Blog: Does Disclosure Of A High CEO-Employee Pay Ratio Affect Consumer Behavior?

by Cooley LLP

The answer is yes, according to a recent study from the Harvard Business School,  “Paying Up for Fair Pay: Consumers Prefer Firms with Lower CEO-to-Worker Pay Ratios.  Just in time to be part of the mood music for the SEC’s expected adoption of final pay-ratio rules on August 5, this working paper demonstrates “that the disclosure of a firm’s pay ratio can influence consumer purchase intention” and  that a “firm with a high ratio must offer a 50% price discount to garner as favorable consumer impressions as a firm that charges full price but features a lower ratio.”

The paper first takes note of a “natural experiment,” observing that, of the 126.000 comment letters received  by the SEC in connection with its pay-ratio proposal, over 25% used the term ”consumer” (e.g., pay-ratio disclosure will be a “useful factor for me when considering which businesses to support with my consumer and investment dollars”).

According to prior research cited in the working paper, consumers are seriously out of date when it comes to pay ratios:  “consumers’ ideal ratio of CEO pay to average unskilled worker is 4.6 to 1, while their estimated actual ratio of CEO pay to average unskilled worker pay is 10 to 1.  However, according to a recent study from the Economic Policy Institute, for the largest U.S. public companies, CEO pay in 2014 was 303 times an average worker’s pay, compared to just 20 times in 1965. Data from the AFL-CIO estimates the ratio to be approximately 331 to 1, while the paper cites “one recent study [that] uncovered large public firms with pay ratios ranging from 284 to 1 to 2239 to 1, when taking into account the value of base salary, cash bonuses, perquisites and the grant-date value of stock and option grants….”

The working paper describes a series of experiments conducted to assess the effect of pay ratios on the relationship between companies and customers. In one study, participants were given a set of towels, long with the retail price, but some were informed that the retailer had a high pay ratio (1000 to 1) and some that the retailer had a low pay ratio (5 to 1).  Participants were then asked to indicate the highest amount they would be willing to pay for the towels, as well as their perceptions of wage fairness, all on a sliding scale.  Even when controlled for variables such as gender, education, age and income, “willingness to pay for the product from the high ratio firm was significantly lower than from the low ratio firm.”  Another experiment looked at whether placing the item on sale counterbalanced the negative effects of revealing a high pay ratio. In that case, participants were told that a high pay-ratio retailer had the same towel set on sale for prices representing discounts of 10%, 25% and 50%; only at the 50% price discount did the participants’ willingness to buy from the high pay-ratio retailer reach the same levels as for the low pay-ratio retailer.  Multiple experiments (with variations) were conducted, some testing  various hypotheses drawn from prior research:  whether disclosure of a high pay ratio could signal higher quality for certain product categories, whether a “low pay ratio may signal that a company is ‘warm and fuzzy’ – but therefore not competent, ” and whether a low pay ratio might  improve perceptions of some consumers, but alienate other consumers.

The study concludes that the

“experiments demonstrated that the disclosure of a firm’s pay ratio can influence consumer purchase intention. The disclosure of a high pay ratio versus a low pay ratio leads to decreased willingness to buy and willingness to pay for a good….. These effects hold across different product categories and price ranges…. Relative to a high pay ratio, the disclosure of a low pay ratio positively increases consumer perceptions of firm warmth without sacrificing perceptions of firm competence….. Moreover, the disclosure of a low pay ratio versus a high pay ratio improves perceptions of most consumers without alienating any customer subgroups by political affiliation….. The negative effect of a high pay ratio persists in the presence of a price discount of up to 25%, and only diminishes (but does not reverse) at a 50% price discount….. Across our studies, we find that perceptions of wage fairness mediate the effect of revealing pay ratio consumer purchase decisions.”

What remains on the table to be studied in this context? The authors suggest that one possible avenue is further exploration of gender inequality in wages within a company. If consumers knew of a significant “gender wage gap within the whole firm, would consumers care? Thus, future research could further explore the repercussions of ratio disclosure on consumer behavior in other wage-related contexts.” We’ll have to wait for the results of that study.  In the meantime,  it remains to be seen, when the pay-ratio rule finally goes  into effect, whether pay-ratio disclosure will ultimately have any competitive impact on consumer-oriented companies.

[View source.]

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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