by Cydney Posner

Or, at least, that seems to be the position of the SEC staff following the tongue–lashing it suffered in 2011, when the D.C. Circuit tossed out the SEC’s mandatory proxy access rules. (See these news briefs.) You may recall that plaintiffs Chamber of Commerce and Business Roundtable had argued, among other things, that the SEC failed to properly analyze its costs and that it used inconsistent data to justify the rule and calculate its costs. Oops. The court agreed, concluding that the SEC acted “arbitrarily and capriciously” in issuing the rule when it failed to provide an adequate cost/ benefit analysis. At the time, the WSJ characterized the opinion as a “sharp rebuke to the SEC, marking the fourth time in recent years the same court has thrown out an SEC rule based on similar grounds. The judges scolded the SEC for ‘inconsistently and opportunistically’ presenting the economic costs and benefits in its justification for the rule.”

Perhaps in anticipation of an almost certain court challenge to the pay-ratio rules it proposed in 2013 (and expects to finalize this fall), and presumably hoping to avoid a replay of its prior mortifying defeat, the SEC today announced the availability of some additional economic/statistical analysis of the pay-ratio calculation and indicated that more may be added later.  The analysis, performed by the Division of Economic and Risk Analysis (DERA), “considers the potential effects of excluding different percentages of employees from the pay ratio calculation.” 

The Dodd-Frank pay-ratio provision mandates that the SEC require most public companies to disclose, in a wide range of their SEC filings:

  • the median of the annual total compensation of all employees of the company, except the CEO (that is, the point at which half the employees earn more and half earn less);
  • the annual total compensation of the CEO; and
  • the ratio of the two amounts above.


Opponents of the provision argued that, for almost all companies, calculating the ratio would be of little value to investors, but tremendously complicated, expensive and potentially inaccurate, especially for companies with a global workforce. Compensation information for all employees has not previously been a disclosure requirement and, they contended, most companies’ complex payroll and pension systems are not structured to easily accumulate and analyze all the types of data that would be required to calculate the total compensation for every employee, especially employees outside the U.S. The view of some was that the real purpose of the rule was to “name and shame.”


In response to these criticisms, the SEC proposal adopted a flexible approach that allows each company to choose from several options for identifying the median in the way that best suits the size, structure and compensation practices of that company. However, under the proposal, when determining the median employee, a company must consider all employees of the company and its subsidiaries, including non-U.S., part-time, temporary and seasonal workers employed as of the last day of the last fiscal year. This requirement of the proposal elicited comments recommending that certain groups of employees (for example, employees in foreign countries or part-time, seasonal or temporary employees) be excluded from the determination of median employee compensation.  The DERA analysis shows how various percentage exclusions from an employer’s workforce can affect the calculation of the median, thereby changing the ratio of PEO pay to the median of employee pay.


After describing the important assumptions made for purposes of the analysis, DERA explains that it evaluated two broad alternatives related to excluded employees (excluded “observations” in statistics  speak) and their effects on the calculation of the pay ratio: in the first alternative, all those excluded are below the median for the underlying distribution of pay, which would have the effect of decreasing the pay ratio relative to the pay ratio for the underlying distribution. (For example,if non-U.S. employees were excluded, this alternative might assume that employees outside the U.S. on average receive lower compensation than employees inside the U.S.)  In the second alternative, all excluded “observations” are above the median for the underlying distribution of pay, which would have the effect of increasing the pay ratio. To the extent that there are variations at particular companies, the effect will be in the range between the two alternatives.


The analysis excluded different percentages ranging between 1% and 20%. The results showed that the exclusion of 5% of employees could cause the pay ratio to decrease by up to 3.4% in the first alternative or to increase by up to 3.5% in the second alternative. For a 10% exclusion, the pay ratio may decrease by up to 6.7% in the first alternative and increase by up to 7.2% in the second alternative. At 20%, the pay ratio may decrease by up to 13% or increase by up to 15%, depending on the alternative considered.

Can we infer from DERA’s having undertaken this analysis that the SEC is actually considering allowing these types of exclusions? Or is the SEC primarily seeking to establish that it has performed and considered an adequate analysis of the issue and its consequences, regardless of whether the final rule allows any exclusions or, most especially, if it rejects this particular concept?

Posted by Cydney Posner