Mohamed Khenissi, Université Grenoble Alpes (UGA) and Vanessa Serret, University of Southern Brittany (UBS)
For the first time, publicly traded companies must disclose an equity ratio in their universal registration documents. This is a requirement of the Pacte Act.
The equity ratio measures the gap between each executive’s compensation and the (average and median) salary of the company’s full-time employees. The plan is to track changes in this ratio over the past five fiscal years and to analyze it in the context of the company’s financial performance. These comparisons provide insight into how value creation is distributed between executives and employees.
The purpose of this ratio is to enhance transparency regarding executive compensation policies and, according to the Ministry of the Economy, Finance, and Recovery, it contributes to “greater accountability in corporate compensation practices.” As such, it serves as a new governance tool that improves transparency regarding the compensation practices for executives at large companies.
Protecting Employees' Interests
The board of directors’ determination of the executive compensation policy affects both shareholders and other stakeholders (creditors, employees, the government, etc.). From this perspective, which is based on partnership-based governance, the directors’ decisions regarding compensation have consequences for employees and other stakeholders.
For example, excessive executive compensation can prevent employees from receiving pay raises, since the company’s resources are tied up in compensation plans.
Thus, the equity ratio serves as a governance tool that supports partnership value.
The publication of this ratio will influence executives in two ways: by providing information to all stakeholders and by affecting the reputation of executives and board members in the public sphere.
Thus, the disclosure of this ratio undermines the prestige of executives and board members when a pay gap is perceived as too wide in light of prevailing social norms.
By providing information on the gap between executive compensation and the (average and median) wages of employees, the equity ratio offers stakeholders an additional opportunity to influence management’s discretion. It strengthens the discretionary power of employees and unions in particular.
An upward alignment
According to Claudine Mangen and Michel Magnan, researchers at Concordia University, there is a positive correlation between the extent of compensation disclosure and observed compensation levels. This finding stems from the use of this publicly available data by those involved in the wage negotiation process.
In practice, established standards serve as benchmarks for negotiating compensation levels above those standards for the most talented executives. Subsequently, the highest salaries negotiated are incorporated into public statistics, which in turn help set new, higher standards, driving an inflationary spiral.
The requirement to disclose the equity ratio would reinforce this wage-leveling effect once a threshold for the equity ratio were established that companies would not be allowed to exceed—without taking into account, in particular, sector-specific characteristics.
In addition, executives at companies with the lowest ratios may respond by increasing their compensation in order to move closer to that threshold.
An Initial Assessment
Based on the compensation paid in 2019 by the companies that make up the CAC 40 stock index, French CEOs received an average salary of 5 million euros, a 9.1% decrease compared to 2018.
This figure represents 53 times the average compensation of their employees (72 times the median compensation): an acceptable ratio, according to the proxy advisory firm Proxinvest. In fact, according to this firm, to ensure social cohesion within the company, the equity ratio should not exceed 100 (relative to the average employee compensation).
Nevertheless, two executives receive compensation that exceeds the socially acceptable maximum: Bernard Charlès, vice chairman of the board of directors and CEO of Dassault Systèmes, and Paul Hudson, CEO of Sanofi, with equity ratios of 268 and 107, respectively.
It should also be noted that for the two publicly traded companies included in the CAC 40 stock index, the equity ratio exceeds the 20 threshold (35 for Engie and 38 for Orange) set by Decree No. 2012-915 of July 26, 2012, regarding government oversight of executive compensation at public companies.
A “fair” equity ratio?
At this point, a question arises regarding the acceptable level of the equity ratio: 100, as recommended by Proxinvest, or 20, as specified in the 2012 decree on executive compensation for public companies? This ratio will be assessed differently depending not only on the nature of the company’s ownership but also on its industry sector, etc.
At the end ofthe 19thcentury, banker J.P. Morgan believed that a “reasonable” wage gap between a CEO and his employees should not exceed a multiple of around 20.
First, establishing a relevant and meaningful ratio must take into account differences between economic cultures, particularly those concerning public tolerance of disparities in wealth and wages.
The perception of injustice within organizations and in society is linked to the symbolic dimension of the status of elites and executives at large corporations. By way of comparison, a study conducted by Bloomberg reveals that American CEOs have the highest equity ratio (401), followed by Swiss and Dutch executives.
As for French business leaders, they rank15thin the world. Yet 66% of French people have a negative view of the leaders of large companies.
However, the cultural argument may be countered by the existence of a global market for executives. Thus, a threshold (a standard) that is too low in a given economy may encourage the most experienced executives to move to an ecosystem where wage differentials are greater, thereby allowing them to capture a larger share of value creation.
Many French executives are moving to Asia or the Middle East to earn more, which tends to confirm [the conclusions of economist Eugene Fama] from 1980 regarding the executive market.
Second, implementing this new indicator is not straightforward, as it requires defining an appropriate scope of calculation for multinational companies. Indeed, the Pacte Act applies to employees of the publicly traded company that prepares the corporate governance report, not to employees of the group as a whole.
A Useful Tool for Shareholder Democracy
Thus, most large French companies are holding companies that often employ fewer than 50 employees with high salaries. In this context, the equity ratio will not be representative.
On the other hand, many significant disparities are still linked to sectoral differences.
It is worth noting that in 2019, the technology and healthcare sectors were the most generous to their executives due to their strong stock market performance. For other sectors, the average equity ratio ranged from 37 to 55.
More generally, differences in executive compensation policies across industries are evident on an international scale, which can create tensions in the executive labor market. Overall, these sectoral differences make it even more complex to set a socially acceptable cap.
At the 2020 annual shareholder meetings, the equity ratio was virtually absent from the presentations. It was mentioned by only 7 CAC 40 companies. Yet this ratio could contribute to the debate on shareholder democracy. To do so, it must be carefully analyzed by shareholders and proxy advisory firms—that is, from a comprehensive and dynamic perspective that takes into account potential changes in the scope of consolidation.
Mohamed Khenissi, Associate Professor of Management Sciences (IUT2 Grenoble, GEA Department) — Member of the Center for Applied Management Studies and Research (CERAG), Université Grenoble Alpes (UGA) and Vanessa Serret, Associate Professor of Management Sciences, University of Southern Brittany (UBS)
This article is republished from The Conversation under a Creative Commons license. Read the original article.