Newly Merged Firms Face Choice When Tallying CEO Pay Ratio

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By Jacob Rund

Recently merged companies reporting the difference in compensation paid to their CEOs and their median worker face a choice: Do they factor out the employees they received during those acquisitions?

Most U.S.-based corporations involved in the highest-valued acquisitions of 2017 opted to include the workers gained from these deals when developing their CEO-to-worker pay ratios, according to a Bloomberg Law analysis of last year’s top 50 deals by volume from Bloomberg Law’s Deal Analytics.

The Securities and Exchange Commission’s pay ratio rule, mandated by the 2010 Dodd-Frank Act, requires companies to report the ratio between their CEO’s pay and that of their self-selected median worker. The ratios, being reported this year for the first time, are intended to contrast the annual compensation of a company’s principal executive to that of its self-selected median employee.

The SEC gave firms the flexibility to leave out employees acquired in a transaction from their median worker calculation. It’s one of a few exemptions to the rule, which requires most public companies to report pay ratios covering their fiscal 2017.

So far, seven U.S.-based acquirers involved in the 50 largest deals in 2017 opted to exclude their new workers from their pay ratio calculation, while 25 included them. (Eighteen companies that merged last year have yet to file their pay ratio.)

Amazon.com included its 89,000 Whole Foods Markets Inc. workers in its 2017 pay ratio, for example. The tech giant bought Whole Foods for $13.6 billion in September.

Sherwin Williams Co. made the same choice, incorporating some 11,000 employees into its calculations after it acquired Valspar Inc. for $11 billion in June.

But CenturyLink Inc. made the opposite call. It excluded some 12,000 Level 3 Communications Inc. workers from its pay ratio after it bought the company for $33.5 billion in November.

Outside the top 50 mergers, the exemption is also infrequent. Only 11 percent of the 631 companies in the S&P 1500 Index that disclosed pay ratios left out workers from an acquisition, as of April 5, according to Willis Towers Watson.

Impact on Ratios

The decision to include new employees in the pay ratio can make a big difference. A new worker pool could skew the median wage up or down, but in many cases, any employees factored out of a ratio this year will need to be factored into next year’s selection.

Some factors influencing the decision include the timing of the deal and the accessibility of a target company’s payroll data, legal advisers and compensation experts said.

“In essence, the rule says if you did a deal and it’s hard for you to get the payroll data [of the new workers], you can decide that you don’t want to include those people,” Steve Seelig, a regulatory adviser with Willis Towers Watson, told Bloomberg Law.

Seelig said he advises companies to consider various methods for figuring out the pay of their acquired workforce, such as statistical sampling. “And to the extent that you’ve done an acquisition and somehow it’s going to change your pay ratio next year, you have to really think about that.”

In or Out?

For merging companies with segregated payroll processes or divergent compensation structures, it can be tough to get the needed data in a timely fashion, said Andrea Orr, a partner in the corporate and securities practice at Bass, Berry & Sims PLC.

“There’s oftentimes a delay in terms of bringing those employees onto centralized payroll systems,” she told Bloomberg Law. This could be enough for a corporation to wait until next year to include newly acquired employees in the calculation, and even more so if the deal happened near the end of the year.

“The later into the year you get, I think that’s a driver,” Orr said. “If it’s the beginning of the year, you might have plenty of time to get that information and include them.”

Seelig said the “trickiest issue for companies is unifying pay data, especially when they’re acquisitive organizations.”

“It isn’t surprising to me that companies would just say, ‘We’re not going to bother,’ because that’s really the easy way out,” Seelig said. “But a more studied approach potentially could have yielded a different answer for them.”

Wait Until Next Year

Whether a company’s ratio might swing in either direction next year based on its acquired workers could also factor into its decision.

If a company gains lower-paid employees through a deal, it might opt for a better-looking pay ratio by not including them in the median worker calculation, Seelig said. But if the company acquired a number of higher-paid workers, they might contribute to a narrower ratio if included.

“It’s not just looking at this year. It’s thinking about how, when you do include these workers, is your ratio going to look next year,” said Seelig. “If your ratio expands, that’s probably something that’s going to look bad.”

Recalculate?

Companies are also taking note of whether they need to re-select a median employee in future reporting periods, which could be an added burden, Orr said.

The SEC allows companies to keep the same median employee for up to three years unless a difference in workforce composition or pay would cause significant changes to their ratios.

“It’s not necessarily a question of whether your pay would go up or down overall on average, but is the person in the middle, is that going to change significantly?” Orr said. “If you’ve had a sizable acquisition and you exclude those employees, it might be a little difficult to say that you’re keeping the same median employee” next year.

However, companies using the exemption may not need to recalculate their median employees if the businesses they bought are “substantially similar” to their own, Seelig said.

To contact the reporter on this story: Jacob Rund in Washington at jrund@bloomberglaw.com

To contact the editor responsible for this story: Fawn Johnson at fjohnson@bloomberglaw.com

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