Is Your Bank Ready for the CEO Pay Ratio Disclosure?

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ceo-pay-ratio-1-4-17.pngStarting with the 2018 proxy statement (covering fiscal year 2017), most public companies will be required to start reporting their CEO pay ratio, that is, the ratio of the CEO’s pay to the median of all other employees’ pay. While it is questionable whether the CEO pay ratio disclosure will be a truly meaningful or useful figure to aid shareholders understanding of a company’s compensation practices, the new disclosure is likely to be a focus of both the media and shareholder activists. Directors and management should be aware of how their CEO pay ratio compares to peers and how it may change from year to year. The good news is that banks are expected to produce lower CEO pay ratios compared to companies in other industries. However, as with any new process, this will require time and planning.

Here are some questions to ask to see if your bank is ready.

1. Do you know how your CEO pay ratio will compare to the market?
To avoid surprises, know where your CEO pay ratio fits in with similar sized banks. McLagan’s research shows that the estimated CEO pay ratio ranges from 10 to 67, depending on asset size for banks under $30 billion in assets. Business focus also matters. Retail-focused banks tend to have a higher ratio as compared to non-retail focused banks as a result of lower median employee compensation (about 20 percent lower on average). Start planning your communications strategy to proactively consider employee concerns and press coverage. You’ll also need to evaluate the need for supplemental disclosure in the proxy statement if your CEO pay ratio is outside the norm.

Bank CEO Pay Ratio Information
CEO Pay Ratio Chart.PNG

2. Does the CEO pay ratio apply to my bank?
If you are a smaller reporting or an emerging growth company, you do not need to report the CEO pay ratio. However, even if you are not required to disclose the ratio publicly, your board may want to know how your CEO compares to the market.

3. How do I determine who is included in my employee population?
Employees are identified based upon any date within the last three months of the year. It must include all full-time, part-time, seasonal and temporary employees (including subsidiary employees and potentially, independent contractors). While the date flexibility is less of a benefit for banks, this may simplify the process for some companies, such as those in the retail industry who have significant seasonal employees.

4. Is there flexibility in the methodology used to calculate the median employee?
Yes, W2 data, cash compensation, or some other consistently applied compensation measure can be used. In addition, the time period for measuring compensation does not have to include the date on which the employee population is determined. Keep in mind that decisions regarding specific methodologies may affect the resulting median and may require additional disclosure.

5. Can I use estimates?
Yes, reasonable estimates and sampling can be used; however, the methodology and assumptions must be disclosed. Regardless of the method used, ensure that your process is reliable, repeatable and able to be explained in the proxy. This is not likely a benefit for wholly owned U.S.-based banks with centralized human resource information or payroll systems.

6. How often is the disclosure required?
Annually; however, the median employee may be updated every three years, provided the employee population has not changed significantly. Banks on an acquisition path may need to update the median employee each year.

7. Can all my data providers supply the information I will need and on time?
Do your due diligence now to determine your data requests from payroll vendors, stock reporting systems, benefits providers, actuaries for retirement plan accruals, etc. The time and resources to comply could be substantial and working through the various decisions and establishing a methodology ahead of time will make for a smoother process in 2018.

In summary, don’t assume your CEO pay ratio calculation will be quick and easy. Getting started now will allow time to provide education and manage expectations. Be proactive to ensure your methodology is well tested to be ready for implementation in your 2018 proxy statement.

Compensation and Governance Committees: Sharing the Hot Seat in 2016

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hot-seat-11-19-15.pngThe compensation committee has been on the hot seat for several years. Outrage regarding executive pay and its perceived role in the financial crisis has put the spotlight on the board members who serve on this committee. Say-on-pay, the non-binding shareholder vote on executive compensation practices, was one of the first new Securities and Exchange Commission (SEC) requirements implemented as part of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010. Since that time, public companies have responded to shareholder feedback and changed compensation programs and policies to garner support from shareholders and advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis & Co. In recent years, only 2 percent of public companies have “failed” their say-on-pay vote. The significant majority of public companies (approximately 75 percent of Russell 3000 companies) received shareholder support of 90 percent or greater during the 2015 proxy season. Today, companies with less than 90 percent should increase their shareholder outreach, as a dip below that level is often an indicator of emerging concerns.

Compensation committees can’t sit back and relax on these results. The SEC’s proposed rule for pay versus performance disclosure (published in April) and the final rule for the CEO pay ratio (published in August) will further intensify the focus on executive pay and require compensation committees to dedicate much more time and energy to evaluate and explain their pay decisions in light of these new disclosures. Fortunately, implementation of the CEO pay ratio is delayed until the 2018 proxy season while the SEC has not yet adopted final rules for the pay versus performance disclosure (as of September). It is hard to predict what influence these additional disclosures will have on shareholders’ say-on-pay votes. What is clear is that boards will need to monitor these and other pending Dodd-Frank Act rules (i.e. mandatory clawback, disclosure on hedging policies, incentive risk management) in the coming year.  

In the meantime, however, boards may face increased shareholder scrutiny in key governance areas.

Proxy access, the ability of significant shareholders to nominate board members on the company’s proxy ballot, achieved momentum in 2015 when New York City Comptroller Scott Singer submitted proxy access proposals at 75 public companies as part of his 2015 Boardroom Accountability Project. We expect proxy access proposals will remain a focus among activist shareholders during the 2016 proxy season. Dissatisfaction with executive compensation and board governance are often the reasons cited by shareholders seeking proxy access.

Institutional shareholders and governance groups have also started to focus on board independence, tenure and diversity. Institutional investors such as Vanguard and State Street Global Advisors consider director tenure as part of their voting process and ISS includes director tenure as part of their governance review process. This could lead to a push for term and/or age limits for directors in the near future. While many companies use retirement age policies as a means to force board refreshment, it is unclear if that will be enough. Boards would be wise to start reviewing their board composition and succession processes in light of their specific business strategies but also in consideration of these emerging governance and shareholder perspectives.

The intense scrutiny by investors and proxy advisors of public companies’ compensation and governance practices shows no signs of abating. Bank boards will need to develop their philosophies, programs and policies with an acknowledgement of emerging regulations and perspectives. Board composition and processes such as member education, evaluation, nomination and independence will gain focus. Executive pay levels and performance alignment will continue to be scrutinized based on new disclosures mandated by Dodd-Frank. The spotlight on pay and governance is not winding down, but rather widening and both the compensation and governance committees will need to spend more time addressing these issues in the years to come.

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

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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.

Say What on the CEO Pay Ratio?

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The first day of our annual Bank Executive and Board Compensation event got off to a rousing start with two back-to-back sessions focused on how the regulations are effecting the compensation committee’s role. After the session, I had a chance to follow up with Mike Blanchard, partner at compensation advisory firm Blanchard Chase, for a quick video recap on his recommended approach for handling the controversial CEO pay ratio requirements.

Click play button to start the video:

As Mike points out in the video, the full effects of this new regulation are not yet known and will vary by company. However, the best way to deal with this piece of the regulation is to be prepared to tell your story on why you pay what you pay, talk through the process and feel good about your decisions. The last thing you don’t want is to find yourself contemplating something crazy like outsourcing your janitorial services just to help minimize the disparity in salaries.