One Page Letter

THE IMPLICATIONS OF INCOME INEQUALITY W ith more Americans turning their attention to the disparity between executive and

employee pay and the fight to raise the m inim um wage, organizations increasingly

find themselves exposed to a wide range o f reputational and financial risks.

by Will Kramer

NIGEL TRAVIS IS THE CHAIRMAN AND CEO OF DUNKIN’ BRANDS, THE PARENT COMPANY OF DUNKIN’ DONUTS AND

Baskin-Robbins. And as o f his July appearance on CNNM oney, where he commented on the news that N ew York’s Wage

Boaid recommended that fast tood workers earn S15 per hour, he is also an internet merne. A picture of Travis has circulated on

social media with the caption, Dunkin Donuts’ CEO says S15 an hour is outrageous.’ He makes 84,889 an hour.”

Several articles in major newspapers have also criticized Travis w ith headlines like D u n k in ’ Donuts C E O tone deaf on m ini­ m um wage” in The Boston Globe and “D u n k in ’ CEO says raising m inim um wage to $i5-per-hour is ‘absolutely outrageous’...as he lives in mansion and makes $10 m illion per year” in the Daily M ail. Seattle Times columnist Jon Talton went so far as to call Travis “the best advocate for the $15 m inim um wage,” w riting th at “when high-paid executives get hysterical about improving the pay o f their workers, it doesn’t help their case.”

Nigel Travis is not the first corporate leader to be targeted by advocacy groups and the media for a compensation package that dwarfs those o f the company’s workers, and he certainly won’t be the last. In August, the Securities and Exchange Commission adopted a final rule th a t will require every public company to disclose the ratio o f their C E O ’s total compensation compared to th at o f the organization’s median worker. A lthough the rule does not go into effect until the fiscal year beginningjan. 1,2017, its adoption has already drawn concern throughout the business

com m unity. C onsidering the uproar stem m ing from Travis’ brief commentary on a proposed m inim um wage increase, cor­ porate leaders must assess all o f the risks th at can stem from the increasing focus on income inequality.

THE CONTEXT OF INCOME INEQUALITY W H I L E t h e U nited States has always been an economically unequal society, most economists agree that inequality has been increasing since the 1970s. According to the Economic Policy Institute, a nonprofit and nonpartisan th in k tank, the CEO-to- worker compensation ratio was 20:1 in 1965 and grew steadily to almost 296:1 in 2013. Meanwhile, Emmanuel Saez and Gabriel Zucman, economic researchers at the University o f California, Berkeley, found that the share o f all wealth owned by the richest 0.1% o f Americans has grown from 7% in 1978 to 22% in 2012.

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Until recently, many Americans seemed n ot to know or care about the growing divide in income and wealth. Even at the height o f the so-called G reat Recession in 2009, only 47% o f Americans polled by Pew Research agreed that there were “very strong” or “strong” conflicts between the nation’s rich and the poor. By late 2011, that figure had grown to 66%. Since then, income inequality has become a regular topic o f political debate and public discourse.

Many observers attribute the increasing focus on wealth and economic inequality to the Occupy Wall Street movement that began in N ew York C ity ’s Z uccotti Park in September 2011 and spread to cities and towns across the country. A lthough the protestors were derided at the time for not outlining a clear platform o f demands, their efforts to provoke public discussion about income inequality and the divide between the 99% and the 1% has had a lasting impact.

Less than a year later, in November 2012, approximately 200 fast food workers in New York went on strike, demanding a $15 m inim um wage in what was then the largest labor action in the industry. T he “Fight for 15” movement grew from there, hold­ ing strikes and walk-outs, filing lawsuits over wage theft, and generally keeping the issue o f income inequality prom inent in the media. O n April 15, 2015, roughly 60,000 workers in more than 200 cities across the United States took part in the largest coordinated protest by low-wage workers in history. By then, the movement had grown beyond the fast food industry to include home-care workers, child-care staff, security guards and anyone who earned less than what they considered to be a living wage.

As o f mid-2015, Seattle, San Francisco and Los Angeles have begun phasing in a $15 m inim um wage. Democratic presidential candidate Sen. Bernie Sanders introduced Congressional legisla­ tion to raise the federal m inim um wage to $15 per hour. W h a t was once considered inconceivable has become more and more commonly accepted as a necessary and even moral imperative for many American businesses.

THE RISKS OF THE PAY RATIO DISCLOSURE RULE A RECENT online presentation by business law firm Dorsey & W hitney LLP and C am H oang, senior counsel and assistant corporate secretary at General M ills, exam ined many o f the risks public companies face as a result o f the SEC’s new pay ratio disclosure rule. A t the most obvious level, Dorsey & W hitney predicts that companies w ith high ratios between C E O and median worker pay may see negative consequences related to media coverage and public relations. The compensation for the C E O s o f public companies is already disclosed in SEC filings,

and such disclosures have led to negative attention for companies with highly-compensated executives. For example, the A FL-C IO reports that one o f the most highly-trafficked sections o f its web­ site it its Executive PayWatch page, which names the 100 most highly-compensated CEO s in America alongside testimonials from low-wage workers at their companies. Similarly, California- based nonprofit As You Sow recently published a report entitled The 100 Most Overpaid CEOs: Executive Compensation a t S& P 500 Companies. Apart from potentially influencing public opin­ ion, the A FL-C IO , As You Sow and like-minded organizations also lobby institutional investors, such as mutual and pension funds, to closely examine executive compensation data for their stock holdings as a measure o f shareholder value. This attention will only increase as information about the relative compensation o f public companies’ median employees becomes public.

Beyond the public relations implications, Dorsey & W hitney also noted potential employee-related issues for firms w ith low m edian employee pay, such as reduced morale and a negative impact on hiring and retention. W hile pay is often a taboo sub­ ject among co-workers, disclosing the median compensation for workers at any firm will inevitability lead employees to compare themselves against that measure. Particularly for those who fall below the median, this inform ation may h u rt morale and pro­ ductivity, and even lead some to seek employment elsewhere if they feel the median compensation is too low to justify putting more time and effort toward moving up in the organization. Conversely, morale may be boosted among those employees who are paid above the median thanks to their improved understand­ ing o f their value w ithin the organization.

Finally, it remains an open question how the public will be affected by this information. In a recent working paper, Harvard Business School researchers Bhavya M ohan, Michael N orton and R ohit Deshpande found in six separate studies that pay ratio disclosure can indeed affect the intentions o f consumers. Given an informed choice, they found consumers would prefer to pur­ chase from firms with relatively low CEO-to-median-workerpay ratio such as 5:1 or even 60:1, as opposed to firms with high ratios such as 1000:1. Lower CEO-to-m edian-worker pay ratios also improved consumer perceptions o f products at different price points as well as their ratings o f the firm’s warmth and compe­ tence. Further, the researchers found that firms with a high CEO - to-median-worker pay ratio must offer a 50% price discount to achieve the same customer satisfaction that a firm with a low ratio achieves at full price.

From negative publicity to reduced investor stock valuation, and from reduced employee morale to dim inished custom er opinion, it appears th at the increased social focus on income inequality from the SEC ’s pay ratio rule may have significant potential risk management implications for public companies.

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MITIGATING PAY RATIO DISCLOSURE RISKS G I V E N T H A T the ever-increasing disparity between executive and worker pay is such a widespread phenomenon, risk managers at individual companies might be at a loss to imagine what they alone can do to address the issue. Fortunately, experts in the field have already begun to weigh in.

Eleanor Bloxham, founder and C E O o fT h e Value Alliance, an advisory firm for m ultinational public companies and p ri­ vate start-ups, provided a com m ent letter to the SEC support­ ing the pay ratio disclosure rule as an im portant development for both investors and companies. She acknowledged the risks o f the new rule for public companies, b ut also suggested its implem entation could be an opportunity for corporate leaders to reexamine their com pensation strategies for the long-term benefit o f their employees and shareholders.

Because the SEC rule requires the calculation o f total com­ pensation including benefits, Bloxham suggested th a t com ­ panies could increase employee stock ownership as a m ethod to boost the com pensation o f the m edian worker. Even more im portant, she said, corporate leaders need to begin to under­ stand how th eir employees actually live in order to better inform decision-making about compensation.

O n e unconventional way to increase this u n d erstanding would be to take a note from the Undercover Boss television show where executives work alongside low-level employees, Bloxham said. In her experience, too many companies have gotten away from the age-old strategy o f “management by walking around.” Crucially, she noted, “communication at the workers [regarding compensation] is n ot going to get anywhere. Instead, we need comm unications th a t begin w ith understanding and learning from the workers, and w ith the workers.”

For a company w ith a higher CEO-to-median-worker com­

pensation ratio, there is no easy answer to how it will mitigate the risks to its reputation, stock value, employee morale and customer opinion. O ne thing risk managers can agree upon is that the time to begin addressing these issues is now, rather than in 2017.

THE BROADER IMPLICATIONS FOR ALL ORGANIZATIONS P E R H A P S T H E greatest risk to American organizations regard­ ing income inequality is the greatest unknow n: H ow far will the public take its concern? W h a t began as the rallying cry o f an encampment o f disenfranchised people in N ew York C ity has gone on to propel one o f the largest labor movements in recent m em ory and has im bedded itself into the consciousness of Americans o f all races, classes and creeds. T h e unfairness o f the current economic system is no longer just a discussion topic in universities and coffee shops, but in factories and on the streets o f every American city.

W hile the SEC’s pay ratio rule only directly impacts public companies, privately-held organizations should consider the likelihood th at their stakeholders and customers may begin ask­ ing for this inform ation as well. As the Fight for 15 movement continues to have success, employers offering less to their work­ ers may rightly wonder how th at decision will affect their repu­ tation in their communities and among their own employees.

A ll indications are th at discussions around income inequal­ ity and specific proposals such as the $15 m inim um wage will only increase as the 2016 election season ramps up. C orporate leaders m ust therefore begin in ten tio n ally addressing the related risks, or risk joining D u n k in ’ Brands’ Nigel Travis in the world o f internet infamy. ■

Will Kramer C PC U , A R M - E , A R M -P , is an independent risk management

consultant a n d writer.

Risk M an a g e m en t 25

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