Unintended Consequences of CEO Pay Reform

James Joyner | Tuesday, January 24, 2006

Dominic Basulto argues that, if it forces companies to publish CEO pay as a single dollar figure, it may have the ironic effect of escalating executive compensation.

[B]y attempting to quantify CEO compensation (including hard-to-value items like retirement benefits, severance packages, deferred compensation, perquisites and stock option grants) with a single number, the SEC may be unleashing the Law of Unintended Consequences. In other words, by focusing on a single number for annual executive compensation, the SEC may actually inflate future executive pay packages.

[...]

By attempting to reduce executive compensation to a single number, the SEC runs the risk of actually fanning the flames of compensation envy. It’s a topic that has been broached more than a few times by academics, compensation experts and bloggers. Just last week, Peter Lattman of the Wall Street Journal’s law blog and others — such as law professors Larry Ribstein and Gordon Smith — raised the prospect of a “ratcheting effect” if the SEC rule goes into effect. Ratcheting is not some arcane corporate governance term — it’s probably better known as “Keeping up with the Joneses.” In this case, it’s a matter of keeping up with the CEO next door.

That strikes me as quite plausible. Indeed, it is rare for any sweeping legislation, however well intended and studied, not to produce a number of responses that a) were not anticipated and b) would be considered undesirable by those who sponsored it.

This is not, by the way, an argument against the policy. While I have no strong view as to whether Congress needs to regulate compensation disclosure, my general view is that more information is a good thing. If greater availability of comparative pay results in the market pushing it up, so be it.

About the Author: James Joyner is the publisher of Outside the Beltway and the managing editor of the Atlantic Council. He's a former Army officer, Desert Storm vet, and college professor with a PhD in political science from The University of Alabama. He lives just outside the Beltway in Alexandria, Virginia with his wife and infant daughter.

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Tags | Economics and Business, General, James Joyner Congress, ironic, Wall Street Journal

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While there will always be 'unintended consequences' from any action, I think this is an excellent idea... Without transparency and credible disclosure of what corporate leadership is doing, and what they're getting for it, shareholders can't make informed decisions on whether or not the company is responsibly using their money.

Now, if only our government worked the same way...

Posted by legion | January 24, 2006 | 10:23 am | Permalink

 

I'm willing to take that risk.

Posted by slickdpdx | January 24, 2006 | 11:41 am | Permalink

 

If the point of the reform is to cause financial pain to The Man, then obviously having the reform result in larger CEO compensation packages is simply intolerable.

However, if the purpose is to actually accomplish good, the unintended consequence described here is beside the point.

Therefore, I agree with slickdpdx.

Posted by McGehee | January 24, 2006 | 05:02 pm | Permalink

 

The 'Keeping Up With the Jones's" effect will be there with the CEOS of Americas most successful and profitable companies.

The companies having performance and profitability issues may be better served by this.

It sounds like a decent rule to me.

Why just limit it to the CEO? What about the highest tier of company management?

Posted by Hoodlumman | January 24, 2006 | 05:15 pm | Permalink

 

Also, the entire 'keeping up with the Jonses' fear assumes that CEO salaries just spontaneously happen, without anyone's control. If shareholders see that their CEO is paid hansomely (compared to similar CEOs), even though the company is tanking, it might be time for a little 'regime change'... likewise, good performance might result in a raise, but maybe not as much if he's already making something in the top 10% of his peers.

Pay linked to performance? Say it ain't so!

Posted by legion | January 24, 2006 | 05:32 pm | Permalink

 

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