The SEC recently approved final CEO pay ratio disclosure rules. As mandated by the 2010 Dodd-Frank Act, these rules will require annual disclosure by most public companies of the ratio of the compensation of a company’s CEO to the median compensation of its employees. Following are a few highlights of the new rules:
When Do The New Rules Become Effective? Fortunately, there is some time to plan. The rules do not require the pay ratio disclosures until fiscal years beginning January 1, 2017, or later. So, these disclosures will first be required in 2018 proxy statements for companies with a fiscal year ending December 31, 2017.
How Is The Pay Ratio To Be Disclosed? Proxy statements and other filings that require executive compensation disclosures would have to include:
- The median of the annual total compensation of all of its employees, other than the CEO (i.e., the median employee’s compensation);
- The annual total compensation of the CEO; and
- The ratio of those two amounts.
The compensation comparison may be shown either as a ratio (e.g., 40:1) or as a multiple (e.g., the CEO’s total compensation amount is 40 x that of the median of the annual total compensation of all employees).
How Do You Determine A Median Employee? In order to make these calculations, companies must first determine the employee population. There is some flexibility in this regard, including using the total employee population, a statistical sampling of the employee population, or other reasonable methods. Once the employee population has been determined, the median employee must be identified. Again, there is some flexibility. For example, the median employee may be identified using any consistently applied compensation measure from amounts reported in the company’s payroll or tax records (e.g., salaries, salaries plus bonus, W-2 earnings or its non-U.S. equivalent).
Fortunately, the median employee identification is generally required only once every three years.
What Employees Are Considered In Identifying The Median Employee? The pay ratio is to be based on the compensation of all employees of the company (and its consolidated group) generally including full-time, part-time, temporary and seasonable workers, both inside the U.S. and outside the U.S. The rules do not permit full-time equivalent adjustments for non-full-time workers. The rules do allow exclusion of a limited number of non-U.S. employees (e.g., up to 5% of a company’s employees may be excluded, as well as employees in jurisdictions with applicable data privacy rules).
How Is The Total Compensation Of The CEO And The Median Employee Determined? The total compensation of the CEO and of the median employee is calculated using the same rules that apply to CEO compensation in existing executive compensation rules (i.e., Item 402 of Regulation S-K). The rules do, however, allow use of reasonable estimates in calculating elements of the median employee’s total compensation.
While the effective date of the new rules may not be imminent, affected companies are encouraged to begin planning for compliance with this potentially cumbersome and time consuming requirement well in advance of the effective date.