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Dec 4, 2013

By Joni L. Andrioff

In September, the Securities Exchange Commission approved proposed rules on calculating the ratio of the chief executive officer’s total annual compensation to the median total annual compensation of all employees, as mandated by section 953(b) of the Dodd-Frank law.

Specifically, the Proposed Rules, which span 47 pages of the Federal Register, require proxy disclosure of the median annual total compensation of all employees other than the CEO, and the ratio of that median employee compensation to the CEO’s annual total compensation. The Proposed Rules also request comments from the public on no less than 60 different issues in calculating the CEO pay ratio.

While there is significant interest in repealing the CEO pay ratio disclosure requirement, it could become effective for calendar year companies in the 2016 proxy (or sooner for some fiscal year companies). This makes it relevant for pay decisions in 2015 (or sooner, depending on the fiscal year).

The purpose of this blog is to give HR professionals some idea of what public companies will face in trying to get a handle on their own CEO pay ratios. Here are eight factors to digest now.

1. CEO pay ratios may be surprisingly large

Early modeling prepared by AonHewitt indicates that, at least in one extreme case, the CEO pay ratio of a large employer of 440,000 employees worldwide could be as high as 1,531:1, assuming CEO pay of almost $30 million (including bonuses and retention pay) and median compensation for all other employees at the U.S. minimum wage.

That is, the CEO’s pay is 1,531 times greater than the median pay of all other employees. When calculated using different assumptions (such as excluding the CEO’s retention pay), the CEO pay ratio in this example is 967:1.

If both the bonuses and retention pay are excluded, the ratio is 601:1. While this ratio may most dramatically influence boards of directors and shareholders, employees will see it, too.

2. Companies face significant data collection challenges

Under the Proposed Rules, employers will have to devote significant time, attention and resources to determine median compensation for all employees in their workforce.

For this purpose, “employee” means an individual employed by the employer (specified as the “registrant,” in SEC filings) or any of its subsidiaries as of the last day of the registrant’s last completed fiscal year. This includes any full-time, part-time, seasonal or temporary worker employed by the registrant or any of its subsidiaries on that day (including officers other than the CEO).

The SEC has requested comments on whether the definition of “employee” should be narrowed.

While the Proposed Rules specifically include subsidiaries of the registrant, the SEC has asked for comments on whether subsidiaries should be excluded and whether the CEO pay ratio should be calculated separately for the U.S. workforce and for the non-U.S. workforce.

The global employer in AonHewitt’s example comprises 10 U.S. subsidiaries and 40 subsidiaries outside of the U.S. Its business was conducted at 14,000 establishments in the U.S., 17,000 establishments in European and Asian countries, and 4,000 establishments in other countries. It is unlikely any employer keeps current pay data on its global workforce.

For now, employers should devise a work plan to identify the data and where it resides. It may be necessary to assemble a team of legal, human resources, payroll and IT professionals, along with the person responsible for preparing the executive compensation portion of the proxy.

3. Flexibility in calculating the median employee compensation

The Proposed Rules do not require any particular calculation method for identifying median employee compensation, and they allow companies to determine the methodology appropriate to their particular circumstances. Employers could, for example, use their actual workforce data, payroll data, or tax records.

Alternatively, the Proposed Rules allow the use of statistical samples and estimates. Whatever the method, employers will likely be required to disclose their methodology and any material assumptions used in identifying the median compensation. The SEC notes this information could be provided in an additional narrative explanation, although such a narrative is not required.

The SEC said it did not require a uniform calculation of median pay across companies because it thought that “a registrant’s competitors could infer proprietary or sensitive information about the registrant’s business, which could increase the costs to registrants of the proposed requirements.” It noted also that apples-to-apples comparisons of companies in the same industry “could allow inferences about the business, such as how a company and its workforce is structured, what its compensation practices are, its labor costs and use of outsourcing.”

While these are very legitimate concerns, it is not clear that samples and estimates solve the problem or whether a CEO pay ratio that is not apples-to- apples makes any sense.

4. Employees may have more access to pay information

In collecting data and providing a narrative explanation of how the median employee compensation was determined, compensation data may become available to employees, possibly putting the employer at a competitive disadvantage.

It has been suggested that employers may try to determine median compensation by dividing their workforces into compensation bands, at a minimum identifying which workers are above the median and which are below.

In explaining their assumptions, employers might enable employees to figure out their own compensation band in comparison to the rest of the workforce. This comparison would necessarily highlight the variation in employee wages around the world (i.e., the minimum wage in Spain is $28.87 per day) and distort perceptions of the employer’s median employee compensation.

5. Global employers must address data privacy concerns

International data privacy concerns add to the difficulty in transmitting workforce pay information around the world.

6. Business manipulation

The calculation of the CEO pay ratio could have the unintended consequence of workforce manipulation.

For example, employers may take it into account in the timing of layoffs or reductions-in-force. Similarly, the pay ratio may influence changes to company pay scales or compensation practices.

7. Business disruption

All this data collection will require time and attention ordinarily devoted to other purposes.

8. Uncertain future

The comment period on the Proposed Rules closed on Dec. 2, 2013. It is expected that the SEC received thousands of comments on such issues as the definition of employee, the exclusion of subsidiaries, how the ratio is disclosed in the proxy (fine print?), how estimates may be used, and myriad other issues.

For now, HR professionals should keep an eye on developments in this area.

This was originally published on Littler Mendelson’s Employment Benefits Counsel blog© 2013 Littler Mendelson. All Rights Reserved. Littler®, Employment & Labor Law Solutions Worldwide® and ASAP® are registered trademarks of Littler Mendelson, P.C.