On August 5, 2015, the Securities and Exchange Commission adopted the pay ratio disclosure rule that requires public companies to disclose the ratio of CEO compensation to the median compensation of employees starting in 2017. Through this rule, companies will provide investors information to analyze a CEO’s compensation relative to the compensation of its employees and other companies. The rule will not apply to smaller reporting companies or companies of emerging growth, foreign private issuers, MJDS filers or registered investment companies.
The pay ratio disclosure will be required to be reported in registration statements, proxy statement and annual reports beginning January 1, 2017. Companies will be required to provide the following information in their disclosures:
the median of the annual total compensation of all employees, excluding the CEO,
the annual total compensation of the CEO, and
the ratio of the above items: median employee pay to the CEO pay (the “pay ratio”). The pay ratio can be expressed either as a ratio or as a multiple (ex: “the CEO’s pay for 2015 was 100 times the median of the total compensation of our total employees for 2015”).
Companies have considerable flexibility in determining the pay ratio. For example, when identifying the median compensation of its employees, a company could use total annual compensation or compensation amounts that were reported in its payroll or tax records. Adjustments for cost-of-living, employee foreign status and business combinations could also be used with adherence to certain requirements. Whatever methodologies, assumptions, or adjustments issuers choose to employ, they must provide appropriate disclosure of such in their filings.
The rule requires companies to disclose the median employee’s wage for the first time. Consequently, employees will quickly learn that they are near the bottom in pay at their company and will have a rough estimate of how their compensation compares to their peers. This new information could potentially create morale issues and problems within the company.
According to USA Today, CEO compensation as a whole has grown to nearly 300 times what an average employee earns. Going forward investors will be able to see the pay ratio and consider whether a CEO provides hundreds of times the value of a company’s employees and decide whether to invest in that particular company.