by Cydney Posner
There’s been a lot of hand-wringing about what the data will show when public companies are finally required, in 2018, to disclose their CEO-to-median-employee pay ratios as required by new SEC rules implementing Dodd-Frank (discussed in this Cooley Alert). Not to worry! Those ratios promise to be lower than anticipated, says a just-completed CEO Pay Ratio Survey conducted by compensation consulting firm Mercer.
The spot survey, which was conducted in August, consisted of 117 companies across 12 industries, with average revenues of $12 billion. The survey found that the pay ratio was less than 200:1 for “the majority of respondents that have estimated a ratio,” with only 20% estimating ratios of more than 400:1. And an earlier Mercer study of 81 tech companies showed, for 2015, an even lower pay ratio: 95:1 at the 50th percentile.
In contrast, other organizations have arrived at quite different data. For example, the AFL-CIO reported that, last year, the average S&P 500 CEO made 335 times the pay of the average worker (which represented a dip from a multiple of 373 in 2014), based on U.S. government reports. (See this PubCo post.) Similarly, according to a recent study from the Economic Policy Institute, for the largest U.S. public companies, CEO pay in 2014 was 303 times an average worker’s pay, compared to just 20 times in 1965. (See this PubCo post.) And an analysis by Glassdoor showed some rather striking ratios for several companies in the S&P 500 at over 1000:1, with one company at almost 2000:1.
As you may recall, 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.
The SEC rules require that, with a couple of exceptions, when determining the median employee, a company must consider all employees of the company and its consolidated subsidiaries, including non-US, part-time, temporary and seasonal workers employed on any date within the last three months of the last fiscal year. However, there is some flexibility in identifying the median employee: companies may determine the median employee from among the entire employee population, a statistical sample or other reasonable method. In addition, the company may then identify the median employee in the population or sample using annual total compensation or any other consistently applied compensation measure, such as compensation amounts reported in its payroll or tax records (e.g., W-2 wages). Reasonable estimates may also be used in calculating the annual total compensation or any elements of compensation for employees other than the CEO. Absent a significant change, companies are required to identify the median employee only once every three years.
The survey, which was conducted by Mercer to gauge the extent of readiness for the new disclosure, showed that companies were making progress, with 60% of respondents having already estimated their ratios and more than 80% indicating that their data systems were adequate to the task. About one-third of respondents were “using or considering” statistical sampling to determine the median employee. Not surprisingly, the nature of the industry makes a significant difference in the size of the ratio. Industries such as banking/financial services, non-financial services and technology, which tend to employ more professional staff, had the lowest ratios, and industries such as retail/wholesale and consumer goods, which tend to employ more part-time, temporary and “less-skilled employees,” as Mercer characterizes them, reported higher ratios.
An earlier Mercer study of total comp data at 81 tech companies used a methodology that Mercer characterized as closely approximating the SEC requirements. The data showed a 2015 pay ratio of 95:1 at the 50th percentile. Mercer indicated that the data identifying the “median” employee for each company was based on complete census data submitted by the surveyed companies about their full- and part-time employees, rather than wage data from broad economic reports. Revenue for these companies ranged from approximately $100 million to $130 billion (with a median of $2 billion), with market caps ranging from about $100 million to more than $350 billion (with a median of $6 billion). Mercer reported that the ratio tended to increase with company size due to a combination of higher CEO pay and lower median employee pay; among the tech companies with revenue over $10 billion, the median ratio was 196:1. Interestingly, Mercer found that the average ratio for all 81 companies was significantly higher (168:1) than the median ratio because of a few outliers, including — every company’s dreaded scenario — the “largest ratio of 2,105:1 at a company where the CEO received a large equity award and a clerical worker in China earned the median salary.”
Companies that have not begun to consider what approach to take in identifying the median employee and calculating the ratio may want to start that process soon, analyzing the test data and outcomes using various methodologies and keeping in mind the need to maintain consistency and avoid distortion of the data. Companies that are beginning to fret about how their ratios will compare with others in the same industry will want to work on their communications strategies and shape an appropriate narrative around the pay ratio with additional relevant information. (See this PubCo post.) An unseemly gap might be detrimental to corporate reputations and unsettle companies’ work forces — as Mercer notes, when the pay ratio is disclosed, half of the employees will learn that they are paid in the bottom half of employees at their companies. Insights gleaned from test data may provide a head start in determining the kind of supplemental ratios and narrative that could be necessary down the road.
SideBar: As discussed in this PubCo post, a recent study from the Harvard Business School demonstrated that the disclosure of a firm’s pay ratio can influence consumer purchase intentions. In one of a series of experiments conducted to assess the effect of pay ratios on the relationship between companies and customers, the evidence showed that, to achieve as favorable a rate of purchase as a hypothetical company with a low pay ratio offering a product at full price, a hypothetical company with a high pay ratio had to offer a 50% price discount. As a result, companies in consumer-facing industries may feel additional pressure to justify their ratios in narrative discussions.