Despite perhaps fond hopes, the SEC’s Pay Ratio Disclosure rule remains in force and many companies will be dealing with it for the first time in the 2018 proxy season. Between lack of experience, data headaches, and potential public backlash, the required disclosures might be a real challenge for many companies. In a recent webinar, Katten Muchin partner Lawrence Levin and Amy Bilbija, a managing director at Strategic Governance Advisors, gave tips on preparing the disclosures and releasing the news to the public.
Pay ratio disclosure. Adopted in 2015, the Pay Ratio Disclosure rule amended Item 402 of Regulation S-K to require covered registrants to disclose (1) the median of the annual total compensation of all employees of a registrant (excluding the CEO); (2) the annual total compensation of the registrant’s CEO; and (3) the ratio of these two numbers.
Registrants must comply for the first fiscal year beginning on or after January 1, 2017. Therefore, calendar-year companies must include pay ratio disclosures in their 2018 proxy statements, said Levin.
The rule and accompanying September 2017 guidance specify:
- Which companies do not need to disclose pay ratio, including emerging growth companies, smaller reporting companies, foreign private issuers, Canadian MJDS filers, and registered investment companies;
- Which communications must contain pay ratio disclosures, including Form 10-Ks, registration statements, proxy and information statements;
- How to determine the “median employee”, including methodology, statistical sampling and reasonable estimates; U.S. vs. foreign employees; included employees versus contractors, consultants, “leased employees”, and other excludable individuals.
However, it doesn’t look like the SEC is looking to play “gotcha” for any inadvertent mistakes. Bilbija said the September guidance gives assurances that flexibility is genuinely allowed, and as long as companies have a reasonable rationale they should be okay.
What are peers doing? In surveys, companies reported:
- Most companies (56 percent) expect to disclose a pay ratio of over 100 to 1. The largest group (35 percent) expects to disclose a ratio between 101-250 to 1. One compensation consultant told Levin that one of her clients, a worldwide retailer with over 100,000 employees, will report a ratio of 1800 to 1.
- For respondents that have decided on their approach, many plan to provide either the bare minimum disclosure (22 percent) or expanded disclosure with some explanations and clarifications (22 percent ). Six percent plan to provide expanded disclosure with alternate ratios, and 4 percent will provide expanded disclosure with carve-outs. Bilbija noted that although she’s mostly hearing companies taking the “less is more” tactic, expanded disclosure can help companies provide important context. For example, large international companies might want to provide a supplemental disclosure of U.S.-only numbers, or companies might additionally disclose figures by employee strata.
- For the employee determination date, many respondents plan to use the fiscal year end (35.7 percent) or October 31 or equivalent for non-calendar-year companies (25.7 percent). In addition, 7.1 percent plan to use November 30 or equivalent for non-calendar-year companies, and 31.4 percent will use some other date
- In using a consistently applied compensation measure (CACM), most respondents plan to use taxable wages (25.3 percent), base salary (24.0 percent), or total gross compensation (21.3 percent). 14.7 percent will use total cash compensation, and 14.7 percent will use some other measures. No respondents planned to use total annual compensation.
Breaking the news. Although the SEC might not pounce on innocent mistakes, legal missteps aren’t the only potential hazard. Given that more than half of companies in a recent survey expect to disclose a ratio of over 100 to 1, companies might well face public backlash. Employee morale and retention may suffer, and employees may use the information to bargain for higher pay.
Given potential negative reaction, it’s critical to develop messaging ahead of time. For companies opting to communicate directly to employees, rather than through human resources, Bilbija said companies should be make sure to explain why they are required to disclose the numbers, provide assurance that employees are being fairly compensated, and encourage employees not to read too much into it. Further, companies can emphasize other pieces of compensation like 401K contributions, pensions, etc.
If disclosing through human resources, managers should be given big-picture corporate and competitive data, as well as training so they know how to manage disappointment, bitterness, anger, etc. Managers should also anticipate possible backlash through possible increased sick time and decreased productivity. As a mitigating measure for the future, companies may want to consider pushing profit-sharing down through the ranks, said Bilbija.
Though probably not as strong a focus in the first year, proxy advisors and institutional investors are expected to take an interest as well. A recent survey by Institutional Shareholder Services (ISS) found that nearly three-quarters of institutional investor respondents said they will use pay ratio information in some way, including (1) comparing ratios across companies and industry sectors; (2) assessing year-on-year changes at an individual company; or (3) using it as background material for engagement with companies.
Finally, regarding media coverage, Bilbija expects there will not be a lot of coverage at first except for outliers. Companies should look at disclosures by peers as they start to come out. If it looks like a company will be an outlier, on either a local or industry basis, then it would be wise to prepare a written statement in case the media calls for comment.