Original Research

The 'pay ratio' provision of the Dodd-Frank Act 2010 and presentation of the Paulo–Le Roux Index

Stanley Paulo, Pierre le roux
SA Journal of Human Resource Management | Vol 14, No 1 | a803 | DOI: https://doi.org/10.4102/sajhrm.v14i1.803 | © 2016 Stanley Paulo, Pierre le roux | This work is licensed under CC Attribution 4.0
Submitted: 25 February 2016 | Published: 19 August 2016

About the author(s)

Stanley Paulo, Department of Accounting, Economics and Finance, Lincoln University, New Zealand
Pierre le roux, Department of Economics, Nelson Mandela Metropolitan University, South Africa


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Abstract

Orientation: This article addresses the issues of executive remuneration and whether it was excessive or not.

Research purpose: On 05 August 2015, the US Securities and Exchange Commission (SEC) adopted a rule to operationalise Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act 2010 (Dodd-Frank or the Dodd-Frank Act 2010), the ‘pay ratio provision’, as part of a process to ensure sound corporate governance and shed light on assertions that corporate executive remuneration was excessive and detrimental to the economic wellbeing of the USA. This pay ratio rule will be operative starting from 2017 and requires public firms to publish the ratio of chief executive officer (CEO) remuneration to the median remuneration of all its employees. Hence, it is a measure of income distribution. It does not reveal the relationship between executive compensation and the value added to the firm by executives. In anticipation of this rule becoming mandatory and as part of a quest to quantify the value of executives to the firm, Paulo and Le Roux (2014) developed an approach to measure the value executives add to the firm, drawing from audited financial statements and thereby demonstrating that the value added by executive management could be measured according to the requirements of sound research methodology and rigorous epistemology.

Motivation for the study: Statutory enactment of the pay ratio provision provided the impetus to create an index, the Paulo–Le Roux Index, that shows how much executives are paid in relation to how much value they add to the firm.

Research design, approach and method: Paulo and Le Roux (2014) developed an approach to measure the value executives add to the firm, drawing from audited financial statements and thereby demonstrating that the value added by executive management could be measured according to the requirements of sound research methodology and rigorous epistemology. Statutory enactment of the pay ratio provision provided the impetus to create an index, the Paulo–Le Roux Index, that shows how much executives are paid in relation to how much value they add to the firm. The value added to the firm is a composite of the value drivers, sales, growth, capital requirements (CR), operating profitability (OP), and the discount rate in the form of a weighted average cost of capital (WACC).

Main findings: Discussions that hitherto have been normative regarding executive remuneration, and unrelated to the value created by executives, can now be based on rigorous valuations that draw from audited financial statements.

Practical/managerial implications: Numerous advantages accrue from the use of this index for all stakeholders, managers, organised labour, investors, as well as for asset allocation and corporate restructuring, the risk incurred in adding value, and the strategies applied. This index can be used for any enterprise, division, functional area, or project, and for any financial period for which audited financial statements are available.

Contribution: Using the index ensures sound corporate governance and shed light on assertions that corporate executive remuneration was excessive and detrimental to the economic wellbeing.


Keywords

executive remuneration; corporate value added; corporate governance; agency theory

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