Does Sensationalism Affect Executive Compensation? Evidence from Pay Ratio Disclosure Reform

By | September 28, 2022

A rise in chief executive officer (CEO) compensation in recent decades has attracted intense criticism from the media and public, with a frequent focus on excessive levels of executive compensation relative to rank-and-file employees. In response to such criticism, Congress passed Section 953(b) of the Dodd–Frank Act (hereafter, the pay ratio disclosure mandate) on July 21, 2010 and directed the Securities and Exchange Commission (SEC) to amend Item 402 of Regulation S-K, which details reporting requirements for executive compensation. Under the pay ratio disclosure reform, publicly traded companies are required to disclose the following in their annual proxy statements starting in 2018: (1) the median annual compensation of all employees (excluding the CEO), (2) the CEO’s annual total compensation, and (3) the ratio between these two numbers. A unique aspect of the pay ratio disclosure mandate is that it does not provide any new information regarding a CEO’s compensation package. The only new information required by the mandate is the compensation of the firm’s median employees. As evidenced by the 287,000 comment letters received on the pay ratio disclosure, the rule triggered significant controversy regarding the necessity of government intervention into executive compensation and the usefulness of this disclosure. 

Proponents, mostly consisting of pension funds, unions, and shareholder activists, assert that the pay ratio disclosure will inform shareholder decisions on CEO pay (e.g., say-on-pay voting), root out ineffective pay practices that led to the financial crisis, and reduce income inequality in the United States. In contrast, critics question the effectiveness of pay ratio disclosure. Michael Piwowar, a former SEC Commissioner, dissented that the pay ratio reform was the result of a populist effort to “name and shame” CEOs and a blatant attempt to limit executive compensation. 

In a forthcoming study, we examine the effect of the pay ratio disclosure mandate on CEO compensation. Specifically, we examine whether boards respond to the newly required disclosure by altering either the level, risk, or mix of CEO compensation. Our study is one of the first papers to examine and document the consequences to the pay ratio disclosure mandate.    

We exploit the fact that pay ratio disclosures are first required for firms for fiscal years ending on or after December 31, 2017. We compare the level, mix, and risk of CEO compensation for firms that were required to first adopt the new disclosure requirement (initial reporting firms) against firms with June to December 30, 2017 fiscal year-ends (delayed reporting firms). We collected and utilized data from over 2,600 firms in the Russell 3000 Index and examined trends in executive pay both prior to and following the implementation of pay ratio reform. With respect to the level of CEO compensation, we find no evidence that boards proactively reduce CEO pay at initial reporting firms following the implementation of the pay ratio mandate. Thus, we fail to find evidence that the pay ratio disclosure curtails “runaway compensation,” as hoped for by some proponents of pay ratio reform.  

Rather, we find that companies at initial reporting firms adjusted their CEO compensation mix to limit some of the more controversial components, such as equity grants and perquisite compensation, that could generate negative scrutiny at these firms. As part of these changes, we also observed that boards at initial reporting firms reduced the sensitivity of the CEO’s wealth to equity price changes (referred to in the academic literature as the pay “delta”). We find that CEO delta declines by 8% to 11.5% in the pay ratio implementation year for initial reporting firms subject to the pay ratio mandate relative to firms with delayed reporting. Moreover, we found that these effects were stronger for firms that expected more external scrutiny of their pay packages (e.g., those with higher pre-existing media coverage).  

We also found that initial reporting firms were more likely to include incentive compensation contracts with stakeholder-centric metrics (such as “diversity” or “sustainability”), which we argue boards use to offset expected scrutiny from the new pay ratio disclosures. Collectively, we interpret these results as evidence that boards attempted to shield themselves from populist criticism regarding executive pay and the pay ratio disclosure. We argue the weaker connection between executive pay and firm performance for pay ratio disclosing firms is a largely unintended consequence of the disclosure mandate and did not appear to benefit investors.    

We also examined how investors and the media responded to initial pay ratio disclosures. We found that firms disclosing higher pay ratios generate more media coverage around the initial filing of their proxy statement, and that such firms receive more negative media coverage in the month following their disclosure. Firms with higher CEO pay ratios also incur greater selling activity from retail investors and more negative say-on-pay votes following the disclosure of their pay ratio. As such, a wide swath of investors and the media appeared responsive to the pay ratio disclosures in firms’ proxy statements.    

By revealing how much a firm’s highest paid executive earns relative to the median employee, the pay ratio disclosure elevated the issue of within-firm pay disparity and generated corresponding media attention. While many proponents expected the disclosure of within-firm disparity to shame reputation-conscious boards into reducing excessive CEO compensation, our evidence provides limited support for the pay ratio serving to directly limit CEO pay. Rather, sensational scrutiny in the wake of the pay ratio disclosure leads boards to reduce controversial components of CEO compensation, which eventually weakens the link between CEO compensation and firm performance. Although there is room for debate on whether sensational scrutiny is an intended or unintended consequence of the reform, our findings suggest that policymakers should carefully evaluate the economic effects of requiring further disclosures regarding pay disparity and executive compensation more broadly.  


Wonjae Chang is an Assistant Professor of Accountancy at City University of Hong Kong. 

Michael Dambra is an Associate Professor of Accounting at University at Buffalo, SUNY. 

Bryce Schonberger is an Assistant Professor of Accounting at University of Colorado, Boulder. 

Inho Suk is an Associate Professor of Accounting at University at Buffalo, SUNY and an International Joint Appointment Professor at Korea University Business School. 

This post was adapted from their post, “Does Sensationalism Affect Executive Compensation? Evidence from Pay Ratio Disclosure Reform,” Journal of Accounting Research, forthcoming and available on SSRN. 

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