Action Item

New "pay ratio disclosure rules" require a public company to disclose the ratio of the annual total compensation of its CEO to the median of the annual total compensation of all employees, except the CEO. Prepare accordingly with the tips below.

Pay Ratio Rules

On August 5, 2015, the Securities and Exchange Commission adopted final rules implementing the "pay ratio disclosure rules," which require a public company to disclose the ratio of the annual total compensation of its chief executive officer to the median compensation of its employees.

Note that the pay ratio rules become effective for a company's first fiscal year beginning on or after January 1, 2017, so the first pay ratio disclosure will likely be in a company's 2018 proxy statement.

Tips to Prepare

Applicability

  • The rules apply to companies already required to provide executive compensation disclosure and do not apply to smaller reporting companies, emerging growth companies, foreign private issuers or registered investment companies, among others.

Determination of Employee Population

  • A company may select a date within the last three months of its fiscal year for determining its employee population, which can be the total employee population or a statistical sampling thereof.
  • A company is generally required to include all employees, including non-U.S., full-time, part-time, temporary and seasonal employees, in determining its employee population, subject to certain exceptions for non-U.S. employees.
  • However, a company may omit from the population any employees obtained in a business combination in the fiscal year in which the transaction occurs, although it will need to disclose the number of employees omitted.

Selection of Median Employee

  • A company is permitted to annualize the compensation for a permanent (part-time and full-time) employee who did not work the whole year, such as a new hire, but may not annualize compensation for temporary or seasonal employees nor make full-time equivalent adjustments for part-time employees.
  • A company generally will only need to identify the median employee once every three years (unless there is a change in the employee population or compensation arrangements, either of which would reasonably be expected to significantly change the pay ratio disclosure).
  • Identification of the median employee should be based upon employees' annual total compensation as defined in the SEC reporting rules or another compensation measure that is consistently applied to all employees included in the population, such as information from tax or payroll records.

Calculation of Compensation

  • The compensation amount reported for both the CEO and the median employee must be calculated for the last completed fiscal year using the definition of "total compensation" in the existing executive compensation rules (namely Item 402(c) of Reg. S-K), while allowing for the use of reasonable estimates.

Disclosure of Pay Ratio

  •  The pay ratio must be disclosed along with the CEO's pay and the median employee's pay, as either a numerical ratio (1 to "X"), or as a narrative multiple ("our CEO's Annual Total Compensation is "X" times that of our median employee's annual total income").
  • The issuer will be required to describe the methodology used for identifying the median employee and any assumptions used to determine the annual total income.