Under a new rule adopted by the Securities and Exchange Commission last year, public companies in the US will be required to disclose the ratio between the compensation of the CEO and the median annual compensation of every other employee in their proxy statements, starting with the 2017 fiscal year. While the deadline for that first disclosure is still more than a year away, employers affected by the rule are already starting to worry about how their employees will react to these figures: At a moment when a lot of attention is being paid to income inequality, there’s a good chance they will be received negatively.
Estimates of the average CEO-to-median-employee pay ratio vary: the AFL-CIO has put it at about 340:1, but a recent survey from Mercer found that the typical company’s ratio was under 200:1, with considerable differences between organizations comprising mostly salaried professionals and those that employ large numbers of part-time, temporary, and low-skill employees. In any case, these differences are academic in so far as low-ranking employees won’t likely feel much better knowing their CEO only makes 200 rather than 300 times as much money as they do—though a survey published this summer found that most US employees who do know how much their CEO earns are OK with it.
The bigger issue, in fact, is the disclosure of the median employee’s compensation. While few employees will be shocked to learn that their CEOs earn a lot more than they and their peers do (public companies already disclose CEO pay anyway), organizations affected by this rule will soon have half of their employees discovering that they are earning a below-average salary for their company, which may well prove harder for these employees to accept. This discovery may put significant upward pressure on wages and could damage employee morale, meaning that leaders need to figure out how to communicate these numbers in a way that softens the blow. SHRM’s Joanna Sammer suggests some problem-solving HR can do ahead of the 2018 deadline:
When employees believe that they are being paid less than they deserve, many simply leave—triggering a potentially costly and lengthy process to find replacements, HR Magazine reported earlier this year. But rather than fearing pay ratio disclosures, “This is an opportunity to discuss how compensation for the workforce aligns with the company’s values, culture, future growth plans and the brand,” said Lisa Disselkamp, managing director with Deloitte in Washington, D.C. “The HR leader is in a position of explaining their compensation of the larger workforce relative to these executive level pay.” …
This more complex story could include a number of additional data points that put disclosures in context against the company’s earnings, revenue and other metrics. “The goal is to tell a broader story about the workforce that could offset some of the uncomfortable metrics with additional measurements,” Disselkamp said. “This could mean including contractor pay when calculating the pay ratio if the company uses a lot of technology contractors, for example.” Other elements of employee pay can also be factored in, including overtime pay, paid time off, and the value of both financial and nonfinancial benefits, like flexible scheduling.
Another tricky issue is how to calculate the median employee’s pay. Many employers are opting for a calculation based on a comprehensive definition of compensation, but Steve Seelig and Rich Luss from Willis Towers Watson recommend a simpler approach using base pay:
You have less flexibility when using a more inclusive definition. The more basic the compensation definition used, the more likely it is that a company will end up with several “medianable” employees to choose from. For example, if base pay or target cash compensation is used as the compensation definition, we’ve found that there may be several employees at virtually the same pay level. At this point, the regulations permit companies to use any reasonable approach to determining who would be considered the median employee, so companies could then compare the pay histories of this group of employees in deciding which one to select. …
For companies that have direct access to base pay data for most or all of their workforce and relatively little access to consistent data on other measures of pay, using base pay will be the most cost-effective approach. Many clients we have spoken to are interested in reducing the costs of this compliance effort and believe that using base pay will produce an accurate result. This is perfectly acceptable under the regulations, and the reasons for choosing this definition of compensation need not be described in the proxy disclosure. The regulations require only a brief description of the methodology used — not an explanation of the reasons why that methodology was selected.