Headaches with the CEO Pay Ratio Rule
In August, 2015 the Securities and Exchange Commission (SEC) adopted final rules requiring public companies to disclose the ratio of CEO pay to the median employee pay for their first fiscal year beginning on or after January 1, 2017.
Public companies will have to disclose 1) their CEO’s total annual compensation, 2) the median total annual compensation of all their other employees, and 3) the ratio between the two values.
There is much to digest with these rules and not enough space to address them here. I want to focus on the part having to do with non-U.S. employees since they are included in the definition of all employees.
Companies lobbied heavily for the SEC to let them exclude overseas employees from the calculation. This was probably because wages are higher in the United States than in almost every other country in the world and the more foreign workers that are included, the higher a multinational’s pay ratio will be.
As the SEC itself acknowledges, the disclosed ratios will not provide insight as to whether a company’s compensation is appropriate. The pay ratio of a particular company depends on a variety of factors, such as the industry in which the company operates, the geographical locations of the company, the types of employees that make up the company (i.e., professional vs. hourly), the company’s business structure, and the competitive market.
I couldn’t agree more and shudder to think about the monumental task of educating employees as well as the public at large who will have access to this information in company proxy statements.
The rules allow for certain employees to be excluded in the pay ratio calculation but again space does not permit discussing here. Regardless of these exclusions I want to focus on those employees that will be included.
One of the biggest problems I see is with determining median pay.
The “median employee” is one that is at the 50th percentile, or the “middle employee,” calculated by ordering the compensation of all employees (other than the CEO) from highest to lowest, with half of the employees having higher compensation and half having lower compensation.
This is an easy exercise when a company has only U.S. employees. Companies that have employees outside the U.S. have it considerably tougher. The rule says that in making its median employee identification, a company may make cost-of-living adjustments to the compensation of employees in countries other than the CEO’s and this is where it begins to get fuzzy.
The SEC says that cost-of-living adjustments could be based on purchasing power parity (PPP). A company that uses cost-of-living adjustments to present the pay ratio must also disclose the median employee’s annual total compensation and pay ratio without the cost-of-living adjustments. So what is PPP? The PPP conversion factor is the number of units of a country’s currency required to buy the same amounts of goods and services in a foreign market as the US$ would buy in the United States.
For the life of me I can’t see how using PPP or any “cost of living” adjustment makes sense. I’ve been involved with expat pay packages where COLA’s are one of the components. The purpose is to equalize purchasing power of household goods and services between the home and host countries. It’s not at all about comparing pay — just purchasing power.
I have searched high and low and cannot find specifics on just how using PPP would be used in calculating pay. Everyone seems to be lying low on this one — even the most “august” consulting firms. Hopefully a few more precise methods of calculation will surface over time.
There is no need to push the panic button now as this rule may be overturned between now and 2018— but Compensation professionals should put it on their growing list of potential fun projects for the future.