Consider these, probably very familiar, business news items:
The typical chief executive in the [2015] Standard Poor's 500 index made $10.8 million, including bonuses, stock awards and other compensation, according to a study by executive data firm Equilar for The Associated Press.
In 2014, an analysis by the Economic Policy Institute showed that the top US CEOs made 296 times more than the wage of an average worker in their industry.
Excessive pay is the biggest obstacle to restoration of trust in business. [In 2010] Sir Richard Lambert, then head of the Confederation of British Industry, warned it was so out of line that CEOs 'risked being treated as aliens'.
Now look at this one:
A study in the finds that disclosing a high ratio between a chief executive officer's pay and median employee pay at a company prompted participants in an experiment to deem a CEO's pay unfair. The more unfairness they saw, the less likely they were to want to invest in the company. Just disclosing CEO pay that was above the average in the industry, without the ratio, didn't have the same impact. -- Dow Jones Newswires, April 12, 2016
The study cited in the Newswire was published in April 2016, and is co-authored by professor Khim Kelly of the University of Waterloo’s School of Accounting and Finance (SAF) and professor Jean Lin Seow of Singapore Management University.
As the Newswire goes on to report, the duo contend that there’s an important distinction to be made: "If companies are concerned about negative public perceptions, our results suggest that pay ratio disclosures may be better able than current CEO pay disclosures at shaming companies into restraining CEO pay."
Describing Kelly and Seow’s study for Accounting Today (April 11, 2016), Michael Cohn said it revealed the failure of present regulations that only require companies to disclose executive compensation levels and explain how they were arrived at. “Adding CEO-to-employee pay ratios to the disclosure mix,” he observed, “is likely to be significantly more effective than the current requirements.”
Entitled “Investor Reactions to Company Disclosure of High CEO Pay and High CEO-to-Employee Pay Ratio: An Experimental Investigation,” the study supports Section 953 (b) of the Dodd-Frank Act of 2010, which requires disclosure of the CEO-to-median pay ratio. The new regulation is slated to go into effect in January 2017.
Choices and considerations
Kelly and her colleague investigated investors’ perceptions of CEO pay fairness, workplace climate, a company’s ability to attract and retain CEOs, and investment potential. Their experiment asked 75 MBA students at two Singapore universities—a “reasonable proxy” for investors—to make judgments about a hypothetical company.
“Our study will be of interest to management accountants,” the researchers suggest, “since they’re involved in designing compensation packages for executive-level and rank-and-file employees that will attract, retain, and motivate top people.”
Management accountants also participate in making operational decisions that have a significant impact on median employee pay and pay ratios. Compensation design choices and operational decisions become part of external reporting.
“Our results suggest that companies may need to consider how to manage the fairness perceptions of investors or the public,” say the authors. This could mean making changes in compensation or business structure, or explaining how an existing pay structure is fair and appropriate given the company’s strategy and operations.
Investors and sensitivities
As noted, students participating in the project were based in Singapore. Previous studies show they do not differ significantly from their North American counterparts in regard to equity sensitivities.
“Nevertheless,” say Kelly and Seow, “if cultural differences result in varying degrees of aversion toward inequity or identification with rank-and-file employees across investors from different countries, then the effect size of CEO pay and pay ratio disclosures may differ across countries too.” This could open up a future research area.
As well, additional studies could explore settings where investors may be even more sensitive to unfairness—such as when the CEO pay and the pay ratio are higher than the levels in their experiment, or when a company is performing poorly or has received significant government bailouts.
Questions concerning the fairness and effectiveness of compensation policies are becoming increasingly important in our society. Professor Kelly is one of several faculty members at the School working in performance management. She provides valuable evidence to inform policy-makers, organizational leaders, and individuals. Strong unbiased research is essential to answering the specific question concerning the disclosure of relative CEO pay ratios and developing better compensation systems generally. --
Kelly is an associate professor at SAF, where she teaches financial and management accounting. She came to Waterloo in 2008 after serving on the faculty of the Business School of Nanyang Technological University in Singapore, a leading provider of business and management education in the Asia Pacific region. She received a PhD in business administration from the University of Southern California in 2003.
Kelly’s research, which employs experimental and behavioural methodologies, centers on performance measurement, evaluation, and compensation practices in organizations and their effects on stakeholders. Her work appears in leading academic journals such as The Journal of Management Accounting Research, which is published by the American Accounting Association.
The study appears in the Journal of Management Accounting Research, Volume 28, Issue 1 (Spring 2016). For the Accounting Today news story, go to http://www.accountingtoday.com.