Securities regulations have increasingly required disclosure of, and shareholder input into, corporate executives’ pay.  For years, public corporations have been required to disclose the salaries of named executive officers, Dodd-Frank instituted (nonbinding) shareholder say-on-pay votes, and very soon, companies will be required to disclose the ratio of the CEO’s pay to median employee pay.

Many have argued that disclosure creates a Lake Wobegon effect:  No one wants to admit that their CEO gets below-average pay, and so disclosure ends up causing pay levels to rise across the board.

Now, a new study by Hongyan Li and Jin Xu looks at the effect in the context of CFO pay.  

Prior to 2006, the SEC required disclosure of the pay of five highest paid executive officers, including the CEO.  In 2006, however, the SEC changed its regulations to require disclosure of CFO pay, regardless of whether the CFO was one of the most highly paid.  The authors used the change as a natural experiment to discover the effect of disclosure on both CFO salary levels and CFO behavior.

Using a sample of S&P 1500 firms from 1999 through 2013, they find that at firms that had not previously disclosed CFO pay, CFO pay increased at a greater rate than at firms that had been disclosing CFO pay all along.  More worryingly, they also found that after companies began disclosing CFO pay, the quality of financial reporting deteriorated.  I.e., it seems as though once the CFO position becomes more prominent – and more highly paid – CFOs feel more need to “sing for their supper” in the form of generating positive (and potentially artificial) results.

That said, there seems to be room for further analysis.  The authors divide companies into 4 groups based on whether they reported CFO pay prior to the 2006 changes (always reported, often, seldom, and never) and they find that on some measures, the increase in earnings management is confined to the seldom and/or often groups.  So the story is not as simple as disclosure = deterioration.  Still, the study highlights flaws in a regulatory philosophy based on the disciplining effects of disclosure.