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May 9, 2019

Pay-ratio disclosures put executive compensation, income inequality in spotlight

Images | CNBC screenshots Publicly traded companies are now required to disclose pay ratios that compare what their CEOs make in relation to work-and-file employees. Pay ratios for the executives shown above (Top photo, clockwise: CVS’ Larry Merlo, Cigna’s David Cordani, Stanley Black & Decker’s James Loree and UTC’s Gregory Hayes) were recently made public.

Walt Disney Co. CEO Robert Iger’s $65.6 million in compensation last year recently drew the public spotlight, but not just over how much he made.

Abigail Disney, the grandniece of the late company co-founder Walt Disney, criticized how Iger’s pay compared to the ESPN parent company’s rank-and-file workforce.

Iger earned 1,424 times more than Disney’s median pay of $46,127, the company disclosed as part of a relatively new federal rule that requires publicly traded businesses to compare CEO and median-worker pay.

That made Iger one of at least a dozen U.S. CEOs with pay ratios of 1,000 or more, according to CNBC.

Abigail Disney called that “insane,” drawing national media attention and rekindling a focus on how much top executives at publicly traded companies get paid.

“What on earth would be wrong with shifting some of the profits — the fruits of these employees’ labor — to some folks other than those at the top?” Disney, who isn’t involved in the management of the company, tweeted on April 21.

No CEOs of Connecticut-headquartered public companies had a pay ratio anywhere near Iger’s last year, according to a review of U.S. Securities & Exchange Commission (SEC) filings by the Hartford Business Journal, but area academics say the pay-ratio disclosures, which are in their second year after being mandated by the 2010 federal Dodd-Frank financial reforms, offer another window into wealth inequality as debates over how to curb the growing gap between haves and have-nots play out at the state and federal levels.

In Connecticut, which is the richest state in the nation with the second-highest income disparity between the top 1 percent of earners and the rest, according to the Economic Policy Institute, Democratic lawmakers in recent weeks have proposed higher taxes on capital gains, with some also calling for a surcharge on dividends and interest income in the top tax brackets.

Meanwhile, Democratic presidential candidates Bernie Sanders and Elizabeth Warren have struck a populist tone on income inequality, pledging higher federal taxes on the wealthy.

Fred McKinney, Business Professor, Quinnipiac University

With only two years worth of disclosures thus far, the public may not be fully aware of CEO pay ratios, but executive compensation has long been public record, and regular people know that the incomes of wealthy citizens are rising much faster than their own, said Fred McKinney, a business professor at Quinnipiac University.

“There’s a feeling that there’s something awry in our system of divvying up the benefits of the economy,” McKinney said. “I think that it’s fueling populist sentiment.”

Connecticut ratios

Last year, Bloomfield-based Cigna CEO and President David Cordani’s $18.9 million compensation package clocked in at 298 times the median pay of a Cigna employee, who makes $63,526.

That was the highest compensation gap among all Connecticut-headquartered companies that filed pay-ratio disclosures by press time.

Cigna said it determines employees’ compensation relative to the market value of their respective roles. Cordani’s ratio “is considered well within the competitive market range for our industry,” a spokesperson said.

One standout is Rhode Island-based CVS Health, which acquired Hartford health insurer Aetna last year for $69 billion. CVS President and CEO Larry Merlo’s 2018 compensation totaled just under $22 million, which is 618 times the median CVS pay of $35,529.

CVS spokesman Mike DeAngelis said the company has many part-time, temporary and seasonal workers, and that Merlo’s compensation was driven higher last year by long-term incentive awards. Absent those awards, the CVS pay ratio would have been 518 to 1, he said.

Among Greater Hartford headquartered companies, Cigna’s pay ratio was trailed by Stanley Black & Decker President and CEO James Loree, whose $13.6 million in compensation was 284 times larger than the New Britain-based manufacturer’s median worker. Next up was United Technologies Corp. Chairman and CEO Gregory Hayes who outearned the median UTC employee by a 257-to-1 ratio.

UTC declined comment, but pointed to its SEC filing, which noted that the majority of workers included in its median-compensation calculation were based in other countries.

“We believe paying competitive wages targeted at the median of local labor markets within our diverse industry segments is essential to ensuring a productive, engaged workforce and a sustainable business,” the filing reads. “Consequently, a global ratio may not be particularly informative without any context for foreign labor markets and the diversity in the roles of UTC’s employees around the world.”

‘Relatable and shocking’

UTC isn’t alone in questioning the usefulness of pay ratios.

Greg Reilly, Business Professor, UConn

While Congress didn’t provide much guidance as to why it mandated the disclosures, UConn business professor Greg Reilly chalked it up to “an attempt to make [executive pay] more relatable and shocking.”

He said pay ratios are often misinterpreted and not particularly useful to investors or the general public.

One potential point of confusion is that CEO compensation, while it usually includes salary and cash bonuses, also counts stock awards and other deferred income awarded in a given year that the executive doesn’t receive right away, and, depending on how the company performs or other factors, may never earn in full.

Another gray area, he said, is that ratios don’t account for companies with entirely different workforces (like Google vs. Walmart). Varying methodologies for calculating compensation and other factors can also make it tough to compare companies. Reilly said he thinks a more useful measure is what a well-paid CEO is accomplishing for investors.

“If a board truly feels the CEO is worth his or her salt, then why should they be viewed any different from a successful (and highly paid) athlete?” Reilly said. “Lebron changes you from terrible to great.”

However, he admits research has been mixed on whether higher compensation can be cleanly linked to better CEO performance. It’s a question that’s “remarkably hard” to answer, he said. And he agrees with other academics who say the way CEO compensation is determined — by boards of directors that typically use an outside consultant — is not always efficient. In general, CEOs have too much influence over their boards, he said.

In addition, a number of economists have said a key driver of rising CEO pay over the decades boils down to corporate boards not wanting to think their CEOs aren’t in the upper half of their class, and setting pay packages at or above median peer levels. It’s been coined the “Lake Wobegon effect.”

Despite his criticisms of pay ratios, Reilly still perceives some upside to their disclosure.

“It’s disciplining the market a little bit,” he said. “To the extent this is increasing transparency and gets the right conversations started about making sure that pay is closely tied to performance, then this is a good thing.”

David Cadden, Business Professor, Quinnipiac University

David Cadden, a business professor at Quinnipiac, agrees the ratios are likely to be influencing board behavior somewhat, but he says don’t forget the employees.

“I think it may have an impact on a lot of employees who are taking a look and saying ‘why is this guy getting 235 times what I’m being paid?’ ” Cadden said. ”I think, in an era of increasing appreciation of income inequality, people do begin to see it.”

Tax the rich

Meanwhile, executive compensation does play into some of the populist sentiment on display in this state’s and nation’s politics.

In Connecticut, as lawmakers try to figure out how to close a projected $3-billion-plus deficit over the next two fiscal years, progressive Democrats have called for increasing taxes on the wealthy, while Republicans, the business community and even Gov. Ned Lamont say that will make Connecticut less competitive.

“In a time when individuals and companies are more mobile than ever, increasing taxes on capital gains would send a loud and clear message that Connecticut is bad for business,” David Lehman, commissioner of the Department of Economic and Community Development, testified during a recent public hearing at the Capitol, where lawmakers were weighing a proposal to tack on a 2 percent surcharge to Connecticut’s capital gains tax.

A number of people who testified in favor argued the state should expand the proposal to also increase levies on dividends and interest income.

Among them was Merrill Gay, executive director of the Connecticut Early Childhood Alliance, a Hartford nonprofit focused on health, safety and economic security of children. Gay said he’s worried about potential state cuts to early childhood programs.

“At a time when we are short on money, it makes sense to turn to the folks who have the most, especially the folks who have just gotten a huge tax break from the federal government,” Gay said.

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