Although adopted back in 2015, the SEC’s pay ratio disclosure rule has been receiving a lot of attention lately, as companies grapple with it for the first time during the 2018 proxy season. The rule was mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act and generally requires a public company to disclose in its proxy statement the pay ratio between its chief executive officer and its median employee for the most recently completed fiscal year. In particular, the rule requires disclosure of each of the following items:
1) The annual total compensation of the company’s median employee; 2) The annual total compensation of the company’s CEO; and 3) The ratio between the amounts disclosed in (1) and (2).
The process to determine your employee population and then identify your median employee within that population in accordance with the rule can, in some cases, be surprisingly time consuming and complicated. As part of the required disclosure, you will also need to briefly describe the methodology and any material assumptions, adjustments and estimates you used to determine your median employee in accordance with the rule.
Regardless of the methodology you use to identify your median employee, you start calculating your median employee’s annual total compensation under the pay ratio rule by following Item 402(c)(2)(x) of Regulation S-K. The application of Item 402(c)(2)(x) will be very familiar to you, as it is already how you calculate “total compensation” for any named executive officer in the Summary Compensation Table of your proxy statement. The same is true for your CEO–you calculate annual total compensation for your CEO under the pay ratio disclosure rule by first looking at the total compensation column for the applicable fiscal year in the Summary Compensation Table.
Keep in mind, though, that Item 402(c)(2)(x) may not be the end of the story when it comes to calculating annual total compensation, as the pay ratio disclosure rule gives you a few options to consider. Under the rule, you may also add perquisites and personal benefits of up to $10,000, as well as compensation under non-discriminatory benefit plans, to your calculation of the median employee’s annual total compensation. Increasing the median employee’s compensation in this way may help you achieve a more favorable pay ratio. However, if you decide to include any of these types of compensation in your median employee’s annual total compensation, you are also required to include the same types in calculating your CEO’s annual total compensation under the rule (even if you chose to exclude them from the Summary Compensation Table, as may be permitted pursuant to Item 402(c)(ix) of Regulation S-K).
You may also face additional complications in calculating your CEO’s annual total compensation if you had more than one individual serve as CEO during the applicable fiscal year. In circumstances where a company had more than one non-concurrent CEO serving during any fiscal year, instructions to the pay ratio rule provide that a company may either (a) calculate the annual total compensation provided to each CEO who served during that fiscal year (while they served in the position as CEO) and combine those two amounts, or (b) annualize the compensation of the CEO who served in that position on the date as of which the company selected the median employee. In deciding which approach to take, you may want to consider which would yield a more favorable pay ratio in your circumstances. For example, if your first CEO was paid considerably more than your second CEO in any fiscal year, and your second CEO served on the date as of which you identified your median employee, you may wish to choose approach (b). In either case, you will need to disclose which approach you chose and how you calculated your CEO’s annual total compensation.
On the other hand, we note that the SEC has not yet provided guidance on how to address the disclosure requirements under the rule for companies that had more than one CEO serving concurrently as co-CEOs during any fiscal year. In these circumstances, I believe that, in the spirit of the rule, you would choose the co-CEO who had the higher annual total compensation for purposes of disclosure under the rule.
We invite you to contact us if you have any questions regarding the disclosure requirements, including how to calculate annual total compensation, under the SEC’s pay ratio disclosure rule.