CEO Pay Ratio Observations from 2018 and Insights for 2019
During 2018, companies filed their first proxy statement containing the infamous CEO pay ratio disclosure, so what have we learned? The answer may be best summed up by Equilar’s Dan Marcec, who said that the disclosures are “not telling us any more about income inequality that we didn’t already know.” Given that proponents of the pay ratio disclosure intended for it to shine a light on CEO pay practices and possibly lead to executive compensation reform, the rule may have missed the mark.
The SEC stated that the rule was “designed to allow shareholders to better understand and assess a particular registrant’s compensation practices and pay ratio disclosures rather than to facilitate a comparison of this information from one registrant to another.” The rule may have failed in this regard as well, since very little can be learned about compensation practices at a given company based on its disclosure, which often consists of just a few sentences. In addition, the lack of standardization in how the ratio is actually calculated makes it difficult to determine what is actually revealed in the disclosure. The SEC gave broad latitude in its final ruling on the important pay calculation for the median employee. Furthermore, the nature of a particular organization’s workforce can influence the ratio significantly, especially if it employs a significant number of part-time, seasonal, or non-U.S. workers. Finally, the most common application of this year’s first round of disclosures was to compare companies to their industry or geographic peers — an outcome that was unintended by the SEC.
The main outcome from the first round of CEO pay ratio disclosures may have been a few somewhat interesting news stories related to companies that had surprisingly high ratios. For example, the toymaker Mattel’s proxy disclosed that the company’s CEO was paid 4,987 times the compensation of its median employee. Margo Georgiadis was named Mattel’s CEO in February 2017, and the majority of her $31.28 million in 2017 compensation was composed of one-time equity grants related to her hire. In reality, she didn’t actually receive anywhere near $31.28 million in compensation for 2017, as the equity grants were subject to both time- and performance-based vesting conditions. In fact, these equity grants were largely forfeited, as she resigned from Mattel in April 2018 to “pursue a new opportunity.”
Since the CEO pay ratio is here to stay (at least for the upcoming 2019 proxy season), it’s worth noting that the calculation should be less complicated the second time around. This is largely because the SEC only requires identifying the median employee once every three years. Therefore, the same median employee that was used in last year’s calculation can be used again this year. There may be exceptions to this if there were significant changes to the median employee’s circumstances, or there were changes to the company’s overall employee population that the company could “reasonably believe would result in a significant change in its pay ratio disclosure.”
Preparing the CEO pay ratio for 2019 will be simplified, not only due to the ease of identifying the median employee, but also because of the data available on how other companies prepared their disclosures. For example, in the first year of the disclosure, many companies considered whether to include an alternative pay ratio in addition to the required ratio. Based on data from 2018, only about 16% of the S&P 500 companies included an alternative ratio, so it could be reasonably concluded that most companies did not see value in providing an alternative disclosure. In general, most companies presented their 2018 CEO pay ratio disclosure in a way that met the requirements without adding unnecessary complexity.
The following table provides some additional data on how S&P companies utilized exemptions or adjustments in their CEO pay ratio disclosure last year:
Source: Shearman & Sterling, “CEO Pay Ratio: Perspectives on the First Year and a Look Forward”
In short, our recommendations for preparing the 2019 CEO pay ratio disclosure would be to use the same median employee identified in 2018 (provided that there were no significant changes) and to keep the disclosure short and simple.
Dan Steele and Joe Kager of the POE Group.