Preparing for CEO Pay Ratio Disclosures

Public companies face decisions on the variables in the calculation, and on how they plan to present this information

By Joanne Sammer October 7, 2016
Preparing for CEO Pay Ratio Disclosures

Public companies in the U.S. will be required to disclose the ratio of CEO pay to median employee pay in their 2018 proxy statements—reporting on fiscal year 2017—and many are already working through the calculations involved.

Prudent companies are also considering the potential impact of these disclosures on the workforce, not just shareholders. In doing so, these companies face some important decisions, both regarding the variables in the calculation itself and in how they plan to present this information.

Choose a Strategy

As companies consider their approach to pay ratio calculations, this is the time to think through an overall strategy.

Some will choose simply to "disclose and forget it," said John Trentacoste, a director with executive compensation consultants Farient Advisors in New York City. "Other companies are considering disclosure of additional pay ratios that they consider to be more indicative of the full-time employee population, while also explaining why the CEO/median pay ratio has come out as it has." For example, the inclusion of seasonal or non-U.S.-based workers with lower wages could make the ratio higher than it otherwise would be.

Some companies are particularly concerned about how employees and other stakeholders, including unions and specific business units or divisions, might interpret the pay ratio disclosures, making even worse the general perception among workers that CEOs are vastly overpaid. "These companies want to spend the time and figure out their calculations now," said Gregg Passin, a senior partner with Mercer in New York City. "This way, they can start playing around with the results and see if there are other ways to calculate the ratio."

Prepare Employees

Individual employees could react strongly to both the ratio and the median employee pay figure used to calculate it. "What happens if an employee picks up the proxy statement and sees that his or her pay is below the median [for all employees]?" Trentacoste asked. "How are employees supposed to interpret that?"

This is an important consideration for employers. After all, median pay represents the midpoint of the pay range for the entire company, so half of employees will be paid above and half below that number. Employers could face serious questions from employees reacting negatively to this information by concluding they are underpaid. "This could be a big problem among professional employees in North America and Western Europe," who may assume that their professional status would place them above the median, or that the gulf between their pay and their CEO's compensation would be less than it turns out to be, Passin said.

Tell Your Story

When employees believe that they are being paid less than they deserve, many simply leave—triggering a potentially costly and lengthy process to find replacements, HR Magazine reported earlier this year.

But rather than fearing pay ratio disclosures, "This is an opportunity to discuss how compensation for the workforce aligns with the company's values, culture, future growth plans and the brand," said Lisa Disselkamp, managing director with Deloitte in Washington, D.C. "The HR leader is in a position of explaining their compensation of the larger workforce relative to these executive level pay."

Given the stakes involved and the potential for backlash, companies may want to carefully prepare and communicate a fuller story behind pay ratio disclosures. "They may want to disclose other information and additional ratios that tell a better story and contextualize the main number," Passin said.

This more complex story could include a number of additional data points that put disclosures in context against the company's earnings, revenue and other metrics. "The goal is to tell a broader story about the workforce that could offset some of the uncomfortable metrics with additional measurements," Disselkamp said. "This could mean including contractor pay when calculating the pay ratio if the company uses a lot of technology contractors, for example." Other elements of employee pay can also be factored in, including overtime pay, paid time off, and the value of both financial and nonfinancial benefits, like flexible scheduling.

On the other hand, Willis Towers Watson consultants Steve Seelig and Rich Luss, both in Washington, D.C., explained why "in many situations simpler pay definitions (e.g. base pay) will yield a better result" and are likely to be a more cost-effective approach.

A Work in Progress

There is still time to work through these issues, and many companies are using the period before formal disclosures are required in 2018 statements to do so. For example, companies are looking at their employee populations to determine when to make the calculation during the allowed three-month window next year in order to have the best representation of the workforce.

"There may be more part-time employees or seasonal workers at certain times of the year, especially in retail and shipping," Trentacoste said. "There is a menu of assumptions and judgment calls that companies need to make it order to provide a reasonable representation of the immediate employee population."

When required disclosures begin, companies can re-evaluate their approaches based on the reaction and feedback they receive. "I think we will see the most interesting shift in disclosure from year one to year two," Trentacoste said. After seeing how employees and the media react and where competitors are relative to the ratio, companies may decide to provide more or less information in future disclosures.

"We may see more ratios and explanation if there is a fuss, and less information if it turns out to be a nonevent," he said.

Update: The U.S. Securities & Exchange Commission issued additional guidance for companies on the CEO pay ratio rule via five new Compliance & Disclosure Interpretations, published on Oct. 18. The new interpretations "resolve a number of important questions and provide some clarity to companies as they prepare for compliance with the rule," according to an analysis by law firm Sidley Austin LLP.

Pay Ratios May Be Lower than Expected

For companies wanting to know how their CEO-to-median-worker pay ratio stacks up against other companies, key findings from Mercer's recent CEO Pay Ratio Survey show that:

  • A majority (60 percent) of companies have estimated their ratio, with more than half reporting ratios under 200:1 but with 20 percent reporting ratios of more than 400:1.

  • Overall, the responses were significantly lower than the AFL-CIO's 335:1 ratio for 2015, frequently cited by the media.

  • Approximately one-third (32 percent) of respondents are considering statistical sampling as a method to identify the median employee.

  • More than 80 percent report their data systems are ready or, with some manual effort, adequate to identify the median employee.

The survey, which was conducted in August, consisted of 117 companies across 12 industries.

Not surprisingly, industries with low ratios tend to have more professional staff and include banking/financial services, technology and nonfinancial services. Companies with high ratios have more part-time, temporary and less-skilled employees, such as in the retail/wholesale and consumer goods sectors.

Joanne Sammer is a New Jersey-based business and financial writer.


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