Now that most companies have made it through proxy season, the compensation committee is turning its attention to the summer agenda. No doubt the CEO Pay Ratio will be a major point of discussion. Despite all the debate over this regulation and all of the hope that it would have been repealed by this point, the fact remains: we are six months away from this becoming a reality. The bottom line right now is that you have to be prepared to disclose.
We’ve been having in-depth conversations with a number of clients about the technical details of the rule and have compiled a list of some of the initial FAQs we’ve encountered to date.
- What data can we use to determine our employees’ compensation? The SEC’s most recent “clarification” actually caused more confusion. The assumption was that total cash—in other words, simply using base plus bonus—was an adequate measure. However, in guidance issued at the end of 2016, the SEC clarified that the data used needs to be reasonably reflective of annual compensation. That means if equity is widely granted for most employees, your data collection may need to go beyond cash payments.
- Should we take advantage of the data privacy and 5% de minimus exceptions? If you have international employee populations that meet the requirements for these rules, then you may exercise one or both of these exceptions. However, we are cautioning clients that at the tail end of this exercise, you’re going to have to disclose what you excluded and that might be onerous. And with the data privacy exception, you’ll need to file a legal opinion from counsel as a separate exhibit to the proxy statement that it was necessary for your company to use the exclusion.
- If I choose a date other than 12/31 within the last quarter of the year for calculating the median employee pay, how do I calculate the full year’s compensation? You may use the previous year, the previous 12 months, or even a period shorter than 12 months, so long as the period chosen is reasonably reflective of the annual compensation of the employees. But as with the exceptions noted above, this will require explanation in your disclosure. If a period shorter than 12 months is chosen, it may exclude significant portions of compensation such as annual bonuses and equity grants. At the end of the day, most calendar companies are choosing to use 12/31 and a 12-month period even though they’ve been offered additional flexibility.
- Should I use the option to statistically sample my employee pay data? Again, the SEC’s exclusions or alternative pay calculation methods offer little in the way of practical relief. And again, you’ll have to have airtight disclosure if you choose to use the statistical sample, which may not be a simple narrative. In most cases, one must fully understand the full population and the compensation measures to be used in order to select a valid statistical sample. As a company needs to go through this exercise in order to conduct the sampling, it is unclear if the sampling itself would actually prove to be a time- or money-saving option.
- If I’m hiring an independent contractor without a third-party staffing agency, do I need to include them in the data? It’s clear that as a group, contractors who are hired through another organization can be taken out of the calculations. It is less clear whether an individual who is an independent contractor can be excluded unless he or she is clearly determining the level of compensation paid by the company.
Finally, the question everyone asks that can’t be addressed by any regulation is “What’s your best guess on a good ratio?” These ratios are going to vary widely in the first year of disclosure and then may vary for the same company year-over-year. Also keep in mind that the pay ratio may appear higher in years when the company has stellar performance, which may be the result of a strong executive pay-for-performance philosophy. While median employee pay may not vary with stock price and other company financials, CEO pay will. As a result, investor interest may actually be aligned with higher CEO pay ratio results in some years.
