Given the level of attention paid to executive compensation by investors and the public, public companies should be engaged in deciding how best to address the upcoming “CEO pay ratio” disclosures mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The SEC’s rules implementing the mandate require each public company to disclose the ratio between the total annual compensation of its CEO and the median compensation of its employees (the “CEO pay ratio”) and such rules present a number of challenges as well as opportunities. With advance planning, companies will be in a good position to provide the required disclosures in a timely manner. Below are some considerations for public companies as they consider how to implement the CEO pay ratio disclosures. Companies are encouraged to consult the SEC’s Final Rule (Release No. 33-9877, effective October 19, 2015) for additional detail.
Develop a timeline for complying with the new rules. The first step any company should take is to think through the steps to develop the CEO pay ratio disclosures. This should include how the company will consider the various alternative methodologies that are discussed below, as well as how to review the disclosures internally with the appropriate constituents.
Select a team. Companies are likely to find a multidisciplinary team helpful in preparing the CEO pay ratio disclosures. SEC reporting, legal, compliance, accounting and human resources functions should be considered. IT personnel may also be needed to address systems issues when collecting data. External compensation consultants and outside counsel can provide experience and guidance in navigating the disclosure requirements.
Communicate internally. Companies should ensure that the relevant internal parties are aware of the requirements of the new rules. Disclosure committees and compensation committees will likely want to track the company’s efforts. Accounting and payroll functions should be made aware of the data collection requirements so that any roadblocks can be identified and addressed in advance. Human resources departments may be interested in the reaction of the employee population to the new disclosures, and CEOs will almost certainly find this disclosure of interest as yet another way their compensation will be scrutinized.
Consider preparing pay ratio data in advance. Public companies must begin complying with the new rule for the first fiscal year beginning on or after January 1, 2017, meaning that for calendar year reporting companies, the new CEO pay ratio disclosure must appear in their 2018 proxy statements with respect to the 2017 reporting period. However, many companies are calculating pay ratio information internally for the prior fiscal year in order to develop procedures for the timely and accurate collection of compensation data and to evaluate the potential impact of different calculation methodologies. This will also allow compensation committees to see how various decisions could affect pay ratio disclosures going forward.
Choose an appropriate methodology. Companies must select a method of identifying the “median employee” that is appropriate for the size and structure of the company’s business and compensation structure. Any compensation measure that is consistently applied, such as W-2 wages, may be used, and the company has the flexibility to use its entire employee population or statistical sampling. Regardless of the method chosen to identify the median employee, the methodology and any material assumptions, adjustments or estimates will have to be described in the CEO pay ratio disclosures.
Consider whether alternative ratios should be presented. Companies can supplement the required disclosures with additional pay ratios. For example, a company may wish to present alternative ratios to demonstrate the impact of part-time, seasonal or temporary employees.
Consider how equity awards impact the pay ratio. Companies must determine total annual compensation for the median employee in the same manner that they determine total annual compensation for the CEO for purposes of the Summary Compensation Table pursuant to Regulation S-K. Accordingly, when calculating the total annual compensation of its CEO, companies must include the aggregate grant date fair value of equity awards in accordance with FASB ASC Topic 718. As a result, large one-time retention grants or grants intended to cover multiple years may skew the pay ratio in a given year.
Incorporate the CEO pay ratio into the company’s disclosure controls. Each reporting company is required to maintain disclosure controls and procedures designed to ensure that information required to be disclosed in the reports it files with the SEC is recorded, processed, summarized and reported in a timely manner. Because the CEO pay ratio is a new disclosure item, companies should update their disclosure controls and procedures accordingly.
This Client Alert is for information purposes only and should not be construed as legal advice. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information or an explanation about the matters discussed in this Alert, please contact one of the attorneys in the firm’s Securities Regulation and Corporate Finance Practice. To learn more about Maynard Cooper’s Securities Regulation and Corporate Finance Practice, please click here.