Understanding Pay-Ratio Disclosures
Disclosure of the ratio of CEO’s annual compensation to that of median employees is a requirement for certain public companies as of 2018. The requirement gives leeway in the calculation, allowing ratios to vary greatly even within the same industry. Because of the ambiguity of ratio disclosure, investors and public companies should use caution when evaluating companies based on ratio disclosures.
The Rule
All U.S. public companies that are required to provide Summary Compensation Table disclosures are subject to the ratio disclosure rule. Pay ratios must be disclosed by covered companies in several facets including annual reports, on Form 10-K, in proxy and information statements, and in registration statements (if these filings require executive compensation disclosures).
The following companies are exempt from the ratio disclosure rule:
Emerging growth companies (EGCs), Smaller reporting companies (SRCs), registered investment companies, foreign private issuers, and Canadian companies filing in the United States pursuant to the Multijurisdictional Disclosure System.
Calculation
To ease the burden of compliance with the pay ratio disclosure rule, the SEC gives significant flexibility in calculating pay ratios. Companies can choose a process that works best for their business model as long as the methodology used in determining the median employee pay, and the estimates used in calculating the pay ratio are disclosed.
One methodology could be a using only base salary or W-2 wages, which would exclude computations bonuses, overtime, stock options, and other forms of compensation to determine ratios. Or, they could use a statistically representative sample of their workforce rather than the entire population.
When identifying the median compensation, the SEC allows the use of “reasonable estimates,” rather than exact calculation. This rule also allows companies to exclude 5% of their non-US workers and to adjust foreign pay to account for differences in the cost of living between regions.
The leeway offered to companies for pay-ratio disclosures lead to the initial round of disclosures in early 2018 to vary widely. For example, according to one study, ratios disclosed by companies in the financial service industry ranged from 1:1 to 1:429.
Contact us
When evaluating a company for pay ratios, it is important to take the full picture of their disclosures into consideration. The methodology used to calculate the ratios might change the significance of their results. We can answer any questions you may have about pay-ratio disclosures and processes, you can contact us at 818-334-8631 or click here, and we will contact you.
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