Strike up the band, the CEO Pay Ratio is finally here!
Tucked away in the Dodd-Frank Wall Street Consumer and Protection Act, Section 953(b) mandates the SEC develop a regulation requiring issuers to disclose both the median annual total compensation of all employees (excluding the CEO) and the annual total compensation of the chief executive officer or equivalent position, culminating in a ratio of the two rates. Following the inception of this proposed rule, a wide range of proponents and critics have highlighted the cost and benefits of implementing this CEO to employee pay ratio. From a U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness study that estimates the cost of reporting such figures and classifies the rule as a shaming tactic, to the barrage of political attacks centered around the gap between CEO compensation and rank-and-file pay, the spectrum of support and disapproval remains intense and expansive. At the end of 2013, the Securities and Exchange Commission began receiving comments regarding the proposed rule and outlined a number of “technical and interpretive issues” it was considering (here): which employees should be included; identifying the median; determining “total compensation”; disclosure of methodology and assumptions; defining “annual” compensation; and various timing matters.
After a prolonged postponement (and even a FOIA request by AFL-CIO), the SEC Commission finally adopted the CEO-to-worker pay ratio rule today in an open meeting, the result of a 3-2 vote in favor. During the meeting Commissioner Dan Gallagher described the rule as “pure applesauce,” and Chair Mary Jo White characterized the continued dialogue as “heated and contentious.”
Given that this rule arrives five years after Dodd-Frank was implemented, it appears the Commission was in no hurry to have companies actually disclose these ratios: the new regulation only requires companies to disclose the pay ratio beginning on their first fiscal year beginning after January 1, 2017, giving companies plenty of time to figure out how to calculate and disclose it.
Certain smaller reporting companies, foreign private issuers, registered investment companies and registrants filling under the Multijurisdictional Disclosure System would be exempt from the rule. Additionally, the following excerpts from the SEC’s statements provide further information regarding the reporting process by companies.
Commissioner Luis A. Aguilar:
“For example, in calculating the CEO-to-worker pay ratio, today’s rule permits issuers to do the following:
- To choose areasonable method to identify the median employee that is appropriately tailored to their business, including identifying the median employee using statistical sampling or any consistently applied compensation measure (such as payroll records);
- To exclude from the pay ratio calculation ade minimis amount of non-U.S. employees;
- To exempt from the pay ratio calculation non-U.S. employees from certain jurisdictions when foreign privacy laws make it illegal to provide the information necessary to calculate the pay ratio;and
- To calculate the median employee only once every three years, instead of every year, providing certain conditions are met.”
Chair Mary Jo White:
“The staff is also recommending additional accommodations in the final rule, including: an exemption for situations when foreign data privacy laws would prevent companies from being able to process or obtain the necessary compensation information to calculate the ratio; an ability to exclude up to 5% of non-U.S. employees when determining the median employee; and allowing companies to use cost-of-living adjustments when determining the median employee and calculating the employee’s total compensation, in order to achieve a more meaningful reflection of the compensation of employees as compared to the chief executive.”
Although the adoption of the new rule finalizes the disclosure requirements of a company’s pay ratio, numerous questions remain. Some shareholders will welcome the improved disclosure surrounding executive compensation, while others will question the new costs of compiling and reporting the necessary data. Comparing these ratios between industries may provide convoluted information that confuses rather than improves our understanding of CEO pay. Furthermore, the exclusion of certain foreign employees allowed under the rule may alter each companies reported ratio (see the SEC’s analysis on the potential changes). Will the costs outweigh the benefits? Will meaningful changes be made to the pay packages of CEOs that add value to shareholders? Will the increased disclosure be counterproductive in “reining” in CEO pay? As the regulation materializes, the debate is destined to continue.
The SEC’s public statement can be found here: http://www.sec.gov/news/statement/statement-on-open-meeting-on-pay-ratio.html and http://www.sec.gov/news/statement/statement-on-open-meeting-on-pay-ratio-aguilar.html#_edn13