Introduction

As has been widely reported, the government is intending to introduce legislation that requires all UK-listed companies with more than 250 employees in the United Kingdom to report annually on the difference in pay between their chief executive officer (CEO) and their average UK worker. The 250-employee threshold is the same as the threshold for gender pay gap reporting – although that applies to all companies, not just listed ones.

The plan forms part of the government's agenda for corporate governance reform (for further details please see "Executive pay ratio reporting – sound familiar?"). Details are contained in the draft Companies (Miscellaneous Reporting) Regulations 2018.

How will the 250-employee threshold apply?

To determine whether a company exceeds the 250 threshold, it must:

Find for each month in the financial year the number of persons employed under contracts of service by the company in that month (whether throughout the month or not)… add together the monthly totals… [and] divide by the number of months in the financial year.

If the listed company is a parent company, the number of UK employees within group companies must also be included, and pay ratio information must relate to the group rather than the company.

What ratios must be reported?

Under Draft Regulation 17, reporting will be required on the following ratios:

  • CEO to the 25th percentile pay ratio (so-called 'Y25');
  • CEO to the median pay ratio (so-called 'Y50'); and
  • CEO to the 75th percentile pay ratio (so-called 'Y75').

CEO pay is the total remuneration paid to the director carrying out the role of CEO in the relevant financial year. This is based on "the existing 'single figure' in the directors' remuneration report" and must include all elements of remuneration, including:

  • salary;
  • fees;
  • benefits;
  • bonuses;
  • share schemes; and
  • pension benefits.

If more than one person undertakes the role of CEO in the financial year, the total remuneration paid to all persons who held the role must be calculated.

The 25th, median and 75th percentile pay ratios are based on the pay of a representative employee who falls under these pay percentiles – so-called 'P25', 'P50' and 'P75'. 'Employee pay' for these purposes is the employee's full-time equivalent pay and benefits.

How should these be calculated?

The regulations give companies three choices as to how they make the calculations:

  • Option A is to calculate the pay and benefits of all UK employees for the relevant financial year in order to identify P25, P50 and P75, and use those figures.
  • Option B is to use the most recent hourly rate gender pay gap information for all UK employees to identify three UK employees as the best equivalents of P25, P50 and P75.
  • Option C is to use data other than, or in addition to, gender pay gap information to identify three UK employees as the best equivalents of P25, P50 and P75. However, in so doing the company must not use data that:
    • relates to any year prior to the preceding financial year; or
    • is less up-to-date than the gender pay gap information.

Employers will be tempted to crunch the numbers on all three bases before determining which route is preferable, but the directors' remuneration report must include an explanation of why the company has chosen the option that it has.

There are also some anomalies. For example, the definition of an 'employee' (someone who works under a contract of service) is different from that used in gender pay reporting (the wider definition under the Equality Act, which includes workers and some self-employed contractors). Therefore, it is unclear how companies using contractors as well as employees can safely rely on their gender pay gap data.

Whichever option is used, Y25, Y50 and Y75 must be determined with reference to a day no earlier than three months before the last day of the relevant financial year, using a projected calculation of the salary component of pay and benefits. The company can base the calculation on salary only or use a different methodology in calculating benefits, provided that this is explained in the report. If data is unavailable, the company must use a reasonable estimate.

What else must the report include?

Companies must justify their CEO's salary, as well as report on how their directors take employee and other stakeholder interests into account. Specifically, the directors' report for the financial year will need to contain a statement describing the action that has been taken during the year to:

  • introduce, maintain or develop arrangements aimed at systematically providing employees with information on matters of concern to them as employees;
  • consult employees or their representatives on a regular basis to ensure that their views can be taken into account when making decisions which are likely to affect their interests;
  • encourage the involvement of employees in the company's performance through an employees' share scheme or by some other means; and
  • achieve a common awareness among employees of the financial and economic factors affecting the company's performance.

While directors will need to summarise how they have engaged with employees and regarded their interests, information about impending developments or matters in the course of negotiation need not be disclosed if the disclosure would, in the directors' opinion, be seriously prejudicial to the interests of the company.

Directors will also be required to show the effect that an increase in share prices will have on executive pay, in order to inform shareholders when voting on long-term incentive plans.

In each year's report, companies will be required to report the same ratios for up to nine financial years immediately preceding the relevant financial year. The report must also explain the reasons for any changes each year. This means that, over time, there will be a ready reference source as to whether a company's pay gap is narrowing or widening – the implicit intention presumably being that the gap will narrow rather than widen.

Comment

If Parliament approves the proposals, the regulations will come into effect from 1 January 2019, with the first pay ratio reports due to appear in 2020.

The government has been emboldened by what it sees as the success of the gender pay gap reporting regulations and hopes to use these new rules as a tool to address public concern over pay inequality. However, compiling the data required to produce the reports will be another headache for overstretched legal, human resources and payroll teams. If the lesson of gender pay gap reporting is anything to go by, the new regulations may not be as straightforward as the government intends.

For further information on this topic please contact Colin Leckey at Lewis Silkin by telephone (+44 20 7074 8000) or email (colin.leckey@lewissilkin.com). The Lewis Silkin website can be accessed at www.lewissilkin.com.

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