Take 3 steps to prepare for CEO pay ratio disclosure

Compensation Benefits - CEO pay ratio disclosures, June 2015Compensation and Benefits Bulletin
The SEC recently released an analysis regarding the potential effect of excluding different percentages of employees from the CEO pay ratio calculation. According to the analysis, these exclusions don’t significantly affect the calculation of the pay ratio. However, the SEC’s release of the analysis suggests final rules are forthcoming and SEC registrants should start preparing.

The SEC in 2013 released the proposed rules implementing a Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) provision that requires U.S. public companies to disclose a ratio of CEO compensation to median employee compensation. The proposed rules would require disclosure of the following:
  • Median annual total compensation (calculated in the same manner as the one used for the summary compensation table) of all employees except the CEO
  • Annual total compensation of the CEO
  • The ratio of these two amounts

The proposed rules also specified the inclusion of all employees, including non-U.S., part-time, seasonal and temporary employees. To determine the median employee, companies could use any reasonable method, including statistical sampling or a consistently applied compensation measure. The SEC received many comments regarding the calculation of the median annual total compensation of all employees and whether certain categories of employees (for example, non-U.S., part-time, seasonal and temporary) should be excluded. On June 4, the agency released an analysis it thinks will help companies evaluate how the exclusion of different percentages of certain categories of employees may affect the accuracy of the pay ratio calculation.

What the development means
Our observation is that public companies have been less likely to voluntarily disclose the ratio of their CEOs’ pay to the median employee’s pay than to voluntarily release information related to other recently announced proposed disclosure rules, such as hedging policy and pay-for-performance. In fact, in our search of proxy statements filed with the SEC in 2015, we found only three companies that made such a voluntary disclosure. Each of the three used a different methodology to calculate total compensation and determine the median employee. Only one calculated total compensation in the same manner as used for the summary compensation table (as proposed by the SEC) for all employees of the company. The lack of voluntary disclosure could result from many factors, including potential negative media coverage regarding a high ratio (especially without any context or comparisons), lack of SEC recommended methodology for determining the median employee or perhaps the hope that the pay ratio disclosure rules wouldn’t be finalized.

The pay ratio rules seem likely to be finalized and required of all SEC registrants, especially considering the results of the SEC’s analysis showing that excluding different percentages of employees doesn’t significantly affect the pay ratio.

What to do
Companies should take the following three steps:

  1. Determine which method to use to determine the median employee. As previously stated, a company can use any reasonable method, but the method must be applied consistently every year.  Companies should model the pay ratio under different methodologies and scenarios to determine which methodology is appropriate today and into the future.
  2. Gather the necessary compensation data and team members. This is especially important for multinational companies whose employee compensation data may be housed on multiple systems and administered by multiple individuals or teams. Companies should also determine who should participate in preparing the pay ratio disclosure (for example, HR, finance and legal).
  3. Develop a communication strategy. Companies with a “high ratio” (which has yet to be defined) should expect to get negative press. They should proactively determine what, if any, extra communication and disclosure will be appropriate.

The internal pay ratio disclosure requirement was possibly the most controversial item required under the Dodd-Frank Act, and many executives have wished or even expected this requirement to disappear. However, it’s becoming clear that it isn’t going away and could even be finalized for next year’s proxy season. Therefore, companies and boards of directors should start preparing now.

Eric Myszka
+1 312 602 8297

Brian Martin
+1 214 561 2289

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