As part of the Dodd-Frank Act, public companies will soon be subject to CEO pay ratio disclosure requirements. Starting with reporting for any fiscal year that begins on or after January 1, 2017, these organizations will have to disclose not only the CEO annual total compensation, but also the total annual compensation of the median employee and the ratio of the two figures.
This will first need to be disclosed on reports for the company’s fiscal year that began on or after January 1, 2017, and as such will first be required starting in early 2018 (on 2017 reports). According to the Securities and Exchange Commission (SEC) website, this updated regulation “will require disclosure of the pay ratio in registration statements, proxy and information statements, and annual reports that call for executive compensation disclosure.”[i]
How Must the Median Employee Pay Be Calculated?
There is actually a bit of flexibility in how the median employee pay is calculated. This news is both good and bad; it’s good because employers can choose the methodology that both makes sense and is not too costly or burdensome to calculate. The downside, however, is employers will have less guidance on the exact calculations because there are multiple options. It also means that anyone evaluating the disclosed figures may have a more difficult time comparing different organizations because they may have used differing methodologies.
In October 2016, the Securities and Exchange Commission issued guidance on how these calculations are to be made. Explaining the full scope of every available means to calculate the median employee pay is outside the scope of this article, but per the SEC guidance on the matter: “A company could use its total employee population or a statistical sampling of that population and/or other reasonable methods. A company could, for example, identify the median of its population or sample using:
- Annual total compensation as determined under existing executive compensation rules; or
- Any consistently-applied compensation measure from compensation amounts reported in its payroll or tax records.”[ii]
For more information about how to do these calculations, check out the SEC guidance available here: https://www.sec.gov/news/pressrelease/2015-160.html.
What Are the Primary Concerns for Affected Employers?
There are several concerns facing companies subject to this new disclosure requirement; these include costs of assembling the data and doing the calculation, employee perceptions, public perceptions, and impacts on shareholders.
Costs of Calculation
Many organizations are frustrated at the probable cost of gathering the information required to compile these figures accurately. While the flexibility noted above is meant to reduce the burden, for many organizations this still creates a sizeable issue when it comes to collecting the required information and making all calculations needed to determine what final number should be presented.
Because of this, many organizations are starting now to determine which methodology makes the most sense for their calculations and how they will communicate about it in the future.
Employee and Public Perceptions
Organizations will need to be aware of how all of these figures may be perceived by employees and what impact they may have on employee morale and satisfaction levels. Since CEO pay disclosures are not new, the bigger concern for many organizations is the median employee pay figure. Since this is a median figure, half of employees will find themselves making less than the reported amount. Additionally, employees will be able to see how this median figure compares to similar organizations. Either of these issues may lead to some dissatisfaction and even turnover.
The public will also be able to see these figures, and it may have an impact on public perception of the company if the figures are not in alignment with expectations. For example, some companies may experience a change in public perception if their CEO pay ratio is drastically different than most of their peers.
HR teams and other communication professionals will likely have the unenviable task of communicating about all of these figures—and also handling any complaints that may arise after the figures are made public. Employers will have the leeway to disclose additional information with the required figures, such as information about how the median employee pay was calculated or perhaps additional ratios that they may feel are a more complete representation of the company’s situation.
Impact on Shareholders
For public companies, the CEO pay ratio disclosure is also an important component for voting shareholders to consider when voting on executive pay levels. This is one intended benefit of the disclosure.
The ratio could be used publicly to discuss whether shareholders deem the relative CEO pay to be in alignment with the company goals.