Top Ten Emerging Trends in Pay Ratio Disclosure

by Pillsbury Winthrop Shaw Pittman LLP
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Preliminary trends are emerging from the pay ratio disclosures filed by U.S. public companies in 2018.

Takeaways

  • Few companies use statistical sampling to identify their median employees and, instead, companies rely on a consistently applied compensation measure (or CACM).
  • In determining the median employee, companies rely on the de minimis exemption, but not the data privacy exemption. Companies also exclude employees acquired in acquisitions.
  • Very few companies use supplemental pay ratios, even if they have pay ratios that are on the higher end of the range.

Background

The 2018 proxy season is in full swing and, since the beginning of 2017 to date, 1,438 U.S. companies have made public disclosures of the ratio of the annual total compensation of their chief executive officer (CEO) to the median of the annual total compensation of all employees (referred to as the pay ratio) as required by Item 402(u) of Regulation S-K, which was added by the Dodd-Frank Wall Street Reform and Consumer Protection Act. For a detailed summary of the pay ratio disclosure requirements, see our alert “Brace for 2018: The SEC’s Pay Ratio Rule.”

Below is a list of the top ten emerging trends that we identified based on our review of the proxy statements and Form 10-Ks for 45 U.S. public companies that are large accelerated filers with a market capitalization of at least $25 billion filed between January 1, 2018 and March 16, 2018. As companies continue to disclose their pay ratios, we expect trends to evolve.

Pay Ratio Ranges

The 45 companies in the data set represent eight industries. The range of pay ratios differs by industry, with companies in the Industrial & Manufacturing and Wholesale & Retail industries having the highest pay ratios and companies in the Financial & Insurance industry having the lowest pay ratio.

Emerging Trends

1. Placement of Pay Ratio Disclosure

  • The Securities and Exchange Commission (SEC) does not require that the pay ratio disclosure be included in the Compensation Discussion and Analysis (CD&A) or otherwise in the executive compensation section of a company’s proxy statement or Form 10-K. Therefore, companies have flexibility in terms of where they place their pay ratio disclosures.
  • The overwhelming majority of companies that we reviewed—22 companies (or 49 percent) – placed their pay ratio disclosures at the end of the “Potential Payments Upon Termination or Change in Control” table after all the compensation-related tables in the proxy statement. The remaining 23 companies placed their disclosures in a variety of other locations in their public filings, including in the CD&A and among the executive compensation-related tables.

2. Use of Disclaimers

  • Companies are allowed to provide a disclaimer statement in their pay ratio disclosure that, given the different methodologies used by public companies to determine an estimate of their pay ratio, the estimated pay ratio should not be used as a basis for comparison between companies.
  • 13 companies (or 29 percent) included a disclaimer statement in their pay ratio disclosures.

3. Supplemental Pay Ratios

  • The pay ratio rules allow companies to make supplemental disclosures, including additional ratios if desired. Supplemental pay ratios may provide helpful context for investors, especially for those companies with pay ratios on the higher end of the range.
  • Only two companies (or 4 percent) provided supplemental pay ratios:

* A company in the Healthcare & Pharmaceutical industry with a pay ratio of 313 to 1 included a supplemental pay ratio of 223 to 1, which excluded the CEO’s special one-time performance-based incentive award.

* A company in the Energy & Natural Resources industry with a pay ratio of 935 to 1 included a supplemental pay ratio of 156 to 1, which excluded approximately 32,000 retail employees from its pay ratio calculation.

4. Description of Median Employee

  • The pay ratio rules require that only the median employee’s annual total compensation be disclosed, and the rules do not require that any identifying features of the median employee be disclosed. However, companies may voluntarily disclose such features.
  • Nine companies (or 20 percent) included a description of their median employee in their pay ratio disclosure. Of the nine companies, six companies disclosed the employee’s location, three companies disclosed the business segment for which the employee worked, two companies disclosed whether the employee was part- or full-time and one company disclosed whether the median employee received a special pay component.

5. Consistently Applied Compensation Measure

  • In determining the median employee, companies may rely on a consistently applied compensation measure (or CACM), such as total cash compensation or total cash and equity compensation.
  • The three primary types of CACMs used by the companies that we reviewed were:

* total cash compensation (base salary or wages plus cash bonuses or commissions)—17 companies, or 38 percent;

* taxable income as reported on Form W-2 for 2017—12 companies, or 27 percent; and

* base salary or wages only—nine companies, or 20 percent.

6. Statistical Sampling

  • As an alternative to a CACM, companies may use statistical sampling to identify their median employee.
  • Only four companies (or 9 percent) used statistical sampling to identify their median employee. In addition, one company disclosed that it hired an audit firm which used statistical sampling to confirm that the company had correctly identified its median employee.

7. De Minimis Exemption

  • In determining the median employee, a company may exclude non-U.S. employees if they account for 5 percent or less of the company’s total employee population (including those excluded on the basis of the data privacy exemption, described below).
  • 20 companies (or 44 percent) relied on the de minimis exemption to exclude non-U.S. employees. Notably, one company in the Services industry relied on the exemption to exclude approximately 22,000 non-U.S. employees in 70 countries.

8. Data Privacy Exemption

  • In determining the median employee, a company may exclude non-U.S. employees if obtaining the information required to comply with the pay ratio rules would violate a non-U.S. jurisdiction’s data privacy rules. We note that the SEC has set the hurdle very high to rely on this exemption.
  • None of the 45 companies disclosed that they relied on the data privacy exemption.

9. Acquisition Exemption

  • A company may omit employees from its pay ratio calculation if the employees were added to the company’s workforce as a result of an acquisition or business combination for the fiscal year in which the transaction becomes effective, but the company must disclose the approximate number of employees that are omitted.
  • Six companies (or 13 percent) disclosed that they relied on this exemption. There is no cap on the number of employees that may be omitted from the calculation using this exemption. Notably, one company in the Industrial & Manufacturing industry omitted approximately 40,000 employees acquired in 15 corporate transactions in 2017 from its pay ratio calculation.

10. COLA Adjustment

  • Companies may determine their median employee by adjusting the compensation of their employees to the cost of living in the CEO’s jurisdiction.
  • None of the 45 companies disclosed that they made a cost-of-living adjustment.

Conclusion

Based on the trends discussed above, we think that companies will spend most of their time determining their CACM and median employee. Once the median employee has been identified, a company may rely on that determination for three years unless there has been a change in the company’s employee population or compensation arrangements that it reasonably believes would result in a significant change to its pay ratio disclosure. Because this determination can be onerous, it is unlikely that companies will make significant changes to their pay ratio calculations in 2019. Additionally, companies should consider the best location for their pay ratio disclosure, whether to add a disclaimer and whether any of the exemptions are available. Finally, it seems unlikely that companies will elect to provide supplemental pay ratios, take advantage of the statistical sampling alternatives, use the data privacy exemption or provide a COLA adjustment.

The authors wish to thank Julie Park and Charmaine D. V. Lindley  for their contribution to this alert.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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