United States: Will Pay-Ratio Results Be The Catalyst For Local Action?

Last Updated: June 12 2018
Article by Cydney Posner

Besides shock and awe, did pay-ratio disclosure have any immediate practical consequences? Well, for one, if a company did business in Portland, Oregon, the answer could well be "yes." You might remember that, at the end of 2016, the Portland City Council, piggybacking on the pay-ratio data that most public companies were required to begin disclosing this year, adopted a measure adding a 10% surcharge to the city's existing business tax for each company that exceeded a 100-to-1 pay ratio and a 25% surcharge if the pay ratio exceeded 250 to 1. (See this PubCo post.) According to comp consultant Equilar, the median pay ratio for the Russell 3000 was 70:1 (see this PubCo post). So what were the consequences of the Portland surtax—in Portland and beyond?

Even when the surtax was initially adopted, proponents recognized that the amounts to be collected in Portland were likely to be relatively small. Nevertheless, proponents hoped that the underlying message would still be compelling. Oregonlive.com reported that the Portland City Commissioner who was the main proponent of the surtax hoped "the tax might discourage companies—well beyond Portland—from paying disproportionate salaries to their CEOs." (But see this PubCo post regarding a study concluding that pay-ratio results were more affected by median employee pay than by CEO pay.) Objections to the surtax were raised in testimony before the City Council by the Portland Business Alliance, "based on the lack of nexus between CEO pay and a company's sales in Portland, inequities within the rule and the inability of this proposal to impact the stated goal of addressing income inequality." For example, a commentator told Oregonlive.com that the pay-ratio rule was a problematic resource on which to base the surtax because it "is designed to give companies flexibility in how they calculate their compensation ratio and therefore won't provide the best data." (For a discussion of whether the flexibility permitted in calculating pay-ratio data makes it misleading, see this PubCo post.)

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According to The Guardian, the Portland surtax was "inspired" by a 2014 bill proposed in California that would have reduced taxes for companies whose executives were paid less than 100 times above the median worker. The bill failed to reach the supermajority needed to make changes to the state tax code. The Guardian also reported that the Portland surtax proponent was further motivated by reading French economist Thomas Piketty's book Capital. A former lead economist at the World Bank commented that "'it seems [to be] the first tax that targets inequality as such.'"

According to this article in Bloomberg BNA, about 500 public companies have now been notified that they will be facing the surcharge because they earned income in Portland and reported pay ratios in their proxy statements that exceeded the thresholds. In one example provided on the city's website, a public company that pays Portland $250,000 in regular business license taxes that reports a pay ratio of 1,000:1 would have to pay a surtax of $62,500 (25% of its business license tax), resulting in a total tax due to Portland of $312,500. This year, the city expects to raise about $3 million from the surtax, which is "earmarked for Portland's affordable housing efforts and for funding its police force and fire stations," according to a current Portland Commissioner. The Commissioner also indicated that, "the penalty is meant as a way to help tackle income inequality, [and she] hopes that it sparks an increase in what companies pay their average employees." According to one company representative, however, although the penalty imposed on the company was not "'massive[,] that's not the point....You can't use a methodology that has such a wide range of interpretation. It's not so much that it's a financial disadvantage, [it's] more about [the] principal' behind it."

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As discussed in this PubCo post, in examining relative pay-ratio data, Equilar found that market cap, employee count and industry were significant factors in determining the ultimate pay ratio. Equilar reported median ratios that varied directly with market cap: for companies with a market cap above $25 billion, the median ratio was 213:1, while companies with a market cap below $1 billion reported a median ratio of just 32:1. Similarly, the more employees, the higher the ratio, reflecting generally both lower median wages for employees and, largely, higher CEO comp for bigger companies. For the Russell 3000, Equilar reported that the median pay ratio for companies with fewer than 1,000 employees was only 28:1, but where the employee count was between 10,000 and 25,000, the median ratio was 155:1 and, for companies with more than 50,000 employees, the median was 290:1. Industry was also generally determinative, with the highest ratios, as widely predicted, reported for the consumer goods (142:1) and services (127:1) sectors and the lowest for conglomerates (43:1), healthcare (46:1), financial (46:1) and utilities (47:1), industries where the CEO may well rank high on the payscale.

Bloomberg observes that supporters and opponents alike admit that the surtax is "not likely to put a dent in the coffers of most companies, and whether it spurs changes in corporate compensation practices is likely to hinge on this strategy's widespread adoption. 'As a practical matter, it's still a drop in the bucket for these companies," [the Commissioner said], 'Little Portland is not going to make much of a difference on its own.'" According to the Mayor of Portland, quoted in the NYT, the city has "'a habit of trying things...; maybe they're not perfect at the first iteration. But local action replicated around the country can start to make a difference.'" One commentator told Bloomberg that she "expects momentum for pay-ratio penalties to continue to grow, especially as more people become aware that the CEO-to-worker data is now available." But from the business perspective, the idea that the surtax concept might be contagious was, according to the article, "cause for concern in the business community. 'You really have to start thinking about a collective effort to consider this from a legal perspective,'" according to one company representative.

So far, however, the surtax concept has not exactly spread like wildfire. Since Portland adopted its surtax, according to these articles from Meridian Compensation Partners and KPMG, several jurisdictions have proposed tax surcharges, higher corporate income tax rates or other fees tied to pay-ratio results, but none has yet been adopted. The most significant, given the size of the state, is the California proposal, which would link pay ratio—based on the pay of the COO or other employee (if higher) relative to the pay of the median of the US workforce, including contracted employees—to a sliding scale of income tax rates on net income attributable to business transacted in California. Tax rates for companies with ratios up to 50:1 would remain at the current 8.84% (10.84% for financial institutions), while companies with ratios between 50:1 to 100:1 would see a tax rate of 10% and so on up the scale to a top rate of 13% (15% for financial institutions) for companies with ratios over 300:1. The California bill would also increase taxes by 50% if the company decreased its US workforce by over 10% and increased its foreign or contracted employees. The proposal has been in committee since March and requires a 2/3 vote in the legislature for approval.

Other states have taken different approaches. Connecticut, for example, would apply a new sliding scale corporate tax rate ranging from 5% (ratio of 25:1 or less) to 25% (ratio over 250:1), based on the SEC pay ratio. In Illinois, a bill has been introduced imposing a small annual fee based on the SEC pay ratio ($1500 annual fee if the ratio is between 100:1 and 250:1, and $2500 annual fee if the ratio is over 250:1). Massachusetts has proposed to apply a surcharge of 2% if the pay ratio—pay of the CEO (or other employee if higher) relative to the median of the US workforce—exceeds 100:1. Proposals made in Minnesota and Rhode Island mirror the Portland surtax. Legislation is also being discussed in San Francisco. Meridian commented that these proposals appeared to be symbolic only, with little chance of passage.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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