If you ask most people about Keith Hernandez, some might recall his career as a professional baseball player, while more still would remember him from his recurring role on the immensely popular sitcom Seinfeld. But did you know he also holds the major league record for most game-winning RBIs in a season and all-time? If you’re shaking your head, you’re not alone. Even major league baseball has discarded the stat because it’s virtually meaningless.
Bruce Weber, author and journalism professor at New York University, explains:
The main problem with the game-winning r.b.i. was that it did not adequately distinguish the achievement it was meant to reward. Even a casual fan understands that hitting a routine single in an early inning to drive in the first run of a 10-0 victory is a lesser accomplishment than clobbering the decisive home run in the bottom of the ninth. Yet each qualified as a game-winning r.b.i.
Baseball, a sport driven by statistics and numerical analytics, got rid of a stat because it failed to provide meaningful information. Public companies now have their own version of the game-winning RBI statistic, and it is known as “pay ratio.” The statistic comes into the industry as a result of the 2010 Dodd-Frank Act, which requires most public companies to identify the ratio between the total compensation of their CEO and the median level of compensation for all other employees. The Securities and Exchange Commission (SEC) was tasked with its implementation, and this year is the first year companies begin disclosing their ratio in annual proxy statements. The disclosure should suffer a similar fate to the game-winning RBI.
The stated intent of the pay ratio rule was to highlight income inequality in the United States, but in reality, it does little more than shame public companies over CEO pay packages deemed to be too high. The U.S. Chamber has long pointed out that both the intent and the implementation of the pay ratio rule are fatally flawed, much like the now-defunct game-winning RBI statistic.
The pay ratio rule is a fundamentally misleading statistic that has several underlying shortcomings: it is unlikely to have a real effect on boosting wages for low or middle-class Americans; it provides no useful information to investors; and it will actually harm public-company shareholders by imposing billions of dollars in compliance costs. Taken together, the pay ratio rule makes it difficult to compare executive compensation packages across different companies and industries, and therefore, to draw meaning from those comparisons.
Let’s unpack each of these shortcomings a little more.
The pay ratio disclosure is fundamentally misleading.
If part of the intent of pay ratio is to highlight egregious pay practices, it doesn’t tell a clear story across different companies and industries.
Consider for example the pay ratio of an investment bank compared to that of a large retailer. Say the CEO of the investment bank makes $25 million per year, and given the nature of its business, the median employee makes $625,000 per year, resulting in a pay ratio of 40-to-1.
In marked contrast, imagine the CEO of a retailer who makes $5 million per year, while the total compensation for its median employee is $25,000 per year. This results in a pay ratio of 200-to-1. The retailer’s CEO compensation is just 20% of the investment bank CEO’s compensation, yet his company’s ratio is five times higher.
Plus, the pay ratio rule leaves no easy way to rightfully account for part-time and seasonal employees, whose pay rates have a huge impact on a company’s median wage.
What conclusion is an investor supposed to draw from these examples? Which company’s pay practices have more merit or warrant more criticism? There is simply no good answer for investors or anyone else, and this is a concrete example of how difficult it will be to judge this statistic across different companies.
The rule is unlikely to help boost wages for rank-and-file employees.
The intent behind the pay ratio rule is inherently political. Proponents hope it will be a blunt tool to force companies into decreasing the pay of their CEO, raising the pay of rank-and-file employees, or both. But there is no historical evidence that harassment of companies over alleged deficiencies in pay practices has contributed to the long-term welfare of the American worker.
What doesbenefit the American worker is granting businesses more freedom–through things like regulatory and tax reform–to make investments in their employees. Take, for example, the middle market index released last week by RSM and the U.S. Chamber of Commerce. Due in no small part to the recent tax reform package and ongoing regulatory reform efforts, 62% of middle market companies–which collectively employ 40 million Americans–are planning to increase compensation for employees over the next 180 days. This is the true path to prosperity, not shaming businesses into changing their compensation practices.
The rule provides no useful information to investors.
Put simply, the pay ratio rule fails to meet the important test of “materiality” that has long been the standard for the SEC’s corporate disclosure regime. Pay ratio was adopted at the behest of special interests–not investors–and provides no indication as to the long-term performance of a company. Further, when shareholders have taken it upon themselves to vote on proposals related to pay disparity, not a single proposal at an S&P 500 companyreceived more than 10% support since 2010.
The rule will impose billions of dollars of costs on public company shareholders.
By the SEC’s own estimate, the pay ratio rule will impose $1.3 billion in up-front costs as well as $526 million in annual costs for shareholders. That’s not an insignificant sum for a rule that provides no useful information to investors and does nothing to help employees get ahead, and these costs will be borne by American households that invest in public companies.
There are better ways to increase wages for working Americans that don’t involve shaming companies into changing behavior. Onerous mandates like pay ratio also provide yet another disincentive for companies to go and remain public, which has deleterious effects upon both economic growth and the ability of Main Street households to create wealth through investing in the equity markets.
Baseball rightfully recognized that tracking game-winning RBIs added nothing to the game. Investors and the general public should similarly recognize that pay ratio will do nothing to improve our capital markets and little to improve the lot of working Americans.
