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S&P 500 Pay Ratio Disclosures: Emerging Trends

As the 2018 proxy season is now gaining full speed, the first group of the required CEO-to-median employee pay ratio disclosures have made their eagerly-awaited debut.  Gibson Dunn has been tracking all required pay ratio disclosures by S&P 500 and Fortune 100 companies and, while still early, there are a number of key observations and emerging trends from the filings to date.

Background.  In August 2015, the SEC adopted final rules implementing Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The rules, set forth in Item 402(u) of Regulation S-K, require pay ratio disclosures for fiscal years beginning on or after January 1, 2017. The central components of the required disclosure are (1) the median employee’s annual total compensation, (2) the CEO’s annual total compensation, (3) the ratio of these two figures, and (4) additional narrative disclosure addressing topics such as the date and method used to identify the company’s median compensated employee. Generally, the rules permit the use of several exemptions and adjustments to the pay ratio calculation in order to reduce compliance costs for companies. In addition, as emphasized in the SEC’s September guidance, the new rules grant reporting companies wide flexibility on the method used for identifying the median employee.

Emerging Trends and Data as of March 9, 2018

Overview.  As of March 9, 2018, 61 S&P 500 companies have reported required pay ratios, most commonly in a definitive proxy statement.  The average pay ratio among these companies is 204:1, ranging from a high of 935-to-1 to a low of 12-to-1.

Location in the Filing.  The majority of disclosures (or 77%) have appeared in proxy statements after the tabular disclosure required by Item 402 of Regulation S-K for named executive officer compensation (the “Compensation Tables”).  Most of the rest of the disclosures have appeared in the CD&A, among the Compensation Tables or between those two sections.  The specific location of the disclosure may depend on the organization of a company’s proxy statement sections, as well as other factors such as the visibility a company intends for the disclosure and its desire to separate the disclosure from other sections (such as the say-on-pay proposal).

Consistently Applied Compensation Measure (“CACM”).  The rules require a disclosing company to describe, if applicable, the CACM used to identify its median employee.  Thirty-nine percent of S&P 500 companies have so far used total cash compensation, consisting of base salary/wages and cash bonuses, as their CACM.  Other variations have included base salary/wages only (25% of companies), taxable income as reported in Form W-2 for 2017 (21% of companies), and a combinations of both cash and equity compensation (15% of companies).  Nine S&P 500 companies have used a CACM to identify a group of median employees and then used a second, more refined or detailed measure, such as annual total compensation, to identify a median compensated employee.  In addition, as sanctioned in the SEC release adopting the rules, four S&P 500 companies have identified the median employee after eliminating employees whose annual total compensation reflected “anomalous characteristics” that created the risk of a distorted pay ratio.  

De Minimis Exemption.  The most frequent adjustment used so far has been the de minimis exemption, which permits companies to exclude non-U.S. employees (capped at five percent of the total workforce) when identifying the median employee.  Twenty-four S&P 500 companies have used this exemption so far this proxy season. Under the rules, if a company uses this exclusion, it must also disclose the approximate number of employees excluded from each jurisdiction and the total number of its employees (both prior to and after applying the exemption). Some companies using the de minimis exemption have chosen to list the foreign countries and number of excluded employees in their narrative disclosure, while others have presented this information in a table.

Acquisition Carve-Out.  Another adjustment used by S&P 500 companies thus far has been the acquisition carve-out, which permits a company to omit employees from its pay ratio calculation if the employees were added to its workforce as the result of an acquisition or business combination that became effective in the applicable fiscal year.  Six S&P 500 companies have used this carve-out so far this proxy season. Because there is no cap on the number of employees that may be excluded using the acquisition carve-out, this figure has ranged significantly (from several dozen to several thousand excluded employees).

Cost of Living Adjustment.  The final rule permits companies to make cost-of-living adjustments for jurisdictions (other than the jurisdiction in which the CEO resides) to identify the median employee and calculate annual total compensation.  No S&P 500 companies have applied a cost of living adjustment thus far.  Instead, as discussed below, companies appear to prefer the use of alternative ratios or other supplemental narratives to address factors affecting their ratios.

Alternative Ratios and Other Supplemental Disclosures.  Eight companies, including but not limited to companies with higher ratios, have voluntarily disclosed “alternative” pay ratio calculations to provide additional context on factors affecting the relationship between the CEO’s compensation and median employee’s compensation. The most prominent trends in this regard have been alternative ratios that (1) accounted only for U.S.-based employees, or that (2) adjusted annual total compensation used to calculate the ratio for either the CEO and/or median employee, for example by excluding the change in pension value or an unusual element of compensation awarded to the CEO.  In addition, 13 companies included supplemental details about the median employee’s location and/or job function.

Pay Ratio as a Reasonable Estimate. As permitted by the Compliance & Disclosure Interpretation 128C.06 issued by the Staff in September, 50% (or five of 10) of the Fortune 100 companies have included disclosure that their pay ratio is a reasonable estimate calculated in a manner consistent with Item 402(u).

Lack of Comparability Among Pay Ratios.  In the SEC’s release adopting the pay ratio disclosure rule and in its September interpretive release, the SEC emphasizes that the pay ratio rules are “designed to allow shareholders to better understand and assess a particular registrant’s compensation practices and pay ratio disclosures rather than to facilitate a comparison of this information from one registrant to another.” In light of this, we suggested at the pay ratio and proxy disclosure conference hosted by and that companies may wish to consider a “disclaimer” cautioning readers on the potential lack of comparability among companies’ pay ratio disclosures.  To date, 60% (or six of 10) Fortune 100 companies have included disclaimer language noting that their pay ratios may not be comparable to other companies’ disclosures.  Below is language that companies may consider or adapt to address this aspect of their pay ratio disclosures: 

“The SEC’s rules for identifying the median compensated employee and calculating the pay ratio based on that employee’s annual total compensation allow companies to adopt a variety of methodologies, to apply certain exclusions, and to make reasonable estimates and assumptions that reflect their employee populations and compensation practices.  As a result, the pay ratio reported by other companies may not be comparable to the pay ratio reported [above], as other companies have different employee populations and compensation practices and may utilize different methodologies, exclusions, estimates and assumptions in calculating their own pay ratios.”

Gibson Dunn will continue to track company pay ratio disclosures, including information on key data points regarding these disclosures. If you would like further information about these disclosures, statistics or key data points going forward, or if you would like assistance drafting or addressing your pay ratio methodology or disclosures, please do not hesitate to contact the Gibson Dunn attorney with whom you work.

Special thanks to Maya Hoard in our Orange County office and Eileen Park in our New York office for their valuable assistance with this update.

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