Academic journal article SA Journal of Human Resource Management

The 'Pay Ratio' Provision of the Dodd-Frank Act 2010 and Presentation of the Paulo-Le Roux Index

Academic journal article SA Journal of Human Resource Management

The 'Pay Ratio' Provision of the Dodd-Frank Act 2010 and Presentation of the Paulo-Le Roux Index

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

On 05 August 2015, the US Securities and Exchange Commission (SEC) adopted a rule that requires public companies to disclose the ratio of chief executive officer (CEO) compensation to the median compensation of its employees. Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (Dodd-Frank or the Dodd-Frank Act 2010), known as the 'pay ratio provision', required the SEC to prepare and implement this rule. For the fiscal year beginning on or after 01 January 2017, public companies will be required to disclose their pay ratios.

In anticipation of the pay ratio provision becoming mandatory in the USA, Paulo and Le Roux (2014), drawing from Paulo (2011), presented an approach to the calculation of the value added by corporate executives. Whereas the core problem addressed in Paulo and Le Roux (2014) was the measurement of the intrinsic value added by corporate executives to the intrinsic value of the firm, or any sub-part of the firm for which audited financial statements were available, the core problem of this article is to provide an index of executive remuneration to corporate value, added as part of the development and evolution of the pay ratio provision.

The pay ratio provision focuses on reporting income distribution disparities between corporate executives and the median income of employees and hence can be associated with agency theory. In contrast, the approach under discussion herein establishes the relationship between executive remuneration and the value added by executives to the firm. The many benefits of this approach, for all stakeholders, are presented in this article.

This article briefly presents the background to the pay ratio provision, followed by the debate for and against it. This debate provides a motivation for the Paulo-Le Roux Index, which is then presented and discussed. Even though screening and ranking controls are inherent in the application of this index, it is not the intention of this article to prescribe or even suggest control limit values. That issue requires an extensive empirical survey of corporate executive behaviour followed by an appropriate period of consultation, discussion, and public comment with the nation's stakeholders and legislature regarding appropriate norms and guidelines. The fraction of value added by executives that can or should be distributed to corporate executives or the way in which such distributions can or should be made through time are not the purpose of this article. These are matters for future study.

Background to the pay ratio provision of the Dodd-Frank Act 2010

The Dodd-Frank Act 2010, the Financial Stability Forum 2009 (FSF, 2009) (Paulo, 2011, pp. 448-461), and King Codes I, II, and III (Paulo & Le Roux, 2014) specifically seek to improve corporate governance, in part, by ensuring sound executive compensation practices against the backdrop of the Sarbanes-Oxley Act 2002 (SOX), Rule 702 of the Federal Rules of Evidence 2000 of the USA (Rule 702), the UK Companies Act 2006 (UKCA, 2006), and the South African Companies Act 2008 (SACA, 2008). The critical comment from many sectors of society that has accompanied executive remuneration, especially bonuses since the global financial crisis, has raised discussion about the insufficiencies of corporate governance, and former British Prime Minister David Cameron has called for more active shareholder participation to curb executive remunerative excesses (The Guardian, 2012). More recently, Cameron's Business former Secretary Vince Cable told top UK firms to crack down on bonuses or face new laws (Treanor, The Guardian, 22 April 2014). Efforts to improve corporate governance must be supported by robust and rigorous financial valuations that can be used to guide decision making in a manner consistent with the goals of the firm and mindful of agency issues. The value added by corporate executives should form the basis for the estimation and allocation of executive remuneration, in particular incentive-linked remuneration, such as bonuses. …

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