CEO Pay Ratio: How It Will (And Won’t) Work

11-15-13-Pearl.pngThe Securities and Exchange Commission (SEC) is now accepting comments on proposed rules that would require public companies to disclose the ratio of the CEO’s pay to that of their median worker. Proponents say it will serve to better highlight excessive pay practices and shame those companies into adopting more shareholder-friendly programs. Detractors argue that the cost and complexity of implementing the new disclosure outweighs the benefits to investors and may actually ramp up pay levels.

The rules would require public companies to disclose:

  • the median employee annual total compensation, excluding the CEO;
  • the annual total compensation of the CEO and
  • the ratio between the two.

Companies exempt from the rules include:

  • emerging growth companies (those who completed their IPO after 12/8/11 and have less than $1 billion in total annual gross revenues);
  • smaller reporting companies (less than a $75 million float); and
  • foreign private issuers (50 percent or less of outstanding voting securities are held by U.S. residents).

Interestingly, the SEC provided flexibility in terms of how median employee compensation would be calculated: Companies can use either the entire employee population, or a statistical sampling. Companies would be able to choose their own methodology, as long as it is clearly outlined in their proxy and is “appropriate to the size and structure of their own businesses and the way they compensate employees.” We anticipate that the methodologies available for calculating this new pay standard will be front and center in the public debate—perhaps even more than the pay ratios themselves.

So how beneficial would this new disclosure really be in determining the appropriateness of CEO pay within the banking industry? We already know that ratios will vary widely across industries, especially among global versus domestic companies and those with a high number of part-time, temporary and/or seasonal workers. Within the banking industry, there also will be a lot of noise to deal with: Banks’ business models, ownership structures, and operational sizes (e.g., number of branches) will influence the CEO pay ratio, making it difficult to make meaningful comparisons. On top of that, pay ratio disclosures would be based on inconsistent methodologies and different definitions of “total annual compensation.” That number could be established using the Summary Compensation Table in the annual proxy, or any consistently used compensation measure such as amounts reported in payroll or tax records.

Given the wide variations in how companies arrive at these ratios, they are likely to be of limited value in helping shareholders assess banks’ pay programs. In some circumstances, however, pay ratios might provide some additional perspective for bank directors. The following serve as examples:

  • How has the relationship between pay for our CEO and other employees changed over time?
  • Are increases/decreases in the ratio commensurate with our performance?
  • Should the ratio remain constant in good and bad times, meaning that there is an equitable distribution of rewards or cost-cutting measures between the CEO (or management team) and the general employee population—or should there be variation?

Fortunately, there is time to consider various options. However, we recommend banks begin now to investigate the methodologies best suited to their own business and prepare a preliminary pay ratio calculation based on the SEC’s current proposal.

Assuming the final rules become effective in 2014, calendar year companies won’t need to provide pay ratio data until the 2015 fiscal year, and they can provide it in the annual report, proxy or information statement that might not get filed until 2016.

A more detailed client alert that addresses the SEC’s proposed CEO pay ratio rules is available by clicking here.