In August of 2015, the U.S. Securities and Exchange Commission (SEC) issued the Pay Ratio Disclosure Final Ruleunder the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule requires a public company to disclose the total pay of its CEO and its median-paid employee, and the ratio between the two. The rule will be effective for compensation paid in fiscal years starting on or after January 1, 2017 and must be disclosed in SEC filings requiring executive compensation disclosure (e.g. annual reports on Form 10-K, proxy statements) starting in 2018.

Although disclosure is not required for two years, the pay ratio number is expected to attract significant media and employee attention. Companies should begin to develop strategies now to meet the rule’s requirements and handle the potential impact of this disclosure.

Here are some key facts about the pay ratio rule and some information covered employers may wish to consider as they prepare.

What is pay?

Pay includes salary, overtime compensation, bonuses, and stock awards.

Who is the median employee?

In calculating the median employee, the company must count practically everyone: full-time, part-time, temporary, and seasonal workers. Independent contractors hired through third parties are not included.

While the median employee must be an actual employee at the company, companies are not required to identify the median employee.

What should a company do to locate the median employee?

The SEC rule gives companies the flexibility to determine the median employee. Companies may use such methods as statistical sampling and consistently applied compensation measures, among others. Companies may make reasonable estimates in determining the median employee and must be prepared to explain what methodology they used and why.

What could the pay ratio look like?

If, for instance, the median employee’s compensation is found to be $50,000 and the CEO’s compensation is $10 million, the CEO’s pay is 200 times that of the median employee and the pay ratio would therefore be 200:1.

Who could be interested in this information?

In short: everyone. CEO compensation is a hot topic. Though CEO pay information is already found in proxy statements, pay ratio disclosure will make the information much more vivid. Ratios in the hundreds could make for dramatic headlines.

In addition, the following groups will be interested in median employee information:

Unions

Not only will the ratio create a dramatic picture of the top person versus the median worker, it will also provide unions with information as to how an employee’s pay compares to that of other workers. This could  be particularly valuable to unions during bargaining if the pay of their average union worker falls below the median.

Nonunion Employees

Nonunion  employees may push for increases if their pay falls at or below the median.

Regulators

A high pay ratio could be an indication of excessive executive compensation, causing regulators to take a closer look at executive pay.  On the other hand, high median pay could cause regulators to push companies to control pay increases.

Community Groups, Shareholders, and Other Stakeholders

They may be interested in the reasonableness of executive pay versus that of the average worker. 

What should companies do now to get ready for the pay ratio disclosure?

There are a number of actions that companies can take now to prepare for the effective date of the disclosure rule.

  • Meet with the compensation committee of the company’s Board of Directors to explain the rule and its implications.
  • Educate the company’s senior officers, the human resources department, and the investor relations department about the rule and its implementation
  • Identify key internal resources (e.g., human resources, investor relations, public affairs, and the legal department) to set up teams to determine the median employee and potential stakeholder impact.
  • Look at payroll systems and evaluate possible methodologies to identify the median employee.
  • Calculate the compensation of the median employee and the potential ratio based on current data to estimate possible outcomes.

What are some key issues to consider?

  • What is the median pay number, and how will it compare?
  • How big is the ratio, and how will it look compared to that of other companies?
  • Which groups and stakeholders will be most impacted?
  • How will the company’s response and message be crafted?
  • How will the company roll out this information, i.e., in advance of the disclosure or in response to questions from investors, the press, or employees?