Executive Compensation Practical Pointers
As proxy season gets started, we have already seen quite a few proxy statements and other filings, like Forms 10-K, that include the CEO pay ratio disclosures required by Dodd-Frank. In these filings, some consistent themes have arisen as well as some items and language that companies may want to consider including in their upcoming proxy statements.
Below are some observations that we have made after reviewing some of the currently available pay ratio disclosure:
- Magnitude of Ratios: The largest ratio we have seen is 429:1 (KKR & Co. L.P.) and the smallest is 1:1 (Apollo Global Management LLC). Many ratios are disclosed as whole numbers, though some have gone out to one or two decimal places.
- Location of Disclosure within the Proxy Statement: Many of the proxy statements include the pay ratio disclosure right after the summary compensation table and related tables and before the director compensation section. This placement is logical because the disclosure is kept out of the CD&A and is, therefore, not subject to the Compensation Committee certification. One proxy statement included the disclosure in an “Other Legal Disclosures” section at the end of its proxy statement.
- Format of Disclosure: Most of the ratios have been disclosed in narrative format, though some issuers have chosen to disclose in a tabular format.
- Reasonable Estimates: As permitted by Item 402(u) of Regulation S-K (“Item 402(u)”) and related guidance, many issuers are choosing to reference the use of estimates for both the pay ratio itself and in the underlying calculations for determining the ratio. Though not required, issuers might consider leaving themselves some latitude in the disclosure when dealing with compensation numbers, particularly where foreign employees and/or large employee populations exist.
- Compensation Elements for Ranking Employees: For purposes of ranking employees by compensation in selecting the median employee, using W-2 compensation as the measure has been quite popular, though myriad variations on cash compensation (e.g., base salary, base salary plus bonus, base salary plus bonus plus equity awards) have also frequently been used.
- Alternative Ratios: As permitted by Item 402(u), several issuers have included alternative pay ratios that are smaller than the required ratio. These alternative ratios often appear in the sentence immediately following the required disclosure and explain that some unusual item of compensation (such as a sign-on bonus for a newly hired CEO or a retention bonus as part of a merger) skewed the required ratio and that the CEO compensation used in the alternative ratio is more indicative of historical CEO compensation.
- Do Not Compare to Peers Statement: Many companies are pointing out in their proxy statements that pay ratios should not be used to compare the company to its peers because of the flexibility that each company is permitted in determining its ratio (e.g., differing compensation elements included for ranking employees, statistical sampling, and limited exclusions for foreign employees).
- CEO Replacement: Several filings have discussed the replacement of the CEO during the prior year. In these examples, the issuers most often chose to annualize the compensation of the new CEO (so long as that CEO was in place on the date selected for identifying the median employee) as opposed to combining the compensation for the new and old CEOs.
- Annualization of Compensation for New Hires: Not as many issuers are annualizing the compensation of new hires as we had expected. Such annualization likely would have resulted in a median employee with a higher compensation and thus decreased the pay ratio. Companies may be avoiding annualization out of concern over employee reaction to a more highly compensated median employee.
- Business Combination Exception: As permitted under the instructions to Item 402(u), some issuers have excluded individuals who became employees of the issuer as the result of an acquisition or merger for pay ratio purposes. This exclusion could be because of the administrative difficulties of gathering the needed information or perhaps because such inclusion would increase the pay ratio or the compensation of the median employee, depending on the company’s primary sensitivity. Other filings have explicitly stated that such employees have been included in the calculations.