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Companies that must disclose the ratio of CEO compensation to that of the median employee’s are finding the calculation difficult, and they’re not receiving much help from the federal agency imposing it, analysts say.
Publicly traded companies are required to report to the Securities and Exchange Commission the compensation ratio between their CEO and the median worker starting in 2018, or for the first fiscal year starting after Jan. 1, 2017. The rule was included in the Dodd-Frank Act and has drawn criticism from Republicans and business groups such as the U.S. Chamber of Commerce. Making matters worse for employers, how exactly to calculate both CEO compensation and median employee compensation is not well defined.
“Companies are really struggling with it,” John Ellerman, a partner in the Dallas office of Pay Governance, an executive compensation consultancy, told Bloomberg Law Oct. 25. “It’s a pain in the butt” due to the amount of data that companies need to gather and analyze, including doing foreign currency conversions for multinationals, he said.
The SEC “sure could” make companies’ task easier, for example, by restricting those who have to be included in the median employee calculation to full-time U.S. employees, Ellerman said.
“There was hope with the new administration that this rule would go away, but unfortunately it hasn’t,” Sharon Podstupka, a principal and head of communication at New York-based compensation consulting services firm Pearl Meyer & Partners LLC, told Bloomberg BNA Oct. 26.
“Companies seem frustrated about this particular exercise,” Podstupka said. “This disclosure, from an investor and proxy adviser standpoint, is relatively meaningless.” This tracks with the broader argument from critics that this number isn’t necessary for shareholders to make decisions.
These problems and criticisms seem to have triggered a bout of corporate procrastination. About three-quarters (76 percent) of the companies Pearl Meyer recently surveyed haven’t even “discussed how to communicate the ratio internally and externally,” the firm said Oct. 24. That could be a problem when the numbers are reported. The same Pearl Meyer survey of 216 senior executives and 60 outside directors showed 56 percent of companies with a CEO-to-median-pay ratio of above 100 to 1.
To decide what counts as CEO compensation, companies will have to make some “bold assumptions” regarding such matters as valuating restricted stock and stock options provided to the CEO and other long-term incentives, Ellerman said.
There may be big differences between industries as well, Ellerman said. Retail marketers that employ lots of hourly workers are more likely to show an eye-popping CEO-to-median-pay gap, for example.
All of these complications, in Podstupka’s view, mean that comparing the median employee’s compensation, which typically does not include things like stock options, with that of the CEO is “comparing apples to oranges.”
The ratio is “a lot of work but not impossible” to produce, Tharindra Ranasinghe, an assistant professor of accounting and information assurance at the University of Maryland’s business school, told Bloomberg Law Oct. 27.
But he said, “from a technical perspective of computing the pay rate, the SEC has to give a huge amount of discretion as to how to compute it and which employees to include.” Due to the wide leeway companies have and the amount of errors that are bound to creep in, it will be “hard to compare” the pay ratios between companies, he said.
One big worry for companies is the reaction from employees, shareholders, and the public, analysts said.
“Members of top management are used to seeing numbers” on compensation, Ellerman said, “but this will be the first time average employees are seeing it, and they are not going to understand it and are going to be shocked by the number.” By definition, half of employees earn less than the median figure, and they won’t be happy to learn that, he said.
“Some think the whole purpose was to embarrass companies and drive down executive pay,” he said.
Podstupka said “companies should realize how this will be read, and take the opportunity to educate their workforce on the basics of compensation and why comparisons are an unproductive exercise.” Podstupka added that “the media will have a field day with this from a pay and equity standpoint.”
The good news is that the shock value of CEO-to-employee pay ratios will dissipate somewhat as it “will become normal,” Ranasinghe said. But he added that the idea of “social justice” likely would underlie “most of the anger over high pay ratios.”
To contact the reporter on this story: Martin Berman-Gorvine in Washington at firstname.lastname@example.org
An executive summary of the Pearl Meyer survey results is available at https://www.pearlmeyer.com/looking-ahead-executive-pay-practices-2018-executive-summary.pdf. The abstract of the Crawford paper is available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2529112.
Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.
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