An Epic Question: Is This Pay Ratio Too Large, Too Small or Just Right?

by Allen Matkins

California’s corporate tax rate is currently 8.84%.  According to the California Taxpayer’s Association, only nine states (Alaska, Connecticut, Illinois, Iowa, Maine, Minnesota, New Jersey, Pennsylvania and Rhode Island) have a higher top rate.  Nonetheless, a bill that could increase the corporate tax rate for some publicly traded corporations by over 47% continues to move through the California legislature, passing out of the Senate Appropriations Committee last week on a 5-2 vote.

SB 1372 (DeSaulnier) would replace the current rate for publicly traded corporations with a schedule of rates based on the ratio between its chief operating officer or highest paid employee and the median compensation of all employees employed by the taxpayer, including all contracted employees.  The compensation of the chief operating officer or highest paid employee would be the corporation’s total compensation as disclosed pursuant to Item 402 of Regulation S-K.

According to Senator DeSaulnier, the purpose of the bill is to provide “an incentive to corporations to reduce the disparity in the amount of money they pay their CEO and the amount they pay their average worker.”  In this video, Senator DeSaulnier cites SB 1372 as part of his EPIC program.  Students of California history may recall that the writer cum socialist Upton Sinclair ran for governor in 1934 on a campaign of End Poverty In California.  See Upton Sinclair, I, Governor of California, and How I ended Poverty: A True Story of the Future.  Notwithstanding Sinclair’s literary claim of veracity, he never made it to the horseshoe.  Senator DeSaulnier has reminted Sinclair’s EPIC campaign as End Poverty and Inequality in California.

If the concern is income inequality, then perhaps the state may want to look to its own pay practices.  According to the Sacramento Beethe average salary of a state worker in 2012 was $56,800 while the highest paid state employee earned $2,230,000, yielding a ratio of 38 to 1.  Is that ratio too high, too low, or just about right and by what criterion is that determined?  Whether the ratio is 1:1 or 400:1 tells you nothing about whether the highest paid employee is over or under paid.  Moreover, this bill will likely have significant unintended consequences.   For example, the bill will create a strong incentive for public companies to reduce the number of low-wage employees by contracting out those positions.  The bill will also discourage pay-for-performance compensation arrangements.  More importantly, the bill would punish succesful companies with strong stock price performance.  However, that may be an intended consequence since the author’s stated purpose is to end inequality.

Some readers may point out that the pay ratio for public companies is much higher than 38 to 1.  However, Chief Executive Officers of publicly traded companies typically receive a significant portion of their compensation in the form of equity awards while public employees don’t receive stock options or other equity incentive awards.  Item 402(c) of Regulation S-K misleadingly requires that companies disclose the grant date fair value of equity awards computed in accordance with FASB ASC Topic 718.  Consequently, any CEO will be quick to tell you that the total compensation reported in the Summary Compensation Table pursuant to Item 402 does not constitute actual dollars in her pocket or even dollars that will eventually find their way into her pocket.


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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