United States: Early Pay-Ratio Trends From Compensation Consultants

Last Updated: March 22 2018
Article by Cydney Posner

What are the early trends in pay-ratio disclosure?  Surveys conducted by compensation consultants provide some insights.

A survey conducted by Compensation Advisory Partners LLC of pay-ratio disclosures from 150 companies with a median revenue of $2.1 billion showed that, as of March 9, 2018, the median pay ratio was 87:1 (with median employee pay at approximately $58,000 and median CEO pay at $5.6 million). At the 25th percentile, the ratio was 36:1, while, at the 75th percentile, the ratio was 172:1.  According to the survey, the lowest ratio was 1:1 (more about that in a later post) and the highest was 1465:1, for a company with an international workforce.  CAP also reported that the ratio generally correlates with the size of the company, primarily reflecting variations in CEO pay rather than employee pay. The median ratio ranged from 20:1 for companies with revenue under $500 million to 218:1 for companies with revenue over $15 billion.

By comparison,  in an article on a survey of 144 companies from comp consultant Mercer regarding expected pay-ratio disclosure, Bloomberg BNA reported that, for the majority of companies, the pay ratio was anticipated to be 200-to-1 or less. Those results seem to be in line with results of a survey of 356 public companies released in early February by Equilar.  In that survey, the expected median pay ratio was 140:1 and the average was 241:1. At the 25th percentile, the ratio was 72:1, while, at the 75th percentile, the ratio was 246:1. Median employee compensation for all companies in the survey was $60,000. In this survey, pay ratio was also highly correlated with company revenues, with the median pay ratio at 47:1 for companies with revenues below $1 billion, 103:1 for companies with revenues in the $1 billion to $5 billion range, 160:1 for companies with revenues in the $5 billion to $10 billion range and 263:1 for companies with revenues above $15 billion.  (See this PubCo post.)

The CAP survey found that only 15 companies included a supplemental pay ratio and only three provided more than one supplemental ratio. According to CAP, the additional ratios typically reflected adjustments to CEO pay to reflect anomalous payments such as bonuses or equity awards. CAP observed that the supplemental pay ratio provided by three companies was actually higher, which CAP attributed to a probable desire to "provide context for a large year over year increase in the 2019 proxy statement."

The Mercer survey also showed that most companies were taking a minimalist approach; a Mercer representative told Bloomberg  that "companies' 'inherent conservatism' seems to have taken over." Of respondents in the Mercer survey, 87% indicated that they did not expect to add much additional information to their disclosures beyond the requirements. Only a few companies said they would report a second ratio that covers U.S. employees only or other executives only.  For the remaining 13% of companies in the Mercer survey, the most common additional information expected to be included was the median employee's position or location (although not the identity or other information that could violate applicable employee data privacy laws), followed by more information about the company's workforce, such as the proportion of part-time or seasonal employees or geographic location.

SideBar

This minimalist approach to disclosure does seem to be the emerging consensus, at least for the first year of reporting, as companies wait for best practices to become apparent. However, in some circumstances,  additional context may be necessary to prevent misunderstanding.  For example, if the CEO is a new hire and received some hefty welcome-aboard new-hire grants or if the company has a large low paid workforce overseas that has skewed the results, it may make sense to provide additional narrative. Additionally, although the rule requires disclosure of a single ratio covering both foreign and domestic employees, it expressly permits companies, in their discretion, to present additional ratios to supplement the required ratio, so long as the supplemental ratios are clearly identified, not misleading and not presented with greater prominence than the required ratio. But, according to one comp consultant cited in the Bloomberg article, "'[w]hether those added ratios will be helpful is being debated,'... He said it's one of several messaging issues that companies are thinking about."

The CAP survey showed that about one-third of companies excluded a portion of the workforce when determining the median employee, relying most often (approximately 55%) on the de minimis exemption, as well as the exemption for recent acquisitions. Individuals deemed to be independent contractors were also typically excluded.

SideBar

Under the de minimis exemption, if a company's non-US employees account for 5% or less of its total employees, the company may exclude all, but not less than all, of those employees. If the company's non-US employees exceed 5% of the total employees, the company may exclude up to 5% of its total employees who are non-US employees. However, if the company excludes any non-US employees in a particular foreign jurisdiction, it must exclude all non-US employees in that jurisdiction. Under this exemption, if the number of employees in a particular foreign jurisdiction exceeds 5% of the total, none may be excluded from that jurisdiction.

A company may also exclude from the calculation of the median employee any employees that became employees as a result of a business combination for the fiscal year in which the transaction became effective, but must disclose the approximate number of employees excluded.

As described in this PubCo post, in guidance issued in September last year, the SEC expanded the exclusion in the rule for independent contractors. The rule defines an "employee" as "an individual employed by the registrant or any of its consolidated subsidiaries," but excludes from the definition of employee "workers who are employed, and whose compensation is determined, by an unaffiliated third party but who provide services to the registrant or its consolidated subsidiaries as independent contractors or 'leased' workers." Under the guidance, the SEC described the exclusion in the rule as non-exclusive: given that "registrants already make determinations as to whether a worker is an employee or independent contractor in other legal and regulatory contexts, such as for employment law or tax purposes," the SEC said that it will allow companies "to use widely recognized tests to determine who is an 'employee' for purposes of the rule."  The "test might, for example, be drawn from guidance published by the Internal Revenue Service with respect to independent contractors."

In terms of location in the proxy statement of the new pay-ratio disclosure, CAP found that almost 70% of companies disclosed the pay-ratio information after the section disclosing Potential Payments upon Termination or Change in Control, while about 25% located it just before or after the Summary Comp Table.  Only 5% disclosed it in CD&A as it was not typically considered in determining executive comp levels.  About 25% also recommended that shareholders not use the pay-ratio information to compare against pay at other companies.

SideBar

That admonition would be consistent with statements by the SEC in the final rule release: "we believe the final pay ratio rule should be designed to allow shareholders to better understand and assess a particular registrant's compensation practices and pay ratio disclosures rather than to facilitate a comparison of this information from one registrant to another. As we noted in the Proposing Release, we do not believe that precise conformity or comparability of the pay ratio across companies is necessarily achievable given the variety of factors that could cause the ratio to differ. Consequently, we believe the primary benefit of the pay ratio disclosure is to provide shareholders with a company-specific metric that they can use to evaluate the PEO's compensation within the context of their company."

Companies are required to disclose the date selected to identify its median employee.  Under the SEC rules, that date must be within the last three months of the last completed fiscal year. According to the CAP survey, 44% used the last day of the 4th quarter, 57% selected a day in the third month of the 4th quarter, and 29% selected a day in the first month of the 4th quarter.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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