Tax on CEO Pay Ratios That Are Too High

Back in 2010, stuck in Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, corporate America was blessed with a new requirement -- disclose the ratio of the annual total compensation of the CEO to that of the median-paid employee in the company. It seemed simple enough except that it's not. Here are some reasons:

• Annual total compensation isn't what you think. It's compensation as defined for proxy purposes (Form DEF 14A) and it includes things like increases in value and retirement benefits as well as the value of certain stock compensation.
• The median-compensated employee is the one who is compensated such that half the people in the company are better paid and the other half are not paid as well. So, to determine the median-compensated employee, you have to determine that half the company is paid higher and half is paid lower. (Yes, we can make some simplifying assumptions, but it's still not as simple as just picking a person.)
• Foreign-domiciled employees count and we have to convert currency.
• Part-timers and seasonal employees count and we are not allowed to annualize their pay.

All of this is so that a company can disclose a single number in its definitive proxy statement -- the ratio of pay of the CEO to that of the median employee.

And, then the pain ends, right?

Wrong!

People will see this number. Shareholders will see it, unions whose members the companies employ will see it, institutional investors will see it, shareholder advisory services will see it, and cities and states will see it.

Cities and states you say? Why would these issuers of proxies care about that?

Frankly, for most companies, the financial effects imposed by cities and states will be more of a nuisance than anything else, but Portland, Oregon led the way by imposing a surtax on companies doing business there if there pay ratio is too high. The business tax in Portland, generally, is 2.2% of income derived from Portland business. But, the following surtaxes will apply:

• If a company's pay ratio is at least 100 to 1, but less than 250 to 1, there will be a 10% additional surtax;
• If a company's pay ratio is at least 250 to 1, there will be a 25% additional surtax.

Other cities and several states have proposed similar laws and while some may have passed, I personally am not aware.

As I said, these taxes are not a big deal in the scope of the companies involved, at least not for the most part. At the same time, however, I think we are going to see that companies with pay ratios exceeding 100 are going to be quite common.

To the best of my knowledge, taxes of this sort were first proposed by former Labor Secretary Robert Reich in 2014. Secretary Reich points out that pay ratios in the early 70s averaged about 28, but we should note that statistic as being based almost entirely on full-time American workers. The labor force has changed. And, so has the pay ratio.