With only three months left in 2017, mandatory disclosure of the CEO pay ratio draws ever nearer: 2018 is the year most American companies will have to include this information in their public filings. Debate has raged on the why of this data point, on the costs and benefits of such disclosure for issuers, for shareholders and for the general public. We have previously laid out some of the arguments and perspectives on the ratio here, and the current state of discussion is summarized below.
The debate on the why of disclosing the CEO pay ratio, however, has at this point been superseded by the how: how should issuers calculate this ratio and how should they disclose it? With 2018 around the corner, the SEC has released interpretive guidance in response to a variety of comments and concerns raised regarding the disclosure of this ratio. Such guidance may be viewed in full here. We have summarized below the main comments raised by issuers and the corresponding guidance provided by the SEC.
- Use of Reasonable Estimates, Assumptions, and Methodologies and Statistical Sampling
- Comment: Commenters have expressed concerns over compliance uncertainty and potential liability, given the use of estimates, assumptions, adjustments and statistical sampling permitted by the rule to determine the median employee of a company.
- Guidance: In the SEC’s view, if a registrant uses reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.
- Use of Internal Records
- Comment: Commenters have expressed concerns over compliance costs related to the provision that permits registrants to exempt non-U.S. employees where these employees account for 5% or less of the registrant’s total U.S. and non-U.S. employees.
- Guidance: The SEC is clarifying that, in determining whether the 5% de minimis exemption is available, a registrant may use internal records such as tax or payroll records to address compliance costs.
- The SEC is also clarifying that a registrant may use internal records that reasonably reflect annual compensation, such as tax or payroll records, to identify the median employee, even if those records do not include every element of compensation, such as equity awards widely distributed to employees.
- Independent Contractors
- Comment: Some commenters have expressed concerns about the application of the rule’s definition of “employee.” Because 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, some commenters suggested that the Commission should allow registrants to use widely recognized tests to determine who is an “employee” for purposes of the rule. Such a test might, for example, be drawn from guidance published by the Internal Revenue Service with respect to independent contractors.
- Guidance: In determining who constitutes an employee at a company, the SEC considers it acceptable for a registrant to apply a widely recognized test under another area of law that the registrant otherwise uses to determine whether its workers are employees.
The Division of Corporation Finance simultaneously released more specific guidance on the use of statistical sampling to determine the median employee. This guidance can be viewed here.
As the discussion on income inequality continues in America, proponents of the pay ratio have argued that this data point provides insights into how CEO pay levels have grown over the last few decades. Some see the ratio as a starting point for executive compensation reform. The SEC itself intends that the ratio be more narrowly viewed, stating that it “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.”
Opponents of the pay ratio rule have argued that the ratio is misleading, given the different markets in which rank-and-file workers and CEOs operate, and given the different methods by which these two employee groups are compensated. Others have argued that the ratio is intended, at its core, to be used as a shaming tactic rather than as an informative data point for shareholders. The process of determining and disclosing this information can also be costly and time-consuming for issuers, particularly for multinational companies with global workforces.
Glass Lewis intends to display the pay ratio as a data point in our Proxy Paper in 2018. At this time, however, we do not intend to incorporate the pay ratio into our assessment and analysis of Say-on-Pay proposals. We recognize that this data point might provide valuable additional information to shareholders on a company’s pay practices; however, we do not believe that this information is material for our analyses of the structures by which, and the disclosures of how, companies pay their NEOs.
Evania is an analyst covering executive compensation in the United States and Canada.