CEO Pay Ratios: Trouble Ahead for HR?

The result of CEO pay-ratio rules unveiled last month by the Securities and Exchange Commission could be chaos for HR executives trying to deliver that required new data in 2015.

Monday, October 14, 2013
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On Sept. 19, the Securities and Exchange Commission, in a 3-2 party-line vote, proposed its long-awaited CEO pay-ratio regulations called for by the Dodd-Frank financial regulatory reform law of 2010.

Based on feedback from some experts in the executive-compensation field, the SEC's rules -- likely to begin in the 2015 proxy season -- will not win any popularity tests within the HR community. At issue is the new rules requirement that public companies disclose the ratio between the pay of their chief executive and the income for all other employees, no matter how they are classified. For large U.S. companies and those with a global workforce, the rules could pose challenges, say experts.

While the SEC says it tried to give companies flexibility in how they calculate the median employee income and determine what qualifies as "total compensation," considering a company's entire workforce means that HR practitioners will be responsible for cataloguing the pay practices of all full-time, part-time, temporary, seasonal and international employees.

It will be extremely complicated -- if not impossible -- to accurately determine because every country defines pay and benefits packages in different ways, said Cara Woodson Welch, vice president of public policy, news and publications at WorldatWork, a global HR association based in Scottsdale, Ariz., in a statement the day after the SEC announcement was made.

"The SEC vote advancing the CEO pay-ratio regulations is unfortunate," said Welch. "If these proposed regulations are adopted they will force compensation professionals and companies to spend an exorbitant amount of time, money and resources to disclose information that shareholders already receive through existing public disclosures." added that the regulations will not enhance transparency for shareholders or potential investors. Instead, they are likely to add more noise and confusion to information conveyed to the public due to the fact that the ratio will be extremely difficult to understand without knowing the ins and outs of a company's workforce and pay practices.

"The CEO pay ratio will not be meaningful to shareholders," says Irv Becker, national practice leader for the U.S. executive compensation practice with Hay Group, the Philadelphia-based global-management consulting firm.

"I think for HR folks the message is an unfortunate message," he says. "They will have to deal with administration to figure it all out, and once they have done it, it's really going to only provide negative information for the media. HR folks would love to have meaningful benchmarking information for shareholders, but the CEO pay ratio will not provide it."

Hay Group Vice President David Wise adds that the pay ratio is "a misguided attempt to oversimplify a complex discussion into a single ratio," which he says can lead to conclusions that are misleading.

"For example," he says, "investment banking compensation has become a lightning rod for many shareholders. However, it is these very institutions that are likely to show less differential between CEO pay and that of the median employee -- not because banking CEOs are paid lightly, but because the typical banking employee is very well-paid. By contrast, higher ratios are likely to be seen in companies that employ large numbers of unskilled or semi-skilled workers."

Wise also says that calculating median pay is expensive, and companies and shareholders will get stuck with the bill.

"The data needed to calculate pay ratios are not readily available to many companies," he says. "In order to calculate a median, a company needs to have collected and centralized information on every applicable employee." 

However, the impact of the Commission's proposed rule can only be judged after obtaining company input on its ability to comply with this complex requirement, combined with expense and diversion away from more productive use of company resources, says Timothy Bartl, president of the Center on Executive Compensation in Washington.

"Experience shows that when investors have been given the opportunity to vote on a pay ratio proposal, over 93 percent have voted against such proposals," he says. "With this in mind, we will analyze the SEC's proposal, obtain company input and fully engage in the comment process."

The bottom line, Bartl says, is that the Center strongly opposes the pay-ratio requirement as it stands and will continue to work for its repeal in Congress.

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WorldatWork and other organizations have repeatedly maintained that the SEC should at least limit the pool of employees to full-time, domestic employees, and will continue to stress that during the SEC's 60-day open comment period.

According to the proposal, the SEC does not specify any methodologies that companies would be required to use to determine the median employee. Companies, in fact, would be able to select a methodology that best fits their workforce and compensation structures, and can look at their entire workforce or a statistical sample of the workforce. To identify the median of the workforce or a sample, companies may use annual total compensation as defined by existing executive compensation rules, or by any consistently used compensation measure.

Then, any method a company chooses for calculating the median employee or total compensation must be disclosed to the SEC in all registration statements, proxy and information statements, and annual reports that already include executive compensation.

Steve Seelig, a senior regulatory advisor for executive compensation in Towers Watson's Research and Innovation Center in Arlington, Va., takes a somewhat tempered view of the CEO pay-ratio rule, saying that the SEC is at least trying to make things easier and more flexible for companies to comply. For example, Seelig says the Commission stated that, depending on whether companies have actual data, the statistical-sampling approach will make this less onerous.

"Of course, that still depends on whether the data is available and easy to access," he says.

Seelig's advice to HR is to make sure the SEC knows how much the data-gathering process is costing employers. If you look in SEC's economic analysis, there are no cost estimates, Seelig says, adding that it seems it's one thing the Commission wants to hear about from companies.

"There are any number of pundits saying interesting things," he says, "but no one really knows what the end result will be. Some are even saying it will never happen because of potential litigation resulting from the regulations, or that because of the delay in implementing it, there is not enough time for current administration to finalize it all.

"Most of all, it is incumbent on HR to let the SEC know the costs," he says. "If the costs are prohibitive to employers, that's the best chance to get the rules simplified or changed."

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