Providing Context for Executive Compensation Decisions
Commissioner Luis A. Aguilar
SEC Open Meeting, Washington, D.C.
Sept. 18, 2013
Today, the Commission takes an important step to comply with the Dodd-Frank Act’s requirements for better disclosure and accountability regarding executive compensation decisions at public companies.
As required by Section 953(b) of the Dodd-Frank Act, the Commission is proposing a rule to provide for disclosure of CEO-to-worker pay multiples. Reports show that these pay multiples have risen steadily over the years. For example, an April 2013 study by Bloomberg finds that large public company CEOs were paid an average of 204 times the compensation of rank-and-file workers in their industries. By comparison, it is estimated that the average CEO was paid about 20 times the typical worker’s pay in the 1950s, with that multiple rising to 42-to-1 in 1980, and to 120-to-1 in 2000.
Given this backdrop, it is not surprising that investors are asking if such a high level of CEO-pay multiples is in the interest of corporations and their shareholders. As owners of public companies, shareholders have the right to know whether CEO pay multiples reflect CEO performance. Shareholders have the right to know how their company’s internal pay comparisons may impact employee morale, productivity, hiring, labor relations, succession planning, growth, and incentives for risk-taking.
The rule we propose today is only one of several inter-related provisions of the Dodd-Frank Act to require enhanced compensation disclosure and accountability. Some of these rules, like the rules for “say-on-pay” advisory votes and listing standards for compensation committee independence, have been completed. But a number of other important protections have yet to be proposed. In addition to today’s proposed rulemaking, the mandates remaining to be acted upon include:
Section 953(a) of the Act, which requires public companies to provide their shareholders with information showing the relationship between executive compensation actually paid and the financial performance of the issuer; and
- Section 955 of the Act, which requires disclosure of company policies regarding the hedging of company equity securities held or awarded to company directors and employees.
Taken together, the enhanced disclosures on executive compensation will help investors to make informed investment decisions and to exercise their rights as shareholders and owners.
One area in which such additional information may be useful relates to benchmarking. It is well recognized that many public companies rely heavily on benchmarking to set executive compensation. For example, many public companies hire consultants to construct “peer groups” of ostensibly similar companies and to conduct surveys of prevailing compensation practices. In this process, a company’s executive pay levels are often targeted to the 50th, 75th, or even 90th percentile of peer group compensation. Companies justify this practice on the ground that they want to attract—and need to compete for—talented executives.
But commenters have noted a flaw to this practice: Not all CEOs are “above average,” and it is mathematically impossible for all CEOs to be paid above the 50th percentile of their peer group. To many observers, the result is an upward bias in CEO pay that may often fail to reflect actual performance (or even sometimes actual competition in the employment market). As a result, benchmarking may sometimes contribute to a process that results in executive compensation decisions that are not economically efficient.
It is my hope that the enhanced compensation disclosures mandated by the Dodd-Frank Act will help company shareholders and independent directors counter this tendency in two ways: First, more effective disclosure of pay-for-performance standards should help make executive compensation more transparent and foster accountability. Second, pay ratio disclosure can provide a valuable new perspective for executive compensation decisions. If comparing CEO compensation solely to the compensation of other CEOs can lead to an inefficient upward spiral, then comparing CEO compensation to the compensation of an average worker may help offset that trend.
Today’s proposal is a welcome step, but recognizing that the Dodd-Frank Act is now more than three years old, the Commission must act promptly to propose and adopt the other rules required by the statute.
The proposing release includes a number of requests for comment regarding the approach the Commission has taken to implement the statutory mandate, as well as potential alternatives. Public comments are an important part of the rulemaking process. As always, I particularly look forward to comments from investors.
I would like to thank the staff for their work on this important proposal.
I am happy to support this proposal.
 See, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), Pub. L. No. 111‑203, 124 Stat. 1376 (2010).
 See, Elliot Blair Smith, Phil Kuntz, “CEO Pay 1,795-to-1 Multiple of Wages Skirts U.S. Law,” Bloomberg (Apr. 30, 2013), http://www.bloomberg.com/news/2013-04-30/ceo-pay-1-795-to-1-multiple-of-workers-skirts-law-as-sec-delays.html; “Top CEO Pay Ratios,” Bloomberg (Apr. 30, 2013), http://go.bloomberg.com/multimedia/ceo-pay-ratio/. See, also, Lawrence Mishel, Natalie Sabadish, “CEO Pay in 2012 was Extraordinarily High Relative to Typical Workers and Other High Earners,” Economic Policy Institute (June 26, 2013), Issue Brief No. 367, http://www.epi.org/files/2013/ceo-pay-2012-extraordinarily-high.pdf; Russell Grantham, “CEO, worker pay gap huge,” The Atlanta Journal-Constitution (May 26, 2013), p. D3.
 See, e.g., letters from Social Investment Forum (Apr. 21, 2011), Walden Asset Management (Apr. 29, 2011), Trillium Asset Management Corporation (May 6, 2011), Calvert Investment Management, Inc. (May 27, 2011), AFL-CIO Office of Investment (Aug. 11, 2011), available at http://www.sec.gov/comments/df-title-ix/executive-compensation/executive-compensation.shtml.
 Pursuant to Section 951 of the Dodd-Frank Act, the Commission has also proposed, but has not yet adopted, rules that would require institutional investment managers to report their votes on executive compensation and "golden parachute" arrangements at least annually. SEC Rel. No. 34-63123 (Oct. 18, 2010). The Commission should complete this rulemaking expeditiously.
 In addition, Section 954 of the Dodd-Frank Act requires the Commission to direct the national securities exchanges to adopt standards requiring listed companies to disclose their policies on incentive-based compensation based on financial information reported under the securities laws, and to adopt policies requiring the claw-back of incentive compensation based on erroneous data, if such financial information is required to be restated. The Commission should promptly propose and adopt rules to fulfill this mandate. The Commission and other regulators should also fulfill their joint responsibility under Section 956 of the Dodd-Frank Act, by adopting robust rules regarding disclosures and prohibitions of incentive compensation structures that encourage inappropriate risk-taking at certain financial institutions, which were first proposed almost two and a half years ago.
 See, e.g., C. Elson and C. Ferrere, Executive Superstars, Peer Groups and Overcompensation: Cause, Effect and Solution, J. of Corporation Law, Forthcoming (2013) (“In setting the pay of their CEOs, boards invariably reference the pay of the executives at other enterprises in similar industries and of similar size and complexity.”)
 Id. (“It has been observed in both the academic and professional communities that the practice of targeting the pay of executives to median or higher levels of the competitive benchmark will naturally create an upward bias and movement in total compensation amounts.”) See, also, e.g., Russell Grantham, “Why some CEOs get paid so much,” The Atlanta Journal-Constitution (April 28, 2013), p. D1(citing professor John Bizjak, “If everyone’s pay is pegged to the midpoint or higher, that’s going to push pay higher ‘almost by definition’”); Steven M. Davidoff, “Opinion: A Simple Solution on C.E.O. Pay is Not So Simple,” The New York Times (Aug. 27, 2013) (“This has led to a ‘Lake Wobegon’ effect in executive compensation, pushing each chief executive to demand to be paid ‘above average,’ and the result has been ever-increasing compensation.”). But cf, J. Bizjak, M. Lemmon, and L. Naveen, Does the use of peer groups contribute to higher pay and less efficient compensation?, J. of Financial Economics. 90, 152-168 (2008) (finding that, while “benchmarking as currently practiced could have led to greater increases in pay than would have occurred in its absence,” increases in CEO compensation resulting from the benchmarking process can indeed be correlated with “firm performance” and “tighter labor market conditions,” and are not correlated with poor corporate governance.)
 Elson and Ferrere 2013 (“By basing pay on primarily external comparisons, a separate regime which was untethered from the actual wage structures of the rest of the organization was established…. To mitigate this, boards must set pay in a manner [which] is more consistent with the internal corporate wage structures. An important step in that direction is to diminish the focus on external benchmarking.”)