As we predicted last month, the Securities and Exchange Commission adopted a final rule that requires a public company to disclose the ratio of the compensation of its CEO to the median compensation of its employees. This measure was mandated under Dodd-Frank (section 953(b)), but the SEC maintains that its rule “provides companies with flexibility in calculating this pay ratio, and helps inform shareholders when voting on ‘say on pay.'” Specifically, the new rule requires public companies to disclose:
- The median of the annual total compensation of all its employees, except the CEO;
- The annual total compensation of its CEO; and
- The ratio of those two amounts.
However, companies are given flexibility in selecting a methodology for identifying their median employee compensation, based on their own facts and circumstances. In doing so, companies are permitted to take into account either their entire employee population or just a statistical sampling, as well as apply a cost-of-living adjustment. Companies are also permitted to adjust this methodology once every three years. However, companies are also required to disclose their methodology for determining their median employee compensation.
Companies are required to make these disclosures in their registration statements, proxy and information statements, and annual reports, which must already include executive compensation information as set forth under Item 402 of Regulation S-K. However, companies are not be required to disclose the pay ratio information in reports that do not require executive compensation information, such as current and quarterly reports, nor update their disclosure for the most recently completed fiscal year.
The disclosure requirement applies to all companies required to provide executive compensation disclosure under Item 402(c)(2)(x) of Regulation S-K, but not smaller reporting companies, foreign private issuers, MJDS filers, emerging growth companies, and registered investment companies. Such companies are required to disclose their pay ratio beginning on or after January 1, 2017.
Thus, companies subject to this disclosure should begin testing various methodologies for determining their median employee compensation, so as to be able to disclose a pay ratio that is the best fit for them by 2017.