The Usefulness of the Dodd-Frank Pay Ratio Disclosure

Michael Austin Craven

The pay ratio disclosure requirement established under Section 953(b) the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) has been the subject of substantial debate since its passage in 2010. It requires most publicly traded companies to report the compensation of their Principal Executive Officer (PEO), the compensation of a median employee, and the ratio between the two, and allows them to add additional narrative disclosures. The primary point of contention is whether or not these compensation disclosures provide useful information for investors or other stakeholders, although the debate also raises the question of how the pay ratio disclosure would be used to those stakeholders. In study one, a hand-collected sample of pay ratio disclosure data is matched with existing financial statement and market data to assess the use of the pay ratio disclosure in capital markets. It is found that investors do use the pay ratio disclosure and that the new disclosure of the compensation of a median employee is most salient in the first year of the disclosure. The results suggest that the pay ratio disclosure is value-relevant to investors, potentially risk-relevant, and that these or other effects influence investor trading behavior. In study two, a behavioral experiment is conducted to examine how investors might use the pay ratio disclosure in making their evaluations of companies. It is found that investors process the information from the pay ratio disclosure through a heuristic that jointly considers distributive justice and distributive fairness within the organization. These judgements are then used by investors to evaluate the attractiveness of their investment, which in turn may influence voting behavior in say on pay votes. These results will help to resolve the debate regarding the usefulness of the Dodd-Frank pay ratio disclosure. The evidence provided suggests that the pay ratio disclosure is useful to investors in evaluating the value and risk of investments with regard to executive compensation and labor productivity. Further, it is suggested that investors are processing the information from the pay ratio disclosure by means of comparative and affective assessments of distributive justice and distributive fairness.

The Usefulness of the Dodd-Frank Pay Ratio Disclosure

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