The saliency of the CEO pay ratio
Audra Boone, Austin Starkweather, Joshua T White
Review of Finance, Volume 28, Issue 3, May 2024, Pages 1059–1104, https://doi.org/10.1093/rof/rfad039
The CEO pay ratio disclosure became effective in the U.S. in 2018. Although CEO pay disclosure was required, revealing the median employee’s salary and the corresponding ratio was not. Intended to represent vertical pay disparity in a simplified manner, organizational differences and SEC exemptions can reduce its informational quality or comparability across firms. Also, managers can voluntarily provide a narrative disclosure explaining the ratio’s design.
To analyze reactions to the ratio disclosure, we employ the saliency framework developed in several papers by Bordalo, Gennaioli, and Shleifer. They argue that salient information can sway individuals’ decisions by making them overemphasize its significance, especially when it presents high contrast, surprise, or prominence. We anticipate variation in the response to pay ratios that significantly differ from others (contrast) or deviate from expectations (surprise). We also expect that firms will attempt to influence the ratio’s saliency through disclosure choices (prominence).
Employees at firms disclosing high ratios (high contrast) report more dissatisfaction with their pay and higher CEO disapproval based on Glassdoor reviews. High ratio firms also show lower productivity gains. Similar reactions are observed for firms with higher-than-expected ratios (high surprise). Many of these responses continue after the first year of disclosure, indicating that the saliency of the ratios persists.
Managers likely anticipated the employee backlash and might try to influence its reception by altering its prominence through disclosure choices. The SEC affords firms with two discretionary disclosure choices in the pay ratio narrative: a voluntary discussion on pay practices or employee treatment; and providing a supplemental ratio accounting for one-off events affecting CEO or employee pay.
We conduct a textual analysis to identify language used to explain or spin a high or surprisingly high ratio. We argue that this choice represents an attempt by managers to reduce its prominence. Firms with high ratios tend to provide more detailed narrative disclosures, use more explanatory or spin language, and offer more supplemental ratios. However, we find the employee response to the pay ratio’s saliency is not offset by these choices.
To help confirm the ratio’s saliency affects employee reactions, we conduct further tests. First, firms disclosing total employee wages before the pay ratio rule does not lessen the adverse response to high pay ratio disclosure. Second, the pay ratio itself influences employee views beyond its components. Third, although high contrast or surprise ratios garner more negative media coverage, we find no correlation between media coverage and employee responses. Fourth, narrowing the response window to 15 days post-disclosure shows a swift decline in pay satisfaction, suggesting employees react to the pay ratio disclosure itself, not information amplified through other sources.
Our study reveals that mandated non-financial information, in response to increasing demands for more ESG disclosures, can elicit strong negative reactions when complex practices are simplified into a single metric. Although some managers try to bridge the information gap with additional narrative, the singular metric’s prominence often undermines these efforts, highlighting the risks of mandating ESG metrics that convey incomplete information.