.

What am I missing here? I agree that this sort of disclosure isn't free. Virtually impossible on the other hand? Hardly. Don't most companies keep track of the compensation they give their employees anyway? What am I missing here?

[Cornellian]

How could a company not know the size of its own payroll? Where is it getting the data from to arrive at that figure?