As we enter 4Q 2017, public companies are girding themselves to comply with the CEO pay ratio disclosure rules that are part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
The rule requires public companies to disclose the pay ratio between a company’s median employee and the company’s chief executive officer or other principal executive officer. The rule is designed to provide shareholders with information they can use to evaluate a CEO’s compensation. It requires disclosure of the CEO pay ratio in registration statements, proxy and information statements, and annual reports that call for executive compensation disclosure. Companies are required to provide disclosure of their pay ratios for their first fiscal year beginning on or after Jan. 1, 2017, which means companies will need to start providing the information in 2018.
A recent poll of nearly 360 corporate executives and compensation professionals conducted by Willis Towers Watson found 39% of those polled considered their greatest challenge to be determining the consistently applied compensation measure (CACM) that would identify their company’s median employee, and 38% said their greatest challenge would be accurate pay data. Their next greatest challenges are deciding how to present their disclosure (37%) and determining how their pay ratio stands up against their peers, their industries and the market (35%).
There is flexibility in how a company may determine a median employee. According to recently issued guidance from the SEC, “the rule permits registrants to use reasonable estimates to identify the median employee, including by using statistical sampling and a consistently applied compensation measure (such as payroll or tax records). The rule also allows registrants to use reasonable estimates in calculating the annual total compensation or any elements of annual total compensation for employees. The rule further provides that if a registrant changes its methodology or its material assumptions, adjustments, or estimates, and the effects are significant, the registrant must briefly describe the change and the reasons for the change.”
The rule requires companies to calculate the annual total compensation for their median employee using the same rules that apply to the CEO’s compensation. According to the SEC: “’Annual total compensation’ means total compensation for the last completed fiscal year, calculated using the definition of “total compensation” in existing executive compensation rules, namely Item 402(c)(2)(x) of Regulation S-K. The rule would allow companies to use reasonable estimates when calculating any elements of the annual total compensation.”
The employees that will be included in the calculation is wide ranging. Again, from the SEC: “A company would be permitted to select a date within the last three months of its last completed fiscal year on which to determine the employee population for purposes of identifying the median employee. Subject to certain exceptions, the company would be required to include all employees – U.S. and non-U.S., full-time, part-time, temporary and seasonal – employed by the company or any of its consolidated subsidiaries in performing its pay ratio calculation. Individuals employed by unaffiliated third parties or independent contractors would not be considered to be employees of the company.”
It’s clear that the accuracy of payroll data is important. However, assuring that accuracy might be more challenging than expected, depending on a company’s workforce. A recent survey from the American Payroll Association found that nearly 34% of employees are not required to track their hours. Another 14% of respondents stated they are still using antiquated timecards and timesheets to document their hours worked.
Companies should be speaking with their payroll departments to be sure that sick days, overtime and other factors involved in total compensation for employees are being accounted for by payroll providers.
If they are not doing so already, companies should be conducting dry runs of their systems to determine the best approach to generating the CEO pay ratio and determining their median employee. Knowing this information will provide advance knowledge to company boards and assist executives and their HR department in how best to discuss this information with employees.
Interestingly, the Watson Towners poll found that (49%) of respondents cited forecasting how their employees will react to the ratio disclosure as their top challenge. However, while communication with employees was a top concern, roughly the same percentage of respondents (48%) had yet to think about how, or even if, they would communicate the pay ratio to employees. The time to prepare is now.