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The pay ratio disclosure requirement established under Section 953(b) the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) has been the subject of substantial debate since its passage in 2010. It requires most publicly traded companies to report the compensation of their Principal Executive Officer (PEO), the compensation of a median employee, and the ratio between the two, and allows them to add additional narrative disclosures. One of the primary points of contention is whether or not these compensation disclosures provide useful information for investors or other stakeholders.
A hand-collected sample of pay ratio disclosure data is matched with existing financial statement and market data to assess the use of the pay ratio disclosure in capital markets. The value relevance of the pay ratio disclosure information is evaluated through its association with cumulative abnormal returns. The risk relevance of the pay ratio information is evaluated through its association with the standard deviation of returns. Finally, the responsiveness of investors to the release of the pay ratio disclosure is evaluated through share turnover following its release.
It is found that investors do use the pay ratio disclosure and that the new disclosure of the compensation of a median employee is most salient in the first year of the disclosure. The results suggest that the pay ratio disclosure is value-relevant to investors, potentially risk-relevant, and that these or other effects influence investor trading behavior. These results will help to resolve the debate regarding the usefulness of the Dodd-Frank pay ratio disclosure. The evidence provided suggests that the pay ratio disclosure is useful to investors in evaluating the value and risk of investments with regard to executive compensation and labor productivity.