The effects of the mandated disclosure of CEO-to-employee pay ratios on CEO pay

This study examines whether the mandated disclosure of CEO-to-employee pay ratios motivated firms to curb CEO pay prior to their first pay ratio disclosures. In July 2010, the US Congress directed the SEC, via Section 953(b) of the Dodd–Frank Act, to enforce a rule that requires firms to disclose the ratio of the CEO’s pay to the median employee’s pay (the “rule”). The SEC proposed the rule in September 2013 and adopted it in August 2015. Though the SEC contends that the rule is intended to benefit shareholders, opponents claim that the rule is intended to shame firms into reducing CEO pay. The opponents’ claim is consistent with theory that posits, and evidence that suggests, that disclosure mandates can be used to motivate disclosers to adopt certain, desired behaviors. Based on this theory, as well as evidence indicating that firms likely expected to incur reputational losses from disclosing high pay ratios, this study hypothesizes that firms that are required to comply with the rule (relative to firms that are not) curbed CEO pay prior to their first pay ratio disclosures. This study further hypothesizes this relative curb on CEO pay was greater for firms that are more sensitive to the reputational effects of the rule—that is, firms that are more susceptible to public scrutiny of or adverse stakeholder reactions to pay ratios. These hypotheses are tested through a difference-in-differences research design that examines changes in residual total CEO pay (i.e., the portion of total CEO pay that is not predicted by economic determinants) from the periods before to the periods after the SEC’s proposal and adoption of the rule. Although there is no evidence of a curb on residual CEO pay in response to the SEC’s proposal (or adoption) at the average firm, there is evidence of a curb in response to the proposal (but not adoption) at firms that are more susceptible to public scrutiny of or adverse stakeholder reactions to pay ratios. Thus, regardless of the intended consequences of the rule, firms that are more sensitive to the reputational effects of pay ratios behaved as if the rule shamed them into curbing CEO pay. This is important because it contributes to the current understanding of how disclosure mandates can change firm behavior. The results of this study should therefore be of interest to legislators, regulators, special-interest groups, and the public.