CEO Pay Ratios: Deal With It

What is your company doing to prepare?

By Chris Fischer, Senior Client Partner, Executive Pay & Governance Practice, and William Gerek, Associate Client Partner, Executive Pay & Governance, Korn Ferry Hay Group.

It seemed a ways off when the Securities and Exchange Commission adopted a final rule more than a year ago requiring public companies to disclose the ratio of the CEO’s compensation to the median employee’s—commonly referred to as “CEO pay ratio.” But as the date inches closer, the pertinent questions become “Are companies well prepared?” and “What can boards do to help?”

To be sure, no disclosure will be required until fiscal years beginning in 2018, using pay data for 2017, and the upcoming Trump presidency could change some or all of this eventually. But for now, companies must comply, and according to a Korn Ferry Hay Group study, roughly half of them are not ready.

Our survey of 150 publicly traded companies found that 45 to 51 percent of CEOs, HR experts and board members expressed concern over several key areas:

  • understanding the steps to make the disclosure;
  • obtaining and collating the necessary employee data to calculate the CEO pay ratio;
  • determining what to disclose in the various filings; and
  • choosing the best methodologies for data collection and analysis.

In addition, more than half of the respondents were concerned about ensuring that the ratio reflects reality and presenting the best picture to the public, as well as the potential for negative press.

Korn Ferry Hay Group CEO Pay Ratio Study 2016

For companies that have not yet geared up to meet this new disclosure requirement, it isn’t too late. Here are a few recommendations:

Tailor your solution. Since the key variable in a company’s ratio from year to year likely will be the CEO’s compensation, examine fluctuations in CEO pay in recent years. The starting point in any analysis of a company’s CEO pay ratio is to understand what information may be required, given the organization’s particular facts and circumstances. Then develop a working timeline with action steps (including any determinations and decisions), responsible parties and target completion dates.

Consider a “dry run.” Armed with 2016 compensation data, and external assistance as needed, companies may seek to test the process. This would include evaluating alternatives and exemptions, as well as establishing a baseline approach to build upon. Also consider developing a draft disclosure to gain a better understanding of how to properly explain the results to readers and to provide helpful context and rationale.

Carefully consider your “median employee.” Determine the best approach for your company in identifying your median employee, taking into account such critical factors as how seasonal versus part-time workers might impact the testing date selected, and what adjustments to payroll and other systems will be required. Sample size, reasonable assumptions and considerations for non-US-resident employees also may impact the determination.

Plan for potential fallout. Be prepared to proactively address possible consequences of CEO pay ratio disclosure to a range of stakeholder groups by anticipating if and how the disclosure could be perceived poorly. Also plan for costs associated with additional time spent by internal personnel and external advisors, plus the potential impact on employee morale and retention, particularly for the half of employees falling below the median compensation number.

As compensation experts, we don’t find the new pay ratio disclosure rule mandated by Dodd-Frank particularly meaningful, because there are a number of variables that make potentially useful comparisons virtually impossible. Nonetheless, companies will still have to comply annually in various SEC filings. They should begin doing the necessary prep work now to ensure that they arrive at a ratio that best reflects their reality, and so they are prepared to manage stakeholders’ reactions.