Never fall behind on the latest trends in CEO pay ratio with CAP’s CEO Pay Ratio Tracker. The CEO Pay Ratio Tracker uses each company’s most recent pay ratio disclosure.

 

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Click here to read more about the second year of CEO Pay Ratio disclosures: https://www.capartners.com/cap-thinking/deep-dive-second-year-ceo-pay-ratio-disclosures/.

An early look at the second year of CEO pay ratio disclosures shows that the ratios held steady for the overall sample, while on a company-by-company basis the ratio was quite volatile.

The 2019 Proxy Season has begun, and Compensation Advisory Partners (CAP) has done a comprehensive analysis of the second year of CEO pay ratio disclosures to identify what has changed and what trends are emerging. At a high level, CAP has found the following:

  1. CEO Pay Ratio: While CEO pay ratio summary statistics (e.g., 25th percentile, median, and 75th percentile) were flat across the sample, two-thirds of the sample companies had pay ratios that fluctuated up or down by more than 10 percent. The significant volatility in individual company pay ratios is masked in the overall sample, so proxy readers should not be surprised if a company’s pay ratio moved year-over-year.
  2. CEO Pay: CEO compensation increased 7 percent at median with two-thirds of CEO pay fluctuating by more than 10 percent. This may be driven by incentive compensation changing year to year, by CEO transitions and by changes in pension value calculations where applicable.
  3. Median Employee: Only 36 percent of companies used the same median employee year-over-year. For the companies that use the same median employee, the pay of that employee went up 7 percent at median. Where companies selected a new median employee, the year-over-year change in pay was 4 percent at median. This indicates that companies that want to maintain a lower CEO pay ratio may be better off keeping the same median employee from year to year if possible.
  4. Additional Disclosures: Despite interest expressed by some institutional shareholders in greater disclosure about the workforce, only 16 percent of companies disclosed additional information about the median employee (e.g., geographic location, role with the company, full-time vs. part-time, etc.). This is up from 12 percent of companies providing additional disclosures last year.

Methodology

CAP analyzed 201 of the first proxies filed in 2019 in order to study developing trends and examine differences from prior-year disclosures. The median company revenue of this sample is $2.1 billion. Detailed exhibits of findings are shown in appendix below this report.

Pay Ratio

CEO pay ratio at median, 25th and 75th percentiles are stable for this sample of companies when compared to the prior year.

Summary Statistics

2017

2018

% Change

75th Percentile

165x

165x

0%

Median

79x

78x

-1%

25th Percentile

40x

40x

+1%

When looking at this sample on a company-matched basis, the percentage change of pay ratio was flat at median (-1%), 25th percentile (+1%) and 75th percentile (0%). Despite the flat year-over-year summary statistics, significant volatility in the pay ratio occurs at the individual company level, driven by both changes in pay levels for the CEO and in pay levels for the median employee. On a company-matched basis, about half of the sample had increases in the pay ratio, and half had decreases. When looking at the percentage change in the pay ratio, CAP found that two-thirds of companies had year-over-year changes in the pay ratio of more than +/-10 percent. This shows that while the total sample may seem unchanged year-over-year, individual companies have a good amount of variability that ends up being masked when the pay ratio data are viewed in aggregate. This individual company variation will likely be evident in coming years as well, as CEO and median employee pay can fluctuate significantly year to year. These factors coupled with the variety of methodologies that can be used continue to make drawing meaningful comparisons across companies difficult.

CEO and Median Employee Pay

CEO pay increased 7 percent at median, while the pay of the median employee increased 5 percent at median. While the increases in pay were similar at median, there was much greater volatility in CEO pay year-over-year with two-thirds of CEO pay fluctuating by more than 10 percent compared to one-third of median employees’ pay. This can be most easily explained by CEO’s having a much larger percentage of incentive compensation, generally, which may vary in magnitude year to year. Another source of fluctuation could be at companies where the CEO and/or the median employee participate in a pension plan, as increases to the discount rate used to value pension benefits can drive down Summary Compensation Table (SCT) pay. CEO and median employee pay moved in the same direction in 60 percent of companies, which shows at least some correlation between CEO pay and that of the typical employee. A correlation is more likely when the median employee is bonus and/or equity eligible, as more of his or her compensation is linked with the company and, therefore, the CEO’s.

Approximately 35 percent of companies used the same median employee for computing the CEO pay ratio as in the prior year. When a company used the same median employee as last year, the pay for that median employee increased between 7 percent and 8 percent at the median, 25th and 75th percentiles. This represents larger increases than when a company selected a new median employee, with median employee pay remaining relatively flat (0 to 4%). This indicates that re-selecting the median employee will more likely result in decreased or flat pay for the median employee, as salary typically increases over tenure, and incentive compensation tends to be modest for employees at this level. A decrease in median employee pay by more than 3 percent is twice as prevalent (27% versus 13%) at companies re-selecting their median employee. When a company selects a new median employee, they have the option of selecting a substantially similar employee from the previous year, seen approximately 20% of the time, or re-running the selection analysis in the current year, seen approximately 80% of the time.

Median Employee Pay

Summary Statistics

Same Median Employee

Chose New Median Employee

2017

2018

% Change

2017

2018

% Change

75th Percentile

$80,354

$86,352

+7%

$84,883

$86,046

+1%

Median

$59,248

$63,665

+7%

$58,658

$60,726

+4%

25th Percentile

$46,163

$49,976

+8%

$44,980

$44,974

-0%

Disclosure Features

Much of the structure of pay ratio disclosure remained parallel with last year. Approximately 60 percent of companies made reference to the prior-year disclosure in some way. However, only about 15 percent of these companies cited last year’s pay ratio, CEO pay or median employee pay. The location of the pay-ratio disclosure within the proxy statement was nearly identical, with more than 90 percent of the disclosures being within or after the compensation tables. The inclusion of non-discriminatory benefits (i.e., benefits such as health insurance that are provided to all employees and are not included in CEO pay in the SCT) in the CEO and median employee pay calculation remained steady, with an estimated 14 percent of companies including non-discriminatory benefits in the calculation this year, compared with approximately 13 percent of the S&P 500 last year. Including these non-discriminatory benefits in both pay calculations deflates CEO pay ratio as the proportion of pay this makes up is systematically larger for the median employee than for the CEO. The measurement date used, adjustments to employee compensation (cost of living, annualizing compensation), use of a comparability disclaimer and statistical sampling were all very stable as well, with only a handful of companies adopting or removing these features. The use of supplemental ratios, descriptors of the median employee, and exemptions from the employee population had more varied disclosures when compared to prior year.

Supplemental ratios

Supplemental ratios were disclosed at roughly the same rate year-over-year, with approximately 10 percent of companies providing a supplemental ratio. One supplemental ratio is by far the most prevalent practice. Using an alternate CEO compensation calculation continued to be the most prevalent (63%) driver of disclosing a supplemental ratio. Where this feature differed was in the consistency of individual companies between last year and this year. If the supplemental ratio was disclosed in order to explain a one-time event (e.g. special equity award, CEO transition) then that company would likely not have a supplemental ratio for this year. If the company used a supplemental ratio to show an alternate CEO compensation amount (e.g. exclude pension value) or an alternate employee demographic (e.g. exclude non-U.S. employees), then the supplemental ratio was almost always disclosed again.

Description of Median Employee

This year’s sample of early filers saw a slight uptick in the percentage of companies (16%) that provided any description of their median employee compared to last year’s early-filer sample (12%) and the S&P 500 (14%). These descriptions vary in detail but often provide insights into who the median employee is. Geographic location of employment (76%) and the role within the company (48%) are the two most common descriptors, but these are often paired and/or supplemented with detail around employment type (full-time versus part-time) and pay type (salaried versus hourly).

Exemptions from Employee Population

Similar to the use of supplemental ratios, the use of exemptions from the employee population when determining the median employee remained consistent (~37%) between last year and this year. Applying multiple exemptions is not uncommon (~20%), and the De Minimis exemption, whereby a company may exclude up to 5 percent of its non-U.S. employee workforce, continues to be the most commonly (64%) used case. Other exclusions included not considering employees gained from mergers and acquisitions (M&A) activity (33%), contractors (19%) and employees on a leave of absence (5%). When companies did not make the same exemptions again this year, either the company’s non-U.S. portion of its employee population is now over 5 percent, or an M&A event did not occur.

Looking Forward

Overall, the CEO pay ratio did not change materially at median. However, a closer look at the company-matched data shows that significant volatility in the CEO pay ratio occurred at individual companies. While there has not yet been a significant increase in supplemental disclosures outside of the proxy statement or additional disclosures about the median employee, such information may be disclosed more frequently in the future as pressure mounts from shareholders and institutional investors. Looking beyond the CEO pay ratio disclosure itself, shareholders and institutional investors definitely want more disclosure about companies’ human capital. Whether this information is provided through the CEO pay ratio disclosure or elsewhere remains to be seen.


Appendix

Year 2 vs Year 1 – Same Company Data

Overview – Total Sample

CEO Pay Ratio

2017

2018

% Change

Summary Statistics (n=201)

Maximum

2483x

2508x

+1%

90th Percentile

341x

301x

-12%

75th Percentile

165x

165x

0%

Median

79x

78x

-1%

25th Percentile

40x

40x

+1%

10th Percentile

18x

20x

+13%

Minimum

2x

3x

+47%

CEO Pay

2017

2018

% Change

Summary Statistics (n=201)

Maximum

$42,247,984

$129,499,005

+207%

90th Percentile

$15,845,991

$15,695,189

-1%

75th Percentile

$10,253,787

$9,989,992

-3%

Median

$5,060,220

$5,422,777

+7%

25th Percentile

$2,347,314

$2,726,774

+16%

10th Percentile

$1,072,999

$1,333,951

+24%

Minimum

$339,165

$306,000

-10%

Median Employee Pay

2017

2018

% Change

Summary Statistics (n=201)

Maximum

$964,005

$256,300

-73%

90th Percentile

$123,347

$118,209

-4%

75th Percentile

$83,153

$86,046

+3%

Median

$59,092

$61,782

+5%

25th Percentile

$45,409

$47,252

+4%

10th Percentile

$34,967

$35,724

+2%

Minimum

$4,828

$4,563

-5%

Overview – Disclosure Features

Makes Any Reference to Year 1 Disclosure

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Yes

117

58%

No

84

42%

Mentions Year 1 Pay Ratio, CEO Pay, or Median EE Comp

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Yes

31

15%

No

170

85%

Uses Same Median Employee as Year 1

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Yes

73

36%

No – Reran Analysis

105

52%

No – Used Similar Employee as Year 1

23

11%

Discloses Change(s) in Methodology from Year 1

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Yes

3

1%

No

198

99%

CEO Pay & Median Employee Pay Movement from Year 1

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Both Increase

91

45%

CEO Pay Increased & Median Employee Pay Decreased

29

14%

CEO Pay Decreased & Median Employee Pay Increased

52

26%

Both Decrease

29

14%

Overview – Companies Choosing To Use The Same Median Employee

CEO Pay Ratio

2017

2018

% Change

Summary Statistics (n=73)

Maximum

1830x

1511x

-17%

75th Percentile

157x

147x

-6%

Median

90x

84x

-7%

25th Percentile

45x

44x

-3%

Minimum

10x

7x

-30%

CEO Pay

2017

2018

% Change

Summary Statistics (n=73)

Maximum

$42,247,984

$129,499,005

+207%

75th Percentile

$10,845,759

$9,793,261

-10%

Median

$5,060,220

$5,658,238

+12%

25th Percentile

$2,926,176

$2,828,289

-3%

Minimum

$545,525

$607,332

+11%

Median Employee Pay

2017

2018

% Change

Summary Statistics (n=73)

Maximum

$186,172

$191,473

+3%

75th Percentile

$80,186

$85,704

+7%

Median

$59,092

$62,150

+5%

25th Percentile

$46,370

$50,226

+8%

Minimum

$5,237

$6,348

+21%

Overview – Companies Selecting a New Median Employee

CEO Pay Ratio

2017

2018

% Change

Summary Statistics (n=128)

Maximum

2483x

2508x

+1%

75th Percentile

172x

186x

+8%

Median

76x

73x

-4%

25th Percentile

33x

36x

+10%

Minimum

2x

3x

+47%

CEO Pay

2017

2018

% Change

Summary Statistics (n=128)

Maximum

$31,082648

$29,118,118

-6%

75th Percentile

$10,030,633

$10,168,771

+1%

Median

$4,933,902

$5,172,842

+5%

25th Percentile

$2,175,523

$2,662,381

+22%

Minimum

$339,165

$306,000

-10%

Median Employee Pay

2017

2018

% Change

Summary Statistics (n=128)

Maximum

$964,005

$256,300

-73%

75th Percentile

$84,883

$86,046

+1%

Median

$58,659

$60,726

+4%

25th Percentile

$44,980

$44,974

-0%

Minimum

$4,828

$4,563

-5%

How Pay and Pay Ratio Changed – Total Sample

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased

100

50%

Decreased

96

48%

Remained the Same

5

2%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased

119

59%

Decreased

81

40%

Remained the Same

1

0%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased

143

71%

Decreased

58

29%

Remained the Same

0

0%

How Pay and Pay Ratio Changed – Total Sample

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased by 25% or more

39

19%

Increased by 10% to 25%

30

15%

Increased by 3% to 10%

22

11%

Changed between -3% to 3%

24

12%

Decreased by 3% to 10%

19

9%

Decreased by 10% to 25%

43

21%

Decreased by 25% or more

24

12%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased by 25% or more

42

21%

Increased by 10% to 25%

39

19%

Increased by 3% to 10%

28

14%

Changed between -3% to 3%

24

12%

Decreased by 3% to 10%

17

8%

Decreased by 10% to 25%

28

14%

Decreased by 25% or more

23

11%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Increased by 25% or more

11

5%

Increased by 10% to 25%

34

17%

Increased by 3% to 10%

66

33%

Changed between -3% to 3%

46

23%

Decreased by 3% to 10%

23

11%

Decreased by 10% to 25%

12

6%

Decreased by 25% or more

9

4%

How Pay and Pay Ratio Changed – Companies Choosing To Use The Same Median Employee

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased

27

37%

Decreased

43

59%

Remained the Same

3

4%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased

42

58%

Decreased

31

42%

Remained the Same

0

0%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased

61

84%

Decreased

12

16%

Remained the Same

0

0%

How Pay and Pay Ratio Changed – Companies Choosing To Use The Same Median Employee

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased by 25% or more

11

15%

Increased by 10% to 25%

5

7%

Increased by 3% to 10%

7

10%

Changed between -3% to 3%

10

14%

Decreased by 3% to 10%

8

11%

Decreased by 10% to 25%

18

25%

Decreased by 25% or more

14

19%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased by 25% or more

13

18%

Increased by 10% to 25%

11

15%

Increased by 3% to 10%

11

15%

Changed between -3% to 3%

10

14%

Decreased by 3% to 10%

8

11%

Decreased by 10% to 25%

9

12%

Decreased by 25% or more

11

15%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=73)

Increased by 25% or more

6

8%

Increased by 10% to 25%

13

18%

Increased by 3% to 10%

33

45%

Changed between -3% to 3%

12

16%

Decreased by 3% to 10%

4

5%

Decreased by 10% to 25%

5

7%

Decreased by 25% or more

0

0%

How Pay and Pay Ratio Changed – Companies Selecting a New Median Employee

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased

73

57%

Decreased

53

41%

Remained the Same

2

2%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased

77

60%

Decreased

50

39%

Remained the Same

1

1%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased

82

64%

Decreased

46

36%

Remained the Same

0

0%

How Pay and Pay Ratio Changed – Companies Selecting a New Median Employee

How Did Pay Ratio Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased by 25% or more

28

22%

Increased by 10% to 25%

25

19%

Increased by 3% to 10%

15

12%

Changed between -3% to 3%

14

11%

Decreased by 3% to 10%

11

9%

Decreased by 10% to 25%

25

19%

Decreased by 25% or more

10

8%

How Did CEO Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased by 25% or more

29

23%

Increased by 10% to 25%

28

22%

Increased by 3% to 10%

17

13%

Changed between -3% to 3%

14

11%

Decreased by 3% to 10%

9

7%

Decreased by 10% to 25%

19

15%

Decreased by 25% or more

12

9%

How Did Median Employee Pay Change?

 

Prevalence

 

Percentage

Summary Statistics (n=128)

Increased by 25% or more

5

4%

Increased by 10% to 25%

21

16%

Increased by 3% to 10%

33

26%

Changed between -3% to 3%

34

27%

Decreased by 3% to 10%

19

15%

Decreased by 10% to 25%

7

5%

Decreased by 25% or more

9

7%

Early Disclosures Year 2 vs Year 1

Overview – Total Sample

CEO Pay Ratio

Revenue

($mm)

CEO Pay

Median Employee Pay

Pay Ratio

Number of Employees

Summary Statistics (n=201)

Maximum

$170,756

$129,499,005

$256,300

2508x

350,600

90th Percentile

$19,167

$15,695,189

$118,209

301x

52,131

75th Percentile

$6,946

$9,989,992

$86,046

165x

17,521

Median

$2,138

$5,422,777

$61,782

78x

5,148

25th Percentile

$587

$2,726,774

$47,252

40x

1,382

10th Percentile

$152

$1,333,951

$35,724

20x

511

Minimum

$24

$306,000

$4,563

3x

19

Year 1 Early Disclosures:

CEO Pay Ratio

Revenue

($mm)

CEO Pay

Median Employee Pay

Pay Ratio

Number of Employees

Summary Statistics (n=300)

Maximum

$213,395

$113,572,988

$580,335

5463x

364,575

90th Percentile

$22,014

$16,179,146

$144,886

325x

51,370

75th Percentile

$7,033

$10,608,763

$95,149

171x

16,960

Median

$1,879

$5,302,622

$60,823

80x

3,964

25th Percentile

$409

$2,465,703

$45,349

32x

937

10th Percentile

$127

$969,417

$34,082

15x

271

Minimum

$0

$0

$2,526

1x

13

Location in Proxy Statement

Placement In Proxy

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Before CD&A

1

0%

Within CD&A

10

5%

Directly Before Compensation Tables

7

3%

Within Compensation Tables

43

21%

After Compensation Tables

140

70%

Year 1 Early Disclosures:

Placement In Proxy

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Before CD&A

1

0%

Within CD&A

14

5%

Just Prior To or Within Compensation Tables

71

24%

Following “Potential Payments Upon Termination” Section

214

71%

Supplemental Ratios

Supplemental Ratios

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Companies Disclosing a Supplemental Ratio

19

9%

Companies Not Disclosing a Supplemental Ratio

182

91%

Supplemental Ratios – How Many

 

Prevalence

 

Percentage

Summary Statistics (n=19)

Companies Disclosing One Supplemental Ratio

18

95%

Companies Disclosing More Than One Supplemental Ratio

1

5%

Year 1 Early Disclosures:

Supplemental Ratios

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Companies Disclosing a Supplemental Ratio

32

11%

Companies Not Disclosing a Supplemental Ratio

268

89%

Supplemental Ratios

 

Prevalence

 

Percentage

Summary Statistics (n=32)

Companies Disclosing One Supplemental Ratio

27

84%

Companies Disclosing More Than One Supplemental Ratio

5

16%

Supplemental Ratios – Rationale

 

Prevalence

 

Percentage

Summary Statistics (n=19)

Alternate CEO Compensation Calculation

12

63%

Alternate Employee Compensation Calculation

2

11%

Alternate CEO and Employee Compensation Calculation

1

5%

Alternate Employee Demographic

2

11%

Both Change Compensation Calculation and Employee Demographic

0

0%

Multiple Reasons

2

11%

Supplemental Ratios – Rationale

 

Prevalence

Summary Statistics

Alternate CEO Compensation Calculation

13

Alternate Employee Compensation Calculation

4

Alternate CEO and Employee Compensation Calculation

2

Alternate Employee Demographic

3

Both Change Compensation Calculation and Employee Demographic

0

Year 1 Early Disclosures:

Supplemental Ratios – Rationale

 

Prevalence

 

Percentage

Summary Statistics (n=32)

Alternate CEO Compensation Calculation

17

53%

Alternate Employee Compensation Calculation

1

3%

Alternate CEO and Employee Compensation Calculation

6

19%

Alternate Employee Demographic

4

13%

Both Change Compensation Calculation and Employee Demographic

4

13%

Measurement Date / Month

Measurement Date

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Last Day of Q4

103

51%

First Day of Q4

30

15%

Other

61

30%

Not Disclosed

7

3%

Measurement Month

 

Prevalence

 

Percentage

Summary Statistics (n=201)

First Month of Quarter

54

27%

Second Month of Quarter

17

8%

Last Month of Quarter

123

61%

Not Disclosed

7

3%

Year 1 Early Disclosures:

Measurement Date

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Last Day of Q4

141

47%

First Day of Q4

50

17%

Other

94

31%

Not Disclosed

15

5%

Measurement Month

 

Prevalence

 

Percentage

Summary Statistics (n=300)

First Month of Q4

86

29%

Second Month of Q4

23

8%

Last Month of Q4

176

59%

Not Disclosed

15

5%

Exemptions From Employee Population

Exemptions From Employee Population

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Disclosed Utilizing Exemptions

75

37%

No Disclosure About Utilizing Exemptions

126

63%

Year 1 Early Disclosures:

Exemptions From Employee Population

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Disclosed Utilizing Exemptions

106

35%

No Disclosure About Utilizing Exemptions

194

65%

Exemptions From Employee Population – Rationale

 

Prevalence

 

Percentage

Summary Statistics (n=75)

Geographic (De Minimis)

36

48%

Do Not Set Group of Employees Pay

8

11%

Merger / Acquisition(s)

13

17%

Employees on Leave of Absence

3

4%

Multiple Reasons

15

20%

Exemptions From Employee Population – Rationale

 

Prevalence

 

Percentage

Summary Statistics (n=75)

Geographic (De Minimis)

48

64%

Do Not Set Group of Employees Pay

14

19%

Merger / Acquisition(s)

25

33%

Employees on Leave of Absence

4

5%

Year 1 Early Disclosures:

Exemptions From Employee Population – Rationale

 

Prevalence

 

Percentage

Summary Statistics (n=106)

Geographic (De Minimis)

56

53%

Do Not Set Group of Employees Pay

9

8%

Merger / Acquisition(s)

11

10%

Multiple Reasons

21

20%

Other

9

8%

Description of Median Employee

Description of Median Employee

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Disclosure Includes A Description of Median Employee

33

16%

Disclosure Does Not Include A Description of Median Employee

168

84%

Type of Description

 

Prevalence

 

Percentage

Summary Statistics (n=33)

Geographic Location of Employment Only

7

21%

Employment Type (Full-time, part-time, etc.) Only

0

0%

Pay Type (Salary, hourly, etc.) Only

0

0%

Role Only

4

12%

Compensation Detail Only

2

6%

Multiple Descriptors

20

61%

Type of Description

 

Prevalence

 

Percentage

Summary Statistics (n=33)

Geographic Location of Employment

25

76%

Employment Type (Full-time, part-time, etc.)

13

39%

Pay Type (Salary, hourly, etc.)

10

30%

Role

16

48%

Compensation Detail

8

24%

Year 1 Early Disclosures:

Describes Median Employee

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Disclosure Includes A Description of Median Employee

35

12%

Disclosure Does Not Include A Description of Median Employee

265

88%

Adjustments to Employee Compensation

Cost of Living Adjustments

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Utilized COLA For Median Employee Pay

1

0%

Did Not Utilize COLA For Median Employee Pay

52

26%

Silent

148

74%

Annualized Employee Compensation

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Annualized Employee Compensation per CACM

84

42%

Did Not Annualize Employee Compensation per CACM

30

15%

Silent

87

43%

Year 1 Early Disclosures:

Cost of Living Adjustments

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Utilized COLA For Median Employee Pay

3

1%

Did Not Utilize COLA For Median Employee Pay

95

32%

Silent

202

67%

Annualized Employee Compensation

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Annualized Employee Compensation per CACM

132

44%

Did Not Annualize Employee Compensation per CACM

40

13%

Silent

128

43%

Comparability Disclaimer

Comparability Disclaimer

 

Prevalence

 

Percentage

Summary Statistics (n=201)

Disclosure Includes Disclaimer

56

28%

Disclosure Does Not Include Disclaimer

145

72%

Year 1 Early Disclosures:

Comparability Disclaimer

 

Prevalence

 

Percentage

Summary Statistics (n=300)

Disclosure Includes Disclaimer

80

27%

Disclosure Does Not Include Disclaimer

220

73%

CEO & Median Employee Compensation Includes Non-Discriminatory Benefits

Compensation Includes Non-Discriminatory Benefits?

 

Prevalence

 

Percentage

Summary Statistics (n=176)

Yes

25

14%

No

151

86%

Year 1 Subset of S&P 500:

Compensation Includes Non-Discriminatory Benefits?

 

Prevalence

 

Percentage

Summary Statistics (n=353)

Yes

45

13%

No

308

87%

Joshua Hovden and Stella Kovoros provided research assistance for this report.

The new disclosure of the CEO pay ratio in 2018 was met with a surprisingly muted response from the press and shareholders. Companies had been concerned that the CEO pay ratio would be used as a way to shame companies with high levels of CEO pay relative to the median worker, yet for the most part criticism of CEO pay was mild.

Near the end of 2018 however, institutional shareholders began to express greater interest in the CEO pay ratio from two directions:

  1. A group of 48 institutional investors recently sent a letter to many large companies requesting more robust disclosure about their workforces.
  2. The Office of the New York State Comptroller (NYSC) recently issued a press release stating that they have submitted shareholder proposals to several companies to incorporate considerations about the broader workforce into their CEO pay decision making and pay philosophy.

Shareholder Letter from 48 Institutional Investors

The group of institutional investors believe supplemental information will provide reference points for understanding the company’s workforce and will help investors put the pay ratio into context. Their perspective is that human capital is a critical asset of the company and that investors will benefit from a better understanding of a company’s approach to human capital management. The 48 companies are for the most part made up of unions and pension funds (e.g., CalPERS, NYSC, AFL-CIO) so their view may not be representative of other institutions (e.g. index funds, hedge funds, etc.). Supplemental disclosures cited as useful by these investors are largely focused on workforce demographics (i.e. use of seasonal workers, geographic locations, etc.), median employee detail (i.e. job function, education levels, etc.) and the company’s overall compensation philosophy. The letter acknowledges that some of this information has already been voluntarily disclosed by companies and some may be available elsewhere.

New York State Comptroller Proposal

Based on the NYSC’s press release, companies responding and reaching agreement with the NYSC in 2018 are CVS Health, Macy’s, Microsoft, Salesforce.com, The TJX companies; companies reaching agreement in 2017 are BB&T, Discovery Communications and Regeneron Pharmaceuticals. The NYSC withdrew the proposals after the companies agreed to reexamine their CEO and executive pay and adopt policies that take into account the compensation of the rest of their workforces. The proxy disclosure for two of these companies, CVS Health and Discovery Communications, provided more robust disclosure around CEO pay ratio than what is typically seen, such as enhancements to employee base pay/benefits and pay considerations for their global workforce. It is unclear if there are other pending shareholder proposals from the NYSC on this topic.

Current CEO Pay Disclosure Practice

Very few companies currently provide the kind of supplemental disclosures requested by the institutional investors. With approximately 90% of the S&P 500 having disclosed 2018 CEO pay ratios at this point, Compensation Advisory Partners researched the prevalence of the requested information. Among the S&P 500, only about 25% of companies disclosed any specific geographic information on their employee population as part of the pay ratio disclosure. This was primarily discussed as the number of U.S. employees versus non-U.S. employees or in the context of the de minimis exemption, where companies can exclude up to 5% of the non-U.S. employee workforce. Further, the type of workers employed by the companies (i.e. seasonal, part-time, temporary, etc.) was typically disclosed with minimal detail on the relative size of the employee populations. Only 1% disclosed a headcount of part-time employees and a minority of companies provided context around their workforce demographics.

Median employee detail was included in a minority of disclosures, with 14% providing any detail at all. The most common disclosure (85%) provided was the geographic location of the median employee’s employment. Employment/pay type (full/part time, salaried/hourly) was also prevalent; approximately two-thirds and one-third of these disclosures included this information, respectively. Half of the companies providing median employee detail gave information on the role of the median employee, often related to job title, job function, or place of employment (e.g. factory). Incentive compensation eligibility, education level, and compensation mix were rarely provided, with less than 5% of companies sharing such detail.

Detail on Median Employee

Type of Description

Prevalence of Disclosure

Median Employee

62 of 446 (14%)

Geographic Location of Employment

53 of 62 (85%)

Employment Type (full/part time)

41 of 62 (66%)

Pay Type (salaried/hourly)

23 of 62 (37%)

Role (job title or type of work)

30 of 62 (48%)

Bonus Eligibility (eligible/non-eligible)

3 of 62 (5%)

Equity Eligibility (eligible/non-eligible)

1 of 62 (2%)

Compensation Mix

2 of 62 (3%)

Looking Forward

We do not expect that many companies will significantly expand their disclosures around workforce demographics in 2019 proxy statements. We think that what these shareholders are requesting would require fundamental change to the CEO pay ratio disclosure and is substantially different from the original intent of the CEO pay ratio. For the most part, we expect the information disclosed to remain consistent with what companies provided in 2018, with any changes in disclosure being modest (e.g. how many companies will exercise the option of reusing the same median employee, will they provide a comparison of the 2019 pay ratio to the 2018 pay ratio).

Looking beyond 2019, companies should recognize that there is an appetite among some of the larger institutional investors for greater information on the makeup of a company’s human capital. We suspect that the requests in these shareholder letters, combined with some of the requests in shareholder proposals around gender pay equity, may serve as a basis for new legislation from the Democratic majority in the House of Representatives requiring disclosure of workforce demographics and pay equity statistics. While any proposed legislation is unlikely to become law before 2021, we expect that shareholder requests for additional information may evolve from a letter into actual shareholder proposals similar to those submitted by the NYSC.

Beginning with fiscal years ending on or after December 31, 2017, companies are required to disclose the ratio that compares the compensation of the CEO to the compensation of the median employee (pay ratio). This disclosure was part of the Dodd-Frank Wall Street Reform and Consumer Protection Act signed into law in 2010.

Compensation Advisory Partners LLC (CAP) researched early pay ratio disclosures. As of March 9, 2018, we obtained pay ratios from 150 companies with a median revenue of $2.1B from a cross-section of industries.

Pay Ratio

The median pay ratio disclosed by these companies is 87x. The lowest ratio is 1x (Apollo Global Management, Dorchester Minerals and The Carlyle Group) and the highest ratio is 1465x (Fresh Del Monte Produce Inc.).

Summary Statistics

Median Employee Pay

Median CEO Pay

Pay Ratio

75th percentile

$88,612

$10.5M

172x

Median

$58,256

$5.6M

87x

25th percentile

$43,966

$2.5M

36x

As expected, the pay ratio correlates with company size, with larger companies disclosing higher ratios. CEO pay varies greatly depending on the size and complexity of the organization. Employee pay has less variability since it reflects the job function and does not vary significantly based on the size of the organization. The median ratio in our sample of 150 companies ranges from 20x for companies with revenue less than $500M to 218x for companies with revenue greater than $15B.

20x 54x 84x 157x 183x 218x <$500M $500M-$1B $1B-$5B $5B-$10B $10B-$15B >$15B Median Pay Ratio by Revenue Size

Few companies, 15, disclose a supplemental pay ratio with only a handful of companies (three) disclosing more than one additional ratio. These companies with supplemental ratios are typically adjusting the CEO’s pay which may exclude anomalies such as a one-time special bonus or equity award. Interestingly, three companies disclosed a higher supplemental pay ratio likely to provide context for a large year over year increase in the 2019 proxy statement.

Location of Disclosure

Nearly 70% of companies disclose the pay ratio after the Potential Payments upon Termination or Change in Control section of the proxy statement. Approximately 25% of companies disclose the pay ratio just before or after the Summary Compensation Table and a small minority, 5%, disclose it in the Compensation Discussion and Analysis (CD&A).

Pay ratio is typically not disclosed in the CD&A, signaling to shareholders that the pay ratio is not used to determine CEO pay levels. Additionally, around 25% of companies include language in the disclosure that the ratio should not be used to compare pay levels to other companies within the industry, region of the country or revenue size.

Measurement Date

The SEC’s final rules give companies the flexibility to use any date within the last quarter of the fiscal year to identify the median employee. Companies most commonly used the last day of the fiscal year or a date within the last month of Q4. It is also common for companies to use a day within the first month of Q4 to identify the median employee.

Measurement Month

Prevalence

Measurement Date

Prevalence

First Month of Q4

29%

Last day of Q4

44%

Second Month of Q4

8%

First day of Q4

17%

Third Month of Q4

57%

Other

33%

Not Disclosed

6%

Not Disclosed

6%

Exclusions from Median Employee Determination

Approximately one-third of companies excluded a portion of their workforce when determining the median employee. The most common rationale is the de minimis exemption (approximately 55%) whereby a company can exclude up to 5% of its non-U.S. employee workforce. Companies also commonly cited an acquisition or corporate not responsible for setting pay (e.g., independent contractors) as rationales for excluding certain employee groups.

Conclusion

As more companies continue to file their proxy statements in the coming weeks, we will likely see larger pay ratios, particularly as companies with a significant part-time workforce begin to disclose their ratios. We do not anticipate an increasing trend in the number of companies filing supplemental pay ratios though it will be interesting to see the rationale for those that do. We expect to continue to see companies placing the pay ratio outside of the CD&A with most disclosing it after the Potential Payments upon Termination or Change in Control section.

Compensation Advisory Partners (CAP) reviewed executive compensation pay levels and trends at 50 companies (Early Filers) that filed their most recent proxy statement between November 2017 and January 2018 (fiscal year ends from July 2017 to October 2017; 35 companies have September 30 fiscal year ends). Industry sectors reviewed include: Consumer Discretionary, Consumer Staples, Financials, Health Care, Industrials, Information Technology and Materials. Among these 50 companies, median Revenue was $7.5B, median Market Capitalization (based on each company’s fiscal year-end) was $13.0B and 1-year Total Shareholder Return, or TSR (based on each company’s fiscal year-end) was 19.3%.

Overall Findings

Performance: 2017 performance (based on Revenue growth, EBIT growth, EPS growth and 1-year TSR) was strong. Revenue and EBIT grew by approximately 6%, EPS was up 4% and TSR was up nearly 20% vs. prior year.

CEO Pay: Median CEO pay increased slightly by 3.3% mainly driven by actual annual incentive payouts. The grant date value of long-term incentives (LTI) was generally flat.

Annual Incentive Payout: Overall, the median 2017 annual incentive payout was 115% of target, reflective of strong financial performance.

2017 Performance

CAP reviewed Revenue growth, EBIT growth, EPS growth and TSR performance for the Early Filer and the S&P 500 companies. Overall, 2017 median performance for Early Filers was strong. Revenue and EBIT grew approximately 6%, EPS grew around 4% and TSR was up nearly 20%. TSR among the Early Filers showed double-digit growth for the second year in a row; this growth is due to strong financial performance as well as market expectations around tax reform in light of the current political climate.

Financial Metric (1)

2016 Median 1-year Performance

2017 Median 1-year Performance

S&P 500

Early Filers

S&P 500

Early Filers

Revenue Growth

2.1%

2.0%

6.3%

5.7%

EBIT Growth

2.2%

7.6%

6.6%

6.0%

EPS Growth

4.2%

5.2%

9.9%

3.9%

TSR

3.3%

18.4%

17.0%

19.3%

(1) TSR and Financial performance for the S&P 500 is as of September 30, 2016 and September 30, 2017. Financial performance and TSR for Early Filers is as of each company’s fiscal year end.

CEO Total Direct Compensation

Among Early Filers with CEOs in their role for at least two years (n=39), median total direct compensation increased 3.3%. This increase was mainly due to higher actual annual incentive payouts in 2017; the grant-date value of LTI was generally flat year over year. Actual annual incentive payout was up nearly 4% reflective of strong financial performance while LTI, the largest component of CEO pay, was up only 1%. Median base salary for CEOs in our sample was unchanged from 2016.

3.3% 0.6% 6.2% 3.8% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0% 1-Year Median Change in CEO Compensation Actual Annual Incentive Actual Total Cash Grant-Date LTI Value Total Comp

Annual Incentive Plan Payout

The median actual annual incentive payout in 2017 was 115% of target, higher than the median payout in 2016 of 106% of target. In fact, the 25th percentile bonus payout in 2017 was at target, noticeably higher than last year (86% of target).

Summary Statistics

Annual Incentive Payout as a % of Target

2015

2016

2017

75th Percentile

134%

141%

147%

Median

106%

106%

115%

25th Percentile

97%

86%

100%

Performance for companies with at or above target annual incentive payouts was substantially stronger than that of companies with below target payouts. Companies with payouts at or above target had strong EPS (10.9%) and TSR (23.2%) growth and solid Revenue (6.3%) and EBIT (7.2%) growth. Performance for companies with below target payouts was flat or declining from prior year.

Financial Metric (1)

2016 Median 1-year Performance

2017 Median 1-year Performance

Below target payout (n=21)

At/above target payout (n=29)

Below target payout (n=12)

At/above target payout (n=38)

Revenue Growth

(0.7%)

3.0%

2.1%

6.3%

EBIT Growth

(2.8%)

15.9%

1.0%

7.2%

EPS Growth

(3.9%)

16.9%

(4.3%)

10.9%

TSR

16.9%

19.6%

(3.9%)

23.2%

(1) Financial performance and TSR is as of each company’s fiscal year end.

76% of companies in 2017 provided a payout at or above target which is considerably higher than 2016 and 2015 (58% and 62%, respectively). In 2017, significantly more companies provided a payout between 100 – 150% of target than below target. This distribution is more evenly split in prior years. The distribution of payouts in 2017 aligns with stronger overall performance than 2016 and 2015.

8% 10% 8% 30% 32% 16% 42% 38% 54% 20% 20% 22% 2015 2016 2017 Annual Incentive Payout as a Percentage of Target < 50% 50% - 100% 100% - 150% > 150%

Incentive Plan Design

Among Early Filers, 75% of companies use 2 – 3 financial metrics in the annual incentive plan and nearly 83% use 1 – 2 measures in the LTI plan.  Metrics in the annual incentive plan typically focus on growth and profitability, while LTI plans are more likely to reward executives based on profits, return measures or stock price performance. A growing number of companies are beginning to use non-financial strategic goals, primarily diversity and inclusion and creating a more engaged workforce, in the annual incentive plan design. With the recent amendment to 162(m) due to the Tax Cuts and Jobs Act, we anticipate more companies will use strategic measures and individual objectives to reward executives in the future.

As performance-based compensation continues to be championed by both shareholders and proxy advisory firms, the use of performance-based LTI continues to be very prevalent. Performance plan usage remains high, at 90% of Early Filers. Option use declined among the Early Filers (54% down from 62%) and shifted to use of restricted stock.

86% 66% 62% 54% 30% 16% 90% 76% 54% 52% 34% 14% Perf Awards Time-basedRS/RSU Stock Options 2 Vehicles 3 Vehicles 1 Vehicle LTI Prevalence 2016 2017 Vehicle Prevalence Vehicle Mix

TSR continues to be the most prevalent LTI metric, with approximately 60% of companies using a performance-based plan with this metric. Of the companies that use TSR, 25% use it as a modifier, 50% use it as a stand-alone metric in conjunction with a financial measure and 25% use it as the sole measure. The prevalence of TSR as the sole measure has decreased somewhat over the last several years as companies use a balanced approach to reward executives for long-term financial and stock price results. We anticipate its usage as a sole measure to plateau or continue to decline particularly given ISS’ recent shift towards the use of other financial measures in its quantitative pay for performance assessment (ISS and Glass Lewis Policy for the 2018 Proxy Season).

Governance Practices

Over the last decade, many companies adopted good governance practices. Increased scrutiny from shareholders and proxy advisory firms has quickened the pace with which companies incorporated clawback, or recoupment, policies as well as hedging and pledging policies. It is no surprise that more than 90% of companies in our sample have a clawback policy in place. 85% of companies also have implemented hedging and pledging policies for their executives.

Nearly all companies (96%) in our sample have stock ownership guidelines in place; these guidelines encourage executives to hold a meaningful equity stake and align with shareholder interests. The guideline is most commonly expressed as a multiple of salary, with a median CEO multiple of 5x base salary and other NEOs with a multiple of 3x base salary. About one-third of companies also require executives to hold stock (typically 50 – 100% of net shares received) until stock ownership guidelines are met. It is less common for companies to require executives to hold shares for a period of time (e.g., 1 year) in lieu of stock ownership guidelines. Good governance practices continue to be a focus of shareholders, and companies are routinely implementing and updating policies as appropriate in the current regulatory environment.

Conclusion

2017 was a year of strong financial performance for the Early Filers, which resulted in above target annual incentive payouts for approximately 75% of companies. CEO actual total cash compensation increased by 6%, and when combined with generally flat LTI award values, total pay increased by 3%.

2018 will be the first performance year after the passage of tax reform. We do not expect companies to unwind their use of performance-based pay and good governance practices, yet we foresee greater use of individual and strategic performance measures, along with increased use of discretionary pay decisions, in moderation.


For questions or more information, please contact:

Lauren Peek Principal
lauren.peek@capartners.com 212-921-9374

Joanna Czyzewski Associate
joanna.czyzwski@capartners.com 646-486-9746

Melissa Burek Partner
melissa.burek@capartners.com 212-921-9354

Highlights

Requirements of the SEC’s Final Rules:

Disclosure of

  1. the median of the annual total compensation of all employees, excluding the Principal Executive Officer (“PEO”), defined as A;
  2. the annual total compensation of the PEO, defined as B;
  3. the ratio of the amount in B to the amount in A, where A equals one, or alternatively, expressed narratively as a multiple

Example:

If A equals $50,000 and B equals $2,500,000, the pay ratio may be described as either “50 to 1” or “50:1” or the company may disclose that “the PEO’s annual total compensation is 50 times that of the median annual total compensation of all employees.”

Timing:

  • Reporting required for the first full fiscal year beginning on or after January 1 2017.
  • For calendar year companies, this means the proxy statement for the 2018 Annual Meeting

Exclusions: Smaller reporting companies, foreign private issuers, MJDS filers, and emerging growth companies

Assessing the Size and Scope of the Task:

The size and complexity of the task of preparing pay ratio disclosure will vary greatly from company to company. Factors such as the number of employees, their location and the integration of payroll and HRIS systems will determine the amount of work involved.

Complexity of Pay Ratio Disclosure and Information Gathering

Less Complex

More Complex

Smaller number of employees

Larger number of employees

Full-time employees only

Mix of full-time, part-time, temporary or seasonal workers

US only

Multiple international locations

Single corporate registrant with no consolidated subsidiaries

One or more consolidated subsidiaries in addition to corporate registrant

Single HRIS/payroll system

Multiple HRIS/payroll systems

Compensation plans limited to salary, cash bonus and equity

Additional compensation plans, such as commissions or multiple incentive plans and “spot” bonuses housed in different systems

Retirement plans limited to defined contribution plans

Defined benefit pension plan and/or company contributions to non-qualified deferred compensation plans

Limited perks

Extensive perks

Advance Planning

We strongly advise companies to begin the process early, particularly if your company’s situation is “more complex.” In these cases, we advise that you calculate the pay ratio during the last three months of 2016 – a full year in advance. This will give you an opportunity to clearly identify where the data will come from, how the data will be obtained and what type of assumptions must be made.

It will also allow plenty of time to craft the required disclosure language, evaluate any repercussions and communicate it to interested parties – including HR leadership, senior management and the Compensation Committee.

Pay Ratio Disclosure Flow Chart Project Planning Identifying the Median Employee: Take a First Pass Assess Flexibility Permitted Under the Rules • Exclusions Data PrivacyDe Minimus • Adjustments COLAAnnualization • Statistical Sampling Prepare Final Calculations Draft the Disclosure • Methodology • Assumptions • Supplemental Information Communicate Internally and Externally • Management • Board of Directors • Shareholders • Employees 1 2 3 4 5 6

Overview of the Implementation Process

CAP recommends that companies adopt an implementation process that encompasses six phases:

Phase I: Project Planning

  1. Confirm that your company is required to provide pay ratio disclosure. Make sure your company is not in one of the excluded categories where pay ratio disclosure is not required.
  2. Determine who “owns” the project. In most companies, we expect either HR, Legal or Finance staff to be responsible for preparing pay ratio disclosure.
  3. Identify internal resources. We expect most companies to establish a cross-functional team to complete this work. HR and Finance staff will benefit from assistance from Technology staff, particularly if multiple HRIS and payroll systems exist. A member of the Legal staff can help the team draft the text of the disclosure and coordinate with overall proxy preparation.
  4. Identify external resources. Decide whether the internal team charged with preparation of the pay ratio disclosure would benefit from partnering with outside resources. An outside consultant could provide the team with learnings gleaned from client situations and other experience. If multiple non-US locations are involved, the team will require expertise in data privacy laws, and a legal opinion will be required in certain circumstances.
  5. Create an inventory of data sources. Tally up the number of HRIS or payroll systems. Can you access a single integrated system or will you be forced to tap into multiple systems? Overlay the countries in which your company operates to ensure data source(s) for each country are identified. Obtain samples of the data fields that may be retrieved to begin the process of defining a methodology for identifying the median employee. The answer to these questions will be critical in determining whether to use statistical sampling, as well as identifying the pay elements that determine the median employee.
  6. Create a preliminary time line for the project. Coordinate with the schedule for overall proxy statement preparation. Allow sufficient time for communication to the various stakeholders.

Phase II: Identifying the Median Employee: Take a First Pass

  1. Chart the number and types of employees – full-time, part-time, temporary and seasonal — by country. Approximate as necessary to get a rough headcount. Reach out to your HR network as needed to fill in the blanks.
  2. Identify consolidated subsidiaries and include your best estimate of these employees in the preliminary headcount.
  3. Overlay basic compensation data on the preliminary headcount. Use what is most readily available from the payroll and HRIS systems – for example, the average amount, or the median, of annual cash compensation by location.
  4. Assuming your company’s PEO is paid in US dollars and international employees are part of the picture, convert the international compensation data into US dollars.
  5. Step back and analyze the data. Depending on degree to which employees are concentrated, either by category or by location, it may be obvious where the median employee resides.

Here is an example of employee counts for a major retailer with operations in the U.S., Europe and Canada. Keep in mind that the median employee will be the employee whose pay is higher than one-half of the pay of all employees and lower than the pay of the other half. With a total of 47,000 employees, the median employee at this company will be the employee whose pay is higher than 23,500 employees out of the total. The company in our example has a very large group of part-time employees who are store associate, including more than 27,000 such employees in the US. We know that the typical part-time employee in the US works 20 hours per week at an average rate of $12 per hour and annual compensation of about $12,000. Given the high concentration, of U.S. part-timers, we can conclude that in this company the median employee will almost certainly be found in the U.S. part-time category. While additional work is necessary, a picture begins to emerge.

Full Time Employees

Part-Time Employees

U. S.

12,665

27,285

Europe

1,788

3,852

Canada

447

963

Total

14,900

32,100

Estimate: 14,900 full-time employees + 8,600 U.S. part-time employees = Median (ranked 23,500 out of 47,000 total employees)

Naturally, each company will have a unique profile. Many companies may not have an obvious concentration of employees, so the preliminary estimates may not be predictive of the final result. But even in that case, the team will know that more work – and more precise data – will be necessary to complete the picture.

Phase III: Assess Flexibility under the Rules

  1. Determine if the Foreign Data Privacy Law exemption applies. Under this exemption companies are allowed to exclude employees residing in locations where data privacy laws or regulations prevent companies from complying without violating such data privacy laws or regulations.

    But the bar is high, since companies must make “reasonable efforts” to obtain the necessary data. Reasonable efforts include listing the excluded jurisdiction, identifying the specific law or regulation that prevents compliance, explaining how compliance violates the law or regulation, seeking an exemption or other relief and even obtaining a legal opinion from counsel. If you can create a list of the pay for each employee and not include any personally identifiable information (e.g., just number the employees without using their regular employee number), then you likely will have to include them in the calculation.

    We strongly urge clients to bring their privacy officer or legal counsel into the picture early to make this determination up front.

  2. Determine if the De Minimus exemption applies. This exemption allows companies to exclude non-U.S. employees if they account for 5% or less of total employees. If non-U.S. employees exceed 5% of the total U.S. and non-U.S. employees, up to 5% may be excluded. However if any non-U.S. employees are excluded from a particular jurisdiction, all non-U.S. employees in that jurisdiction must be excluded. Both the jurisdiction and the approximate number of employees excluded must be disclosed.
  3. If both exemptions are used, coordinate the two exemptions as required under the rules. When calculating the number of non-U.S. employees that may be excluded under the de minimis exemption, companies much count any non-U.S. employees excluded under the data privacy exemption. This number may exceed 5%, but if it does, the de minimis exemption may not be used to exclude additional non-U.S. employees. On the other hand, if the number of non-U.S. employees excluded under data privacy exemption is less than 5%, additional non-U.S. employees may be excluded under the de minimis exemption provided the total equals 5% or less and all employees in a given jurisdiction are excluded.
  4. Assess efficacy of using COLA adjustments. The final rules allow companies to adjust actual compensation amounts of non-U.S. employees to reflect COLA, or cost of living allowance adjustments. Assuming that the U.S. tends to be a relatively high cost jurisdiction, unadjusted wages in non-U.S. jurisdictions will trend lower, increasing the final pay ratio. Upward adjustments to non-U.S. wage rates will decrease the reported pay ratio – a desirable outcome for most companies

    But once again, meeting the requirements to take advantage of the allowed flexibility will be challenging. Before embarking on this path, companies need to determine if it is indeed worthwhile. Discuss pros and cons and whether additional disclosure is required.

  5. Determine whether to annualize cash compensation of permanent employees. Companies are allowed to correct for mid-year hires of permanent employees by annualizing compensation, but if the number of mid-year hires is small, this adjustment may not be worthwhile.
  6. Evaluate the pros and cons of using statistical sampling to identify the median employee. Remember that to perform valid statistical sampling, the underlying data must be reasonably comprehensive and accurate. In addition, statistical sampling complicates your disclosure, since disclosure of the methodology and your assumptions is required. Best use may be for companies with defined benefit pension plans, since total compensation will be impacted by age and years of service.
  7. Identify how you will measure compensation in a consistent fashion for purposes of identifying the median employee. The rules allow companies considerable flexibility to choose an appropriate methodology for identifying the median employee. Employers can select a methodology that makes sense for them. Reasonable estimates are allowed. In addition, the median employee can be selected by using any compensation measure, provided it is consistently applied. Furthermore, companies may use their actual population to select the median employee or use statistical sampling or any other reasonable method.
    While some companies will take advantage of these flexibilities, others will focus on their actual population and compensation levels. Since statistical sampling depends on valid data, it may not reduce the workload associated with preparing the calculations.
  8. Consider the pros and cons of using various dates within the last three months of the fiscal year. The rules allow employers to identify the median employee on any date within the last three months of the fiscal year. We expect that this decision will most often align with payroll dates when payroll data is used to measure compensation of the median employee.

Phase IV: Prepare Final Calculations

  1. Select a final date during last three months of the year for the calculation based on preliminary analysis.
  2. Obtain updated roster of employees by location as well as final compensation data. Make sure compensation data is consistently applied.
  3. Apply the various exemptions, adjustments and other methodologies reviewed and agreed on during Phases I – III. Review and confirm your methodology and document any assumptions.
  4. Identify the median employee and determine a set of other comparable employees in case of a change in status of the median employee. The rules allow companies to identify the median employee only once every three years. Over time, this will significantly reduce the cost of compliance. Interestingly, the rules require the identification of an actual employee as the median employee, rather than a range of employees or a hypothetical profile employee.

    The exception to the three-year rule involves instances where a change in the employee population or a change in employee compensation arrangements could reasonably result in a significant change in pay ratio disclosure. Assuming no significant changes, the company must calculate annual compensation of the median employee using the methodology for proxy disclosure, subject to reasonable estimates, for years one, two and three. If the median employee leaves the company or has anomalies in his or her compensation, the company may substitute a comparably situated employee.

  5. Evaluate any anomalies related to the PEO’s compensation. Two methodologies are available if turnover resulting in two incumbents during a single year occurs. Under the first approach, a company may add the total compensation reported in the Summary Compensation Table for the two incumbents. As an alternative, companies may annualize the compensation of the PEO in the position on the date selected to identify the median employee.
  6. Determine the final pay ratio. Test and retest. Get a final level of comfort with the data and the methodology.

Phase V: Draft the Disclosure

  1. Prepare a draft of pay ratio disclosure. For disclosure purposes, companies must describe the methodology used to identify the median employee and to determine total compensation and any material assumptions, adjustments (including any cost of living adjustments) or estimates.
  2. Consider whether disclosure of supplemental information would be beneficial. Final rules allow companies to disclose additional ratios or other information to supplement the final ratio. While this is not required, companies may find it beneficial. For example, a company with a large number of part-time or seasonal workers may want to disclose the ratio applicable to full-time employees.

Phase VI: Communicate Internally and Externally

  1. Communication of pay ratio disclosure will be important. The project team has a number of critical stakeholders in the communications process. Plan to communicate progress early and often. Schedule periodic check-ins with HR leaders and senior leadership during the analysis and review process. In addition, brief the board of directors, particularly the Compensation Committee. There is a high potential for negative publicity associated with pay ratio disclosure. Get in front of it and anticipate employee reactions to the disclosure. Provide talking points to the leadership team so that they can respond to employee concerns in a consistent manner.
  2. Talk to peers and outside advisors about trends in disclosure. As companies actually prepare disclosure, trends and best practices will crystallize. Tap into the knowledge and experience that other companies and your advisors can provide.

Interpretive Guidance from SEC

On September 21, 2017 the US Securities and Exchange Commission (SEC) issued interpretive guidance designed to assist registrants prepare their pay ratio disclosures. The interpretive release was designed to respond to concerns raised by registrants about how to identify the median employee and calculate the pay ratio.

Importantly, the SEC confirmed that rules are intentionally crafted to give flexibility to registrants since they allow for reasonable estimates, assumptions and methodologies, including statistical sampling; and reasonable effort to prepare the disclosure. The SEC acknowledged that the ratio may include a degree of imprecision. Further, the SEC clarified that the pay ratio disclosure would not trigger an enforcement action unless the disclosure was made “without a reasonable basis or was provided other than in good faith.” Given that many clients have been intensely debating the pros and cons of various methodologies, this is a very important clarification from the SEC.

The SEC reaffirmed that existing internal records, such as tax or payroll records, may be used to identify the median employee. These records may be used even if they do not include every element of compensation. Use of existing records are certainly in line with the concept of using reasonable estimates.

The SEC also reaffirmed that if the compensation of the selected median employee, as calculated using the Summary Compensation Table methodology, proved to be anomalous, a registrant could select another similarly-situated employee based on the consistently applied compensation measure used in its selection process.

All of this interpretative guidance confirms that the pay ratio calculation is complex. While it is very helpful for the SEC to address concerns about potential liability and reaffirm that registrants have flexibility, one must question whether the pay ratio disclosure actually serves a legitimate business purpose.

The final issue addressed by the SEC involved the definition of independent contractors. In cases where workers are employed by, and whose compensation is determined by an unaffiliated third party, they may be classified as independent contractors and excluded from the calculation. The SEC affirmed that independent contractors defined by widely recognized tests applicable in other legal or regulatory contexts could also be excluded.

Division of Corporation Finance Guidance

In addition to the SEC’s interpretive release, the Division of Corporation Finance released additional guidance and hypothetical examples of the use of statistical sampling and other reasonable methodologies.

This included the following:

  1. Registrants are allowed to combine the use of reasonable estimates with the use of statistical sampling. For example a registrant with multi-national operations or multiple lines of business may use sampling in some areas/businesses and other methodologies or reasonable estimates elsewhere.
  2. Examples of sampling methods that may be used are below. Additionally a combination of methods is acceptable.
  3. Simple random sampling by selecting random number or percentage of employees from the entire population;
  4. Stratified sampling by dividing employees into strata, based on factors like location, business unit, type of employee, etc., and sampling within each strata;
  5. Cluster sampling by dividing employees into clusters, drawing a subset of clusters and sampling within clusters; and
  6. Systematic sampling where every nth employee is included in the sample.
  7. Examples of where registrants may use reasonable estimates include but are not limited to:
  8. Analysis of the workforce;
  9. Characterizing the statistical distribution of the company’s employees;
  10. Calculating a consistent measure of compensation and annual total compensation or its elements;
  11. Determining the likelihood of significant changes from year to year;
  12. Identifying the median employee;
  13. Identifying multiple employees who fall around the middle of the compensation spectrum; and
  14. Using the midpoint of a compensation range to estimate compensation.
  15. Examples of other reasonable methodologies, include:
  16. Making one or more distributional assumptions, provided that the company has determined that the assumption is appropriate given its own distributions;
  17. Reasonable methods of imputing or correcting missing values; and
  18. Reasonable methods of addressing outliers or other extreme observations.

Finally the Guidance provides three hypothetical examples of various approaches that may be applied. While all of the Guidance is helpful, we believe that the extra detail on reasonable assumptions and reasonable methodologies is particularly helpful.

In contrast, complex methods of sampling are less helpful. Our sense at this point in time is that most companies will not employ extensive statistical sampling. Basically the thinking is that if a registrant has the data necessary to perform robust statistical sampling, the registrant will have the data to array employee compensation levels and calculate a median. But we shall see how this plays out next year when the new disclosure is actually implemented.

Conclusion

Pay ratio disclosure represents a significant effort for most companies. It is important to develop an airtight process to support the company’s analysis. The rules are complex and companies will be working through the rules for the first time. The results will undoubtedly get a great deal of scrutiny from senior leadership, the Board, employees and the business press. Recent interpretive guidance gives companies more leeway to employ reasonable estimates and methodologies, but nevertheless companies must be comfortable that their disclosure is accurate. This practical guide to implementation can serve as a guide to achieving a successful result for all.

On September 21, 2017 the US Securities and Exchange Commission (SEC) issued interpretive guidance on the CEO pay ratio calculation and disclosure.  The pay ratio rule was adopted by the SEC on August 5, 2015 under the Dodd-Frank Wall Street Reform and Consumer Protection Act. It requires companies to disclose their CEO’s annual total compensation as a multiple of the annual total compensation of the median employee for the first fiscal year beginning in 2017.

The guidance came in the following three areas:

SEC Guidance

  • As long as the company uses reasonable estimates, assumptions, or methodologies (to identify the median employee or calculating any elements of annual total compensation for employees), the pay ratio itself and related disclosure would not provide the basis for an enforcement action from the SEC
  • A company may use internal records (such as tax or payroll records) to identify its median employee
  • For determining whether independent contractors are “employees”, companies may apply a widely recognized test under another area of law (e.g., tax or employment laws) that they would otherwise use to determine whether their workers are employees

Staff Guidance

  • Provides guidance and detailed examples on the use of statistical sampling

Revised Compliance and Disclosure Interpretations (C&DIs)

  • Adds a new C&DI that issuers can state the ratio is an “estimate”
  • Withdraws C&DI that primarily addressed the treatment of independent contractors and leased workers

The latest guidance now provides more flexibility for companies in determining the median employee, specifically as it relates to the use of statistical sampling and clarification of independent contractors. We will track pay ratio disclosure over the coming year and keep you informed of new developments as they occur.

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