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CEO pay ratio: more than just an SEC disclosure

As part of the 2010 Dodd-Frank Act, Securities and Exchange Commission (SEC) regulations now require public companies to include a CEO pay ratio disclosure in their proxy statements (or in the Form 10-K for companies that do not file a proxy statement). The disclosure requirements include: the annual compensation of the CEO, the median annual compensation of all employees (excluding CEO), and the ratio between the two amounts. With the 2018 proxy season in full swing, this issue is gaining traction and attention with investors, employees, media, social media, etc.

In its recent CEO Pay Ratio Survey of 365 public companies, intelligence firm Equilar found that 356 participating companies plan to report a median CEO Pay Ratio of 140:1 in their 2018 proxy statements. The survey showed that the median ratio was positively correlated with company revenue and number of employees (companies with higher revenues and larger employees had higher ratios), and ratios ranged greatly: the Consumer Discretionary segment had the highest median ratio at 350:1, while the Energy sector had the lowest median ratio at 72:1. The executive summary of the report, which is available as a free download, includes benchmarking data by company size, industry sector and geography.

Of additional importance, a survey conducted by proxy advisory firm ISS found that nearly 75% of institutional investor respondents plan on analyzing pay ratio disclosure data on an annual basis and/or to compare against industry peers. As a former sell-side analyst, I can tell you that easy access to such data points across industry peers will be welcomed by analysts, who are tasked with keeping tabs on all aspects of the companies they cover. This will likely drive comparison analysis and investment ideas, leading to quantitative-backed insight to be shared with the broader investment community and capital markets.  

As with any new reporting requirement, this disclosure will present an array of challenges, including:

  1. Calculating median pay is no small task. At the organization’s discretion are its calculation method (estimation vs. statistical sampling, for example), measurement date (what day in the last three months of the fiscal year best represents the entire year?), who is excluded (are there foreign employees or employees brought in as part of a transaction to exclude?), and any explanatory information that the company wants to include. Choosing the right path requires significant time and resources.
  2. Companies can be exposed to controversy and/or misunderstanding. This is especially true in sectors with a relatively high percentage of low-income, seasonal or part-time employees. In the retail industry, for example, 31% of employees work part-time (versus an average of 17% in other industries), which will drive median annual compensation down and pay ratio up compared to other industries. Without industry context, the ratios could be very misleading.
  3. Reactions among various audiences can be hard to predict. How will employees react? What will investors think? Will the media ask questions? Will the disclosure create a social media buzz? Planning ahead, preparing for anything, and communicating smartly across all audiences begins with having a comprehensive understanding of the situation and a well-developed strategy.
  4. Employee morale may be affected. This is perhaps the most damaging potential impact, as some employees learn they are earning less than the median employee or that the CEO earns several hundred times more than the median (due to either high CEO pay or low median pay, or both). This could compromise a company’s ability to attract and maintain top talent.  

With an effective communications strategy, organizations can be better equipped to overcome these challenges. Here are Dix & Eaton’s five recommendations for developing your communications strategy:  

  1. When preparing the disclosure, include context. The SEC allows flexible calculation methods, certain exemptions (proportion of employees based outside of the United States where pay is generally lower, proportion of seasonal/part time employees) or other information (CEO realized or “take home pay”) that will give context to the disclosed ratio and reduce misunderstanding. Be clear about how you arrived at your calculation, including any assumptions and caveats.
  2. Communicate proactively with key stakeholders, especially employees, to build mutual support and trust. Trust among employees is a key driver of engagement, collaboration and motivation in the workplace, according to David DeSteno, author of The Truth About Trust. Additionally, a recent survey conducted by Edelman found that 82% of investor participants point to trust as critical to their investment considerations – more than peer valuation, innovation and historical financial performance.
  3. Keep communications clear and concise. Prepare management and the board with key questions, strategic responses and consistent messaging with a focus on employee relations. Additionally, be able to provide context on comparability with your company size, industry and geographic peers, and how your median compensation was calculated.
  4. Highlight other positives internally. Emphasize your “total package” approach to the employee experience, which presumably includes not only compensation and benefits but also workforce development, career advancement and work-life balance.  
  5. Take control of the story. If you expect to face extra scrutiny or negative media coverage (e.g., your CEO pay ratio is an outlier in your industry or geography), be prepared for the tough questions. Prepare a media statement, have a contact for media inquiries, and equip leaders with appropriate messaging and context. In some cases, for internal communications, we are recommending that clients proactively issue a memo to explain the CEO pay ratio disclosure – so that the company can take control of the situation before employees hear about it from media or social media channels.

If you want to talk about how to communicate the CEO pay ratio disclosure internally and externally, or discuss other proxy issues, contact me and we’ll work through the new requirements together.

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