As I noted in this recent blogpost, a survey conducted by Compensation Advisory Partners LLC of pay-ratio disclosures from 150 companies with a median revenue of $2.1 billion showed that, as of March 9, 2018, the lowest ratio was 1:1 and the highest was 1465:1. What? 1:1? How did that happen? For one explanation, I refer you to this column from Bloomberg’s hilarious Matt Levine, part of which I quote below:

“Berkshire Hathaway Inc.’s Warren Buffett is scoring particularly well on a new rule requiring companies to disclose the ratio of a chief executive officer’s pay to that of the median employee. His annual compensation of $100,000 was just 1.87 times the median employee’s pay of $53,510, a figure calculated from a sample of about two-thirds of Berkshire’s total employees, according to a filing released Friday. He also gives back about $50,000 to the company ‘for minor items such as postage or phone calls that are personal,’ meaning his take-home pay would be less than that median figure.

“First of all: Unlimited talk, text and data cell-phone plans will run you less than $1,000 a year; landlines are even cheaper. Warren Buffett spends … $49,000 a year on … postage? Like, for personal letters? It is a little mysterious.

“But also: Warren Buffett makes $100,000 a year? Really? I mean, yes, it is famously his salary. But Buffett increases his wealth each year in two ways: He gets paid for doing his job, and also he has billions of dollars invested in Berkshire Hathaway and most years Berkshire’s stock goes up. In 2017, Berkshire Hathaway’s stock was up about 22 percent, meaning that the value of Buffett’s shares increased by about $15.1 billion, to $84.1 billion. So in a sense he made $15.1 billion in 2017, or $15.1001 billion if you include his salary, or $15.10005 billion if you deduct the stamps. That’s a pay ratio of about 282,435 to 1.

“Is that the right way to count? Meh….”

That’s not really how much he is “paid,” Levine continued, it’s really how much his investment appreciated. But that’s how many people like to interpret it because stock appreciation is a big part of his economic reward.

“Obviously the Securities and Exchange Commission has good reason for counting only actual pay, and not stock appreciation, in its pay-ratio rules. And obviously Berkshire Hathaway has good reason for doing the calculation according to the rules. (And perhaps the median Berkshire employee also owns some stock that appreciated last year.) I don’t know exactly what those rules are meant to measure, though to be fair the SEC doesn’t know either. (‘Congress did not expressly state the specific objectives or intended benefits of Section 953(b),’ sniffed the SEC when it begrudgingly adopted the pay-ratio rules in 2015, five years after Congress mandated them.) But in any case, it’s clear that Warren Buffett’s annual economic reward for running Berkshire Hathaway is more than $100,000. That’s barely enough to cover his postage.”

However, this opinion piece from CFO.com frets that some pay ratios will seriously mislead investors—certainly not through any fault of the reporting companies, but rather as a result of flaws in the rule itself: “Most damning as to [the rule’s] lack of efficacy are instances of companies reporting what seem at first glance to be dubiously low ratios.” Looking at the CAP survey data, the author observes that the lowest ratios were reported by limited partnerships, the CEOs of which disclosed total annual compensation that was almost the same as that of their median employees. In those cases, he explained, the CEOs derived the vast majority of their income from dividends on their partnership equity (identical to the dividends paid to the public holders), which the SEC does not typically require to be included as part of total annual compensation in the Summary Comp Table in the proxy statement and, therefore, is not taken into account as part of the pay-ratio calculation.

The author was also skeptical about the other end of the range—the highest ratio reported so far at 1,465:1. (Note, however, that Bloomberg now reports the highest pay ratio at 2,526:1) In that instance, the CEO’s comp was about $8.5 million, while the median employee was paid less $6,000 a year. But the company’s workforce included a number of part-time, temporary and seasonal employees, and 80% of the employees were located in Latin America, Africa and the Philippines. In addition, the author questioned the company’s use of statistical sampling to identify its median employee (a method expressly permitted by the SEC), given the sample size of slightly over 200 out of almost 40,000 employees. What to make of this company’s pay-ratio information, the author asked: “With its employees concentrated in low-wage countries and consisting of many less-than-fulltime workers, does the fact that its pay ratio is the highest reported so far have any real meaning?…In addition, various sampling methodologies are allowed, and two competitors can choose different ones. How does that help investors?”

Of course, it just might be that the critics are looking at this all wrong. In the final rule release, the SEC cautioned that: “we believe the final pay ratio rule should be 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. As we noted in the Proposing Release, we do not believe that precise conformity or comparability of the pay ratio across companies is necessarily achievable given the variety of factors that could cause the ratio to differ. Consequently, we believe the primary benefit of the pay ratio disclosure is to provide shareholders with a company-specific metric that they can use to evaluate the PEO’s compensation within the context of their company.”

What to do? Two academics at MIT, writing in the WSJ, offer their solution (or at least, partial solution). To begin with, they also assert that the pay-ratio data is misleading, pointing, for example, to the anticipated difference in pay ratios for drug, financial and tech companies as compared with retailers’ pay ratios, which are expected to be two or three times higher. “But the reason,” they say, “isn’t soaring CEO pay in the retail industry. For one thing, midlevel retail workers simply make less, on average, than their peers in pharma, finance and tech, which skews the ratio. Another issue is that 31% of retail employees work part-time, compared with 17% for the rest of American employees.” But under SEC rules, companies may not adjust part-time pay to show its full-time equivalent (or, for that matter, “annualize” seasonal pay to year-round pay). As a result, these data drag down the median. And the comparison is not even a fair one, they say, because the CEO is (presumably) paid for full-time, year-round work. Here is their example:

“To understand how much this might overstate the pay ratio, we examined data for a midsize retail company that operates about 1,200 stores, primarily in the U.S. The company had more than 25,000 employees in 2017. Almost half worked less than 30 hours a week. The median pay of these part-timers (without annualizing) was less than $6,000 a year. By contrast, the median pay of full-time employees who worked for the whole year was approximately $30,000. Under the SEC’s methodology, the median pay of all the company’s employees would be $14,928. Since the CEO reportedly earned a little more than $6 million, the ratio would have been 408.”

Their recommendation: annualize the pay of part-time workers into full-time, full-year equivalents. Applying their recommendation to the example above, they came up with an adjusted median pay of $23,133 and an adjusted pay ratio of 263:1, substantially lower than the version calculated under SEC rules. They advocate that the SEC implement this modification and, to accelerate matters, issue guidance now that would permit companies to take advantage of the change.

But this concept is hardly novel; it’s more like “asked and answered.” The SEC’s proposal on pay ratio prohibited adjustments to full-time equivalence for part-time employees or annualizing adjustments for temporary or seasonal employees. Annualization under the rule was permitted only for employees who did not work the full year because they were newly hired or on leave for specified reasons. But the SEC received many comments in response to the proposal contending

“that the final rule should permit registrants to provide full-time equivalent adjustments for the salaries of part-time, temporary, and seasonal employees. Some of these commenters asserted that not doing so would distort the pay ratio. One of these commenters asserted that permitting full-time equivalent adjustments would not undermine disclosure or make it less accurate because any potential concern about shareholders’ understanding of the pay ratio would be mitigated by requiring registrants to disclose their full-time equivalency and the approximate number of part-time, seasonal, and temporary employees for which it made the calculation.”

But after considering the comments, the SEC rejected the commenters’ arguments and adopted the rule as proposed. The SEC said that it was

“taking this approach in the final rule because [the SEC believed] it most accurately captures the workforce and compensation practices that the registrant has chosen to employ. The limited ability to annualize a permanent full-time or part-time employee reflects the fact that these employees are a permanent part of the registrant’s workforce despite having only worked for part of that particular year. In contrast, a temporary or seasonal employee is not a permanent part of the registrant’s workforce. Full-time equivalent adjustments of these employees’ compensation would reflect a different workforce composition and compensation structure than used by the registrant. To the extent a registrant believes that not making full-time equivalent adjustments for temporary or seasonal employees might not provide shareholders a complete understanding of the registrant’s compensation practices as they exercise their say-on-pay votes, the registrant is permitted under the final rule to provide additional disclosure.”

A survey by consultant Mercer (see this PubCo post) reported that 87% of respondents indicated that they did not expect to add much additional information to their disclosures beyond the requirements. Only a few companies said they would report a second ratio that covers U.S. employees only. For the remaining 13% of companies in the Mercer survey, the most common additional information expected to be included was the median employee’s position or location, followed by more information about the company’s workforce, such as the proportion of part-time or seasonal employees or geographic location. The CAP survey found that only 15 companies included a supplemental pay ratio, and, for most part, the additional ratios typically reflected adjustments to CEO pay, not employee pay. (Note that some commentators have discouraged the use of supplemental ratios as creating confusion and litigation risks.) Will more companies now choose to provide supplemental information or pay ratios that address these issues? Will these complaints about misleading data persuade the SEC’s new administration to reopen the matter? Time will tell.