This past week, the Securities and Exchange Commission announced that it is preparing a full new set of regulations on CEO compensation that are in keeping with the Dodd-Frank law. The SEC’s report on the matter puts three issues on the table. First, the firm must disclose “the median of the annual total compensation of all employees of an issuer.” Second, it must disclose the annual “total compensation” of the CEO. Finally, it must state the ratio of the compensation of the median employee to that of the CEO.
These regulations are the brainchild of Senator Robert Menendez, a New Jersey Democrat, whobelieves that investors deserve to know “whether public companies' pay practices are fair to their average employees, especially compared to their highly compensated CEOs." The seductive search for “fairness” is, however, both mischievous in its choice of ends, and perverse in its selection of means.
The first question to raise in evaluating regulations generally is whether their benefits to firm value are greater than the costs, both public and private, of compliance. At no point did Senator Menendez or anyone else examine this question to see if the benefits of the regulation outweigh its costs. The answer is that they do not. By any rational measure, this part of Dodd-Frank should be struck down as unconstitutional.
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