Making Executive Compensation Less Controversial: The Rise of Pay Ratios

Developments in executive compensation have resulted in more legislation and regulations on executive pay being introduced over the past two decades than in the previous hundred and fifty years. Ever since the last financial crisis, executive compensation has remained high on the agenda of many authorities. When there are concerns about executive remuneration, legislators first of all try to find the remedy through increasing the level of transparency. Such a transparency measure, currently favoured by various countries, is the introduction of an obligation to publish the ratio between the remuneration of the average (or median) employee and that of the CEO, known as the pay ratio. In the United States and in certain European countries such as the United Kingdom and the Netherlands, such an obligation has already been introduced. Based on the Shareholder Rights Directive II, all European countries must have adopted a similar regulation by June 2019.

In this article, I will discuss the various pay ratio initiatives in the US, the UK, the Netherlands, as well as the new obligation imposed by the EU on its member states. I will also address the substantiation that lies at the heart of the introduction of these pay ratios, identify which market failure these regulations are aimed at solving, and explain how to give further effect to this obligation; the latter will also discuss and clearly demonstrate that several of those aforementioned initiatives have not been structured effectively.