Amid growing public and investor concern about major British companies potentially overpaying their top executives, the UK government has been kicking around the idea of instituting a pay ratio reporting rule since last year. The government hinted in April that it would propose the regulation soon, and now it is here. The proposal, which Business Secretary Greg Clark is presenting to Parliament today, will require all companies with more than 250 employees to disclose the ratio between the pay of their CEO and their average or median employee, as well as to explain this difference, the BBC reports:
The new rules, as well as introducing the publication of pay ratios, will also require listed companies to show what effect an increase in share prices will have on executive pay, in order to inform shareholders when voting on long-term incentive plans. … Mr Clark said: “Most of the UK’s largest companies get their business practices right, but we understand the anger of workers and shareholders when bosses’ pay is out of step with company performance.”
The plans were welcomed by the Investment Association – that represents UK investment managers – as well as business lobby group the CBI and think tank the High Pay Centre. Chris Cummings, chief executive of the Investment Association, said investors wanted greater director accountability and more transparency over executive remuneration.
That investors are leading the charge for transparency on executive compensation is unsurprising; activist investors were also key proponents of the pay ratio reporting rule that came into effect in the US earlier this year. Shareholders are voicing greater interest in exercising their “say on pay” prerogatives, particularly after recent scandals in the UK over executives receiving massive bonuses, in some cases without company performance justifying them.
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The UK government will propose legislation next month that will require companies to publish the ratio between the compensation of their CEO and that of their median employee, the Financial Times reported on Sunday. The rule is expected to come as part of a package of corporate governance reforms meant to address inequality by reining in executive compensation practices widely seen as excessive, which will also require boards of directors to demonstrate that they have acted in the interests of their companies’ employees, customers, and other stakeholders, rather than just the interests of investors. Large companies will also be required to certify compliance with a corporate governance code.
The writing has been on the wall for UK companies for some time now. The government first announced plans to institute a pay ratio reporting requirement last August, as well as to “name and shame” companies whose investors object to their executive pay packages. Recently, several large British companies have faced drubbings from investors and the media over the millions of pounds in bonuses they paid out to their top executives this year
At the beginning of this year, a report from the CIPD and the High Pay Centre revealed that the average FTSE 100 CEO earned £3.45m last year, or 120 times the £28,758 earned by the average British worker. At an average hourly rate of £898 per hour, the top CEOs earned more than the average employee by the third working day of the year, which campaigners quickly dubbed “Fat Cat Thursday.”
A regulation mandated by the 2010 Dodd-Frank financial reform legislation and adopted by the Securities and Exchange Commission in 2015 requires public companies to publish 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. The regulation was left in place by the Trump administration, although the SEC has made it slightly easier for companies to comply.
Not surprisingly, as companies have started to share this information, much attention has been paid to how much CEOs earn. The net result of this information coming out is the rather unsurprising insight that most CEOs make a lot of money. Companies have rightly been more worried about reporting the median employee salary, which some business groups have said is difficult to calculate and to communicate.
The intent of the rule was that by publishing this information, companies would have an incentive to raise the average wage of their employees to lower their CEO-median employee ratio in comparison to their peers. After all, as the denominator grows bigger, the ratio gets smaller. While there is certainly some truth to this effect, a much more interesting effect is emerging as companies release information about the median wage of their employees. Some of these disclosures are eye-popping; Facebook, for instance, reported a median employee salary of over $240,000, according to the Wall Street Journal, but of course this doesn’t count all the subcontracted workers it uses for services like security, cleaning, and food service at its facilities.
One of the observations we have made about the reporting of the median employee pay data is that, by definition, half of employees are paid below average. While some employees realize that they are paid below average, and are accepting of it, for a significant number of employees this certainly comes as alarming news. But now that more companies are reporting this information, we get to see how median employee compensation compares across companies. Deb Lifshey, Managing Director at Pearl Meyer & Partners, LLC, discussed these comparisons in a recent post at the Harvard Law School Forum on Corporate Governance and Financial Regulation:
Public companies in the US recently began publishing the ratios between the pay of their CEO and that of their median employee in compliance with a regulation adopted by the Securities and Exchange Commission in 2015 that went into effect in the 2017 fiscal year. The regulation, prescribed by the 2010 Dodd-Frank financial reform legislation, had been a potential target for revision, or reversal by the Trump administration, but major institutional investors, particularly activist funds, pressured the SEC not to delay or discard the rule.
As the due date for disclosure approached, executives expressed anxiety about how to communicate these figures to their employees, as well as how the media and shareholders would react. With regard to employees, the concern was not so much that they would learn their CEO was earning an outrageously large salary, but more that half of them were about to learn that they earned less than the median employee and would want to know why.
So far, over 500 companies have published their disclosures, and according to an analysis last month by ISS Analytics, “the numbers have landed all over the map,” from 1.87 for Berkshire Hathaway CEO Warren Buffett, to 2,526 for Aptiv PLC’s Kevin Clark (the median ratio for S&P 500 companies was 166:1). The SEC rule requires companies to compare salary alone, so the ratios don’t account for what CEOs earn from capital gains and dividends.
Because of this limitation, David McCann recently commented at CFO, the rule isn’t as helpful to investors as it’s supposed to be, as it allows some companies to massively undercount how much money their CEOs really make. McCann points to the examples of the private equity firms Apollo Global Management, which reported that its CEO Leon Black was paid $250,888 last year, and Carlyle Group, whose founding co-CEOs David Rubenstein, William Conway, and Daniel D’Aniello each earned $281,315. These numbers are only slightly higher than the pay of the hedge funds’ median employees, but, McCann argues, they are also meaningless:
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An analysis released this week by the CIPD and the High Pay Centre highlights the extent of income inequality in the UK by comparing the compensation of FTSE 100 CEOs to that of Britain’s average full-time employee, the Guardian’s Rupert Neate reports:
The chief executives of FTSE 100 companies are paid a median average of £3.45m a year, which works out at 120 times the £28,758 collected by full-time UK workers on average. On an hourly basis the bosses will have earned more in less than three working days than the average employee will pick up this year, leading campaigners to dub the day “Fat Cat Thursday”. …
The analysis … shows chief executives of FTSE 100 companies are paid an average of £898 per hour – 256 times what apprentices earn on the minimum wage.
The ratio between the pay of the CEO and the average employee (the definition of which is a matter of some controversy) is becoming a widely accepted standard for measuring income inequality within organizations and societies. As the pay gap between top executives and the rank and file has grown in recent decades, spurred on in some cases by tax loopholes, activists have decried this trend as evidence that CEOs are overpaid, while employees are not receiving their fair share of growing corporate profits.
In an effort to address inequality and curb CEO pay packages deemed excessive, the UK government has proposed new laws that will require listed companies to publish and justify their CEO-to-median-employee pay ratios, along with “naming and shaming” companies whose shareholders object to executive compensation plans as determined by the board. A similar disclosure rule was adopted in the US by the Securities and Exchange Commission in 2015, which will require public companies to publish their pay ratios in their proxy statements, starting with the 2017 fiscal year. Portland, Oregon has gone a step further and imposed a surtax on companies doing business in the city whose CEOs earn more than 100 times their median employee.
The CEO-employee pay ratio disclosure rule adopted by the Securities and Exchange Commission in 2015 will require public companies to publish 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. In response to employers’ concerns over how to comply with this rule, the SEC issued guidelines late last month that give companies some flexibility in deciding how to calculate the ratio in order to reduce the cost of compliance.
Despite the commission’s efforts to ease the burden, leaders at these companies remain concerned over the impact these disclosures will have on their workforces. A new survey from Willis Towers Watson illustrates some of these anxieties, finding that one half of companies say their biggest challenge in complying with the rule will be in anticipating their employees’ reactions to the disclosure:
The poll also found that almost half of respondents (48%) have yet to think about how or even if they will communicate the pay ratio to employees. About four in 10 (39%), however, are preparing leadership to respond to employees’ questions. Less than two in 10 respondents (16%) are prepping managers to have discussions with employees, while 14% created a detailed communication plan to educate employees. A similar number are not planning to say anything to employees.
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The rule adopted by the Securities and Exchange Commission in 2015 requiring public companies 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, appears to have survived the presidential changeover and is set to go into effect next year as scheduled. However, new interpretive guidance published by the SEC this week gives companies some additional flexibility in implementing the rule in order to reduce the costs of compliance, with SEC Chairman Jay Clayton saying the guidance “allows companies to use operational data and otherwise readily available information to produce the disclosures.” SHRM’s Stephen Miller details the key takeaways from the new guidance, which does the following:
- Explains the SEC’s views on the use of reasonable estimates, assumptions and methodologies, and statistical sampling permitted by the rule.
- Clarifies that a company may use appropriate existing internal records, such as tax or payroll documents, to identify the median employee and to calculate the median employee’s annual total compensation.
- Clarifies that appropriate internal records also can be used to determine if the company must include non-U.S. workers in pay ratio calculations (the SEC’s final rule allowed companies to exclude non-U.S. employees if these employees account for 5 percent or less of the company’s total workforce).
- Provides guidelines on when a company may use widely recognized tests to determine whether its workers are employees for purposes of the rule, which will allow employers to exclude independent contractors from pay ratio calculations.
This guidance addresses one of companies’ major complaints about the rule, which is that determining the median employee salary is harder than it looks, especially for large organizations with complex workforces in which it is not always obvious who counts as an employee. The SEC is providing some clarity here as to how companies can calculate that figure and making it a bit easier to do so. Employers’ hopes that the rule would be delayed or repealed before coming into effect appear to have been dashed, however.