Tag Archive: median compensation

Applying the SEC’s Newest Guidance on Pay Ratio Disclosures

Published by
alexandralajoux

  Alexandra R. Lajoux

“It ain’t over ‘til it’s over.” Truer words were never spoken when it comes to the new pay ratio rule.

A key chapter in pay regulations closed August 5, 2015 when the U.S. Securities and Exchange Commission (SEC) issued its final rule on the pay ratio disclosure mandated by the Dodd–Frank Wall Street Reform and Consumer Protection Act. This final rule capped a two-year comment period intended to resolve many thorny issues around exactly when and how to calculate the two numbers involved in the rationamely median employee compensation/CEO compensation. (To see NACD’s comment letter, visit the NACD Resource Center on Corporate Governance Standards and click on our Comment on Pay Ratio.)  The NACD comment letter, like some others, noted that the “annual total compensation” figure can be misleading, and suggested solving this problem by asking the SEC to permit the use of industry averages, to limit employees to full-time domestic employees, and to permit supplemental notes. In its final rule, the SEC did not make these changes but did address concerns about total annual pay by allowing companies to use any “consistently applied compensation measure” (CACM) to calculate median annual compensation for employees.

This concept of a CACM led to questions, however. So on October 18, 2016, the SEC’s Division of Corporation Finance addressed them by updating its C&DI for Regulation S-K, one of the 32 “Compliance and Disclosure Interpretations” (C&DIs) the staff maintains on its most complex regulations. Although the five questions raised are technical rather than strategic, and represent only a tiny fraction of the many issues raised by the final rule overall, they still merit board attention. Therefore, this blog presents, in simplified English, the five ratio-relevant Q&As in the newly updated C&DI (codified under Section 128 C) and provides a key question and a final “takeaway” for boards.

Summary of the SEC’s Five Questions and Answers

Summary of Question 1: If a company does not use annual total compensation to identify the median employee, how should it choose another consistently applied compensation measure (CACM) to do so?

Summary of Answer 1: SEC’s updated C&DI assures companies that a CACM can be any measure that “reasonably reflects the annual compensation of employees,” but asks that companies explain their rationale for the metric they choose. An appropriate CACM will depend on “particular facts and circumstances,” says the SEC. For example:

  • Total annual cash compensation can work as a CACM, unless the company has also made a wide distribution of annual equity awards for the same period.
  • Social Security taxes withheld would likely not be an appropriate CACM unless all employees earned less than the Social Security wage base.

Summary of Question 2: May a registrant exclusively use hourly or annual rates of pay as its CACM?

Summary of Answer 2: No. Although an hourly or annual pay rate may be a component used to determine an employee’s overall compensation, the use of the pay rate alone generally is not an appropriate CACM to identify the median employee.

Summary of Question 3: When a registrant uses a CACM to identify the median employee, what time period may it use?

Summary of Answer 3: The SEC’s answer to this question says that the company must select a date within three months of the end of its most recent fiscal year to determine the population of employees from which to identify the median employee. The CACM need not be contemporaneous. In fact, it can come from the prior fiscal year, as long as there has not been a material change in the registrant’s employee population or employee compensation arrangements—that is, a change that would “result in a significant change of its pay distribution to its workforce.”

Summary of Question 4: What about furloughed employees?

Summary of Answer 4: The SEC’s response clarifies that the final rule identifies four classes of employees: full-time, part-time, temporary, and seasonal. It does not define or even address furloughed employees, because a furlough could have different meanings for different employers. It is a matter “facts and circumstances” and provides additional guidance on the matter.

Summary of Question 5What about independent contractors? Under what circumstances can their pay be included in the CACM for the employee?

Summary of Answer 5: The final rule had stated that “leased” workers are excluded from the definition of employees “as long as they are employed, and their compensation is determined, by an unaffiliated third party.” The SEC’s answer preserves this distinction, and gives some flexibility. In determining when a worker is an “employee,” the company “must consider the composition of its workforce and its overall employment and compensation practices.” So a company should include workers whose compensation it (or a subsidiary) determines “regardless of whether these workers would be considered ‘employees’ for tax or employment law purposes.”

NACD Takeaway
Are you familiar enough with compensation patterns in your company to know whether a chosen CACM “reasonably reflects” the compensation in your company? If not, you may wish to meet with the officer responsible for employee pay below the executive level to get a better sense of this important issue.

Compensation committees have traditionally focused on executive compensation, leaving employee compensation to management. In the past few years, however, several factors have combined to broaden the committee’s purview, including concerns about pay disparity, and the new requirement to disclose compensation risk. Therefore, more compensation committees are overseeing enterprise-wide pay. For example, in its 2016 proxy statement, WPX Energy disclosed that in the past year “With the oversight of our Compensation Committee, we conducted a risk assessment of the Company’s human capital with a focus on enterprise-wide compensation programs.” (Emphasis added.)

The key word in all of these questions and answers is “reasonably.” It is exactly the right word for compensation committees to use as they oversee this disclosure, as well they should.


Alexandra R. Lajoux is chief knowledge officer emeritus at the National Association of Corporate Directors. 

Pay Ratios: A Question of When, Not If

Published by

Moving into May and the peak of annual meeting season, executive compensation is one of the top stories in the business media. To date, eight companies have failed their annual say-on-pay votes. With the bulk of annual shareholder meetings in the coming months, this number is expected to increase. This week, an editorial in the New York Times criticized the Securities and Exchange Commission (SEC) for failing to issue rules on another area of executive compensation—pay ratios—claiming the “main problem seems to be foot-dragging in the face of objections from corporate lobbyists.”

The article correctly identifies several factors. The SEC did delay issuing final rules on the CEO pay ratio until the second half of 2012, effectively postponing corporate disclosure of the ratio of chief executive pay to the company’s median salary until the 2013 proxy season. Also, a substantial number of comment letters have already been submitted to the SEC on matters regarding executive compensation disclosures, including some for which there are no rules pending. Lastly, the rules mandated for pay ratios in Dodd-Frank are unlike most other provisions in the legislation, in that Congress did not allow for much flexibility in crafting the final rules.

However, the NYT editorial did not mention several factors that have hindered progress for the SEC. According to the May 2012 Dodd-Frank Progress Report from Davis Polk, of the SEC’s 95 required rulemakings, the agency has missed the deadline for 56. When final rules are actually released, they are often met with criticism and lawsuits. Last summer the U.S. District Court of Appeals overturned the SEC’s proxy access rule on the basis that the agency had not conducted a thorough cost-benefit analysis. The SEC subsequently introduced a more robust economic analysis in its rulemaking process, leading to a missed deadline for releasing a final rule regarding the conflict minerals provision—which will require companies to track and disclose their use of minerals potentially sourced from the Democratic Republic of the Congo.

With the rigid mandates on the pay-ratio disclosure, the SEC is facing difficulties with one area not clearly defined: computing median compensation. While Dodd-Frank was explicit in the calculation of the ratio, it was not clear in how the median total compensation would be measured. This measurement leads to several questions: Does the compensation of every employee at an organization need to be computed? Should part-time employees be included in the calculation? Would international employees be included? If so, what foreign exchange rate would be used? Taking these questions into consideration, last August the AFL-CIO proposed the use of statistical sampling to calculate the median compensation, an option the SEC is taking seriously.

The argument is no longer whether pay ratio disclosures will have the intended effect of changing executive compensation. Instead, it is when and how these rules will be issued.