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CEO Pay Ratio Season Is Heating Up

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With the New Year leaning into the second quarter, the initial trickle of CEO pay-ratio proxy disclosures has begun. Within the next few weeks, as proxy season arrives in earnest, that trickle will transform into a roaring river.

What that means for both compensation committees and companies in general remains to be seen.

A requirement created by a new Securities and Exchange Commission (SEC) rule, the CEO pay ratio became effective Jan. 1, 2017. Ostensibly designed to measure the ratio of compensation between a publicly traded company’s CEO and the company’s median employee pay, the rule creates a challenge for compensation committees.

When management presents its CEO pay ratio, how should a committee react? Steve Seelig, senior regulatory adviser at Willis Towers Watson, suggested a limited role of reviewing the disclosure for the upcoming proxy. Typically, compensation committees perform certain activities such as reviewing CEO performance and setting CEO pay, which is mandated by their charters with minimum requirements dictated by their listing exchange.

“Our experience indicates that SEC counsel generally likes to keep these charters focused, although we have seen some with more detail about additional responsibilities, and some that expand the committee’s role based on a company’s unique circumstances,” Seelig said, who pointed to an article from Willis Towers Watson on the CEO pay ratio and compensation committee challenges.

He explained that proponents of disclosing the CEO pay ratio had a very specific goal in mind: shaming companies whose ratios were out of line from peers. Compensation committees should not do their work for them, he warned.

“While it is important to understand how your company may compare to others — to be prepared for potential criticism — make sure that any peer comparisons do not become part of what you consider in setting CEO pay,” Seelig said.

He added that the compensation committee charter will not require the committee to take any action about the ratio, and it should be clear that the main job is to review the disclosure. When other ratios are disclosed later this year, he explained, there should be no need for a company’s compensation consultant to provide unfiltered data, similar to pay date, about peer company ratios.

“Companies are taking great care to state that shareholders should not use these disclosures for comparisons, so neither should the compensation committee,” he said.

Seelig also explained that high ratios often are caused because of CEO pay that might be out of line for a single year, or for organizations that already are aware that their CEO is paid highly compared to peers. They also are the result of the median employee being a part-timer, an overseas worker, or a combination of the two.

“So, if your business model differs from peers, that can explain the ratio,” he said. “The goal here should be to not use the pay ratio as a reference point in setting future CEO pay, unless a conscious decision is made to do so.”

Tom Langle, a principle and executive compensation expert based in the Mercer’s San Francisco office, said that the firm recently released the results from its February 2018 spot survey regarding CEO pay ratio. The median estimated ratio was 155:1. The results also include findings regarding the various methodology decisions companies can make based on SEC guidance, and what companies are doing to prepare for communications and disclosure.

For example, a Mercer Select Intelligence article explored how two early CEO pay ratio disclosures — by Teva Pharmaceutical Industries and Apollo Global Management LLC — resulted in two very different approaches and ratios: 302:1 for Teva and 1:1 for Apollo.

According to the authors, these early disclosures outline the different approaches companies may take and the wide range of ratios to expect during proxy season 2018. In fact, disclosures from calendar-year companies that must file proxy statements should start appearing in the coming weeks.

“While companies have some flexibility regarding methodology, which has proven helpful particularly for companies with large, global populations and data collection issues, the big unknown at this stage is how external audiences will react,” Langle said.

He noted that the most important of these audiences is each company’s own employees, who may be surprised to see how their own compensation compares to that of the median employee, or how their company’s median employee compares to that of competitor companies.

“As the year unfolds, and in particular the next couple of months, it will be interesting to see the reactions of employees, along with the media, investors and unions, and if there are any noticeable responses or trends that result,” Langle said.

Tom Starner is a freelance writer for WorldatWork.