The pay ratio disclosure requirement called for in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act1 took effect for fiscal years beginning on or after January 1, 2017. Public companies are required to disclose the ratio of the compensation of their chief executive officer (CEO) to their median employee. Deloitte Consulting LLP analyzed pay ratio disclosures of 294 S&P 500 companies from DEF 14A filings as of April 10, 2018. Here’s a summary of what we found.
We first wrote about this disclosure requirement here on HR Times back in 2013. At the time, it was anticipated that companies would have to start reporting the ratio in 2015 or 2016—it finally began in 2017. The 7½-year journey from enactment to implementation has not diminished anxiety or controversy over this requirement.
Those in favor of the disclosure say it informs investors and the general public about pay disparity and gives them a way to compare companies’ pay practices, both in general and within particular industries. Critics point to the “apples to oranges” nature of comparing a CEO’s compensation to that of the median employee, who has a job requiring a completely different skill set and may even be part-time. Even within industries, critics point out the median salaries could vary greatly due to who that median employee is. So, in retail for example, one company’s median employee could be a store manager while another’s is a part-time sales associate. One of our research findings indicates a number of companies included language in their disclosure warning shareholders the data is specific to the company and not comparable to other disclosures.
Identifying that median employee in itself is often a struggle, as it requires companies to calculate the compensation of what could be hundreds of thousands of employees, located in dozens of countries, with data housed in multiple payroll systems, in order to disclose the pay of that one “middle” (median) employee. Another one of our research findings is a number of companies included language in their disclosure that the CEO pay ratio calculation was based on the company’s good faith effort to comply with the requirement.
Disclosure analysis results
Companies affected by the requirement began disclosing the CEO pay ratio, which is based on calendar year 2017 compensation ( or fiscal years beginning after January 1, 2017) , in their 2018 ( or possibly 2019 for late fiscal year companies) annual proxy statements. Because this was the first time for these disclosures, Deloitte wanted to capture how companies disclosed their CEO pay ratio and the methodology they used—both to assist other companies who may be disclosing later this year and to develop a baseline analysis about the data that was disclosed.
For example, our analysis of pay ratio disclosures of 294 S&P 500 companies from proxy statements filed as of April 10, 2018, revealed the following.
- The pay ratio, and the median employee’s compensation used to calculate it, cannot be compared across companies—each company’s unique structure leads to a very different median employee, even within similar companies.
- There is large variation in pay ratios across industries, within an industry, and across revenue sizes. There is a clear trend that the larger the organization, the higher the ratio. This is directly related to the CEO’s level of compensation, which generally increases to reflect the size and complexity of the organization, whereas the median employee’s pay is far less likely to be affected by the overall company’s size.
- Eighty-one (81) percent of companies analyzed placed the CEO pay ratio disclosure immediately following the termination tables—this is to physically separate the pay ratio disclosure from the CD&A, effectively saying that the pay ratio calculation has no influence in how the Board and company determine pay or design the executive compensation program.
- There was fairly even distribution in the Consistently Applied Compensation Measure (CACM) used by companies—Base Pay (23 percent), Total Cash Compensation (32 percent), Total Direct Compensation which includes Equity (18 percent), and W-2 Wages (20 percent).
- Twenty-one (21) percent of companies analyzed provided background information on the median employee (employment status, geographic location, and/or role), while 13 percent of companies disclosed supplemental ratios. Many companies followed a “less is more” approach to disclosure this year to avoid being seen as defensive, but some additional disclosure could provide meaningful and constructive context for shareholders and other readers.
You can see all of our analysis findings here. We also offer the following lessons learned for your consideration.
- Start early. The data-gathering effort is considerable and typically requires input across disciplines: HR, payroll, legal, finance.
- Don’t let perfect be the enemy of good. Do your best to get complete data on every employee, but realize that some data may be too difficult to get to justify the effort and will have little impact on identifying the median employee.
- Be prepared to address stakeholder questions. Developing a list of FAQs can be helpful to describe things like the company’s pay philosophy, what the median employee represents, and “who” that employee is in general terms (e.g., job role and location).
- Consider providing context. While simply disclosing the pay ratio fulfills the requirement, it can be helpful to provide more context for what the ratio represents, such as explaining why the median employee’s compensation amount may vary even within the same industry. Providing alternative ratios can also be helpful. For example, if the median employee is a seasonal employee who worked three months during the year, you may want to consider providing an alternative pay ratio based on a full-time employee.
- Look at improving Human Resources Information Systems (HRIS). While the initial exercise to identify the median employee and calculate the pay ratio was likely not an easy task for any company, it’s safe to say that companies with a more robust HRIS and consolidated payroll systems fared far better in collecting the required data. The rules allow companies to use the same median employee for three years (or use a similarly situated employee should the prior median no longer be an employee), so the actual data-gathering effort will be less intensive in years 2 and 3 for those companies who chose to use the same employee in those years. However, companies that had to put forth a Herculean effort to determin the first year’s median employee will likely face similar difficulties the next time calculations are required, unless they’ve made improvements to their HRIS in the meantime.
Like it or not, we do not anticipate that CEO pay ratio disclosure requirement will be going away anytime soon. We will continue to monitor how disclosures play out in practice and offer insights to help companies comply efficiently and effectively.