The SEC has proposed rules related to pay ratio disclosures required by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. It works like this:
Make sure you have to do this. Emerging growth companies, smaller reporting companies, foreign private issuers and issuers under the Canadian Multijurisdictional Disclosure System need not bother with this as the proposed rules say they are not covered.
Find the employee in the middle: The Dodd-Frank Act requires the ratio to be calculated on the median employee, not average pay. To do this:
- A registrant may employ a methodology that uses reasonable estimates to identify the median
- In determining the employees from which the median is identified, a registrant may use its employee population or statistical sampling or other reasonable methods
- A registrant may identify the median employee using (A) annual total compensation or (B) any other compensation measure that is consistently applied to all employees included in the calculation, such as amounts derived from the registrant’s payroll or tax records.
Calculate the annual total compensation of the employee in the middle: The middle employee’s compensation must then be calculated in accordance with Item 402(c)(2)(x) of Regulation S-K. We all know this is hard to do for NEO’s because of the precision required, but the SEC gives some slack for the purpose of the pay ratio disclosure. The proposed rules say registrants may use reasonable estimates to calculate the annual total compensation or any elements of total compensation for employees other than the principal executive officer, or PEO.
Calculate the annual total compensation of the PEO. You need to do this anyway, and we know it’s not simple, but at least it’s not an extra step.
Calculate the Ratio: The proposed pay ratio disclosure requirements specify that the ratio must be expressed as a ratio in which the median of the annual total compensation of all employees is equal to one, or, alternatively, expressed narratively in terms of the multiple that the PEO total compensation amount bears to the median of the annual total compensation amount. For example, if the median of the annual total compensation of all employees of a registrant is $45,790,39 and the annual total compensation of a registrant’s PEO is $12,260,000,40 then the pay ratio disclosed would be “1 to 268” (which could also be expressed narratively as “the PEO’s annual total compensation is 268 times that of the median of the annual total compensation of all employees”).