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A new academic study has uncovered that some U.S. public companies use loopholes in federal rules to make their CEO-to-worker pay ratios appear more acceptable to shareholders without actually narrowing the pay gap between top executives and rank-and-file employees.

The paper "Discretion in Pay Ratio Estimation" was in the Journal of Banking and Finance by Chip Ryan, Truist Professor of Capital Markets of Georgia State University's J. Mack Robinson College of Business, with researchers Zinat Alam from the University of North Texas and Chinmoy Ghosh and Lingling Wang of the University of Connecticut. Professors Ryan, Alam, and Wang are also Ph.D. graduates of Robinson.

The research shines a light on how firms exploit discretion in estimating and reporting CEO pay ratios mandated under the Dodd-Frank Act. At a time when income inequality is a rising concern among voters, consumers, and policymakers, this study has wide-reaching implications for corporate transparency, public trust, and the perception of the effectiveness of environmental, social, and governance (ESG) disclosures.

What the CEO pay ratio is and why it matters

Since 2017, the U.S. Securities and Exchange Commission (SEC) has required publicly traded companies to disclose the ratio of CEO pay to that of their median employee. The idea behind this was simple: give investors and the public insight into income inequality within firms.

"Many economists and sociologists say that increasing income disparity can decrease social mobility and economic growth, so closing that income gap is considered important for society's overall health," said Ryan.

The SEC gave firms discretion over how they identify the median employee used to report their pay ratio. Research shows that investors and other stakeholders react negatively to the disclosure of a high CEO-to-median employee pay ratio, so it's in the firm's best interest to disclose a lower pay ratio.

"The easiest and most inexpensive way to choose the median employee would be using employee salary or cash compensation—salary plus any bonuses," said Ryan. "Around 75% of firms follow this approach to comply with the mandate. But 25% of firms use a more complex, expensive method for estimating the pay ratio, and our research found that this discretion creates a loophole that allows firms to choose a median employee making a higher income."

The heart of the matter: How companies pick their numbers

The study analyzed 4,609 pay ratio disclosures from 2,678 firms between 2017 and 2018—the first two years of the rule's implementation. It found that companies that used more complex, expensive methods to identify their median employee, including stock options or health benefits, reported lower CEO-to-worker pay ratios.

For instance:

• Companies that used only base salary to identify the median employee reported an average ratio of 192:1.
• Those using the most detailed, comprehensive methods reported an average ratio as low as 70:1.

This doesn't mean CEOs were paid less or employees more. Instead, companies chose methods that led to a more favorable-looking number.

No real change in pay gap

The researchers found no evidence that firms using complex methods had reduced CEO pay or raised worker compensation. In fact, in many cases, CEO pay continued to rise.

This suggests some firms may use estimation tricks, not policy changes, to polish their image.

The study calls this "estimation discretion," a practice that, while legally within the rules, undermines the regulation's goal of providing a clear, informative picture of internal pay equity.

Why it's happening: Social pressure and shareholder dissatisfaction

The study also investigated why companies might go to such lengths. They found firms were more likely to use complex methods and report lower pay ratios when:

• They were based in states with stronger public opposition to income inequality and/or not allowing firms to require salary histories in job postings.
• Their shareholders had recently expressed dissatisfaction with executive pay.
• They had previously reported high CEO compensation relative to other firms.

"We measured a state's societal aversion to income inequality by looking at the state's minimum wage requirements, the range between the highest and lowest income tax bracket, and whether it's a Democratic or Republican-leaning state," said Ryan.

In short, when public or investor scrutiny is high, companies are more likely to massage the numbers.

The bigger picture: What this means for ESG and corporate accountability

This research adds to a growing body of evidence questioning the effectiveness of ESG disclosures when companies have wide latitude in how they report them.

Although some firms may use disclosure to drive real change, others appear to be "window dressing" by giving the appearance of fairness without altering real practices.

"Discretion in ESG reporting allows firms to conform to stakeholder expectations without actually changing corporate behavior," Ryan said. "This could dilute the effectiveness of disclosure-based reforms and erode public trust."

In a business climate where perception can shape investor confidence and brand loyalty, this study reveals a crucial truth: numbers may not lie, but they can certainly be massaged. And in the case of CEO pay ratios, what you see may not be what you get.