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CEO pay ratio update

Analysis of additional pay ratio disclosures

In 2018, public companies began disclosing the ratio of chief executive officer (CEO) compensation to that of their median employee. After analyzing pay ratio disclosures for 294 companies in July, Deloitte’s executive compensation consulting group updated its findings based on an additional 153 disclosures.

Findings from CEO pay rate disclosures” was originally published on July 25th on Capital H blog.

The Dodd-Frank CEO pay ratio requirement

The CEO requirement included in the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act1 took effect for fiscal years beginning on or after January 1, 2017. Under this rule, public companies are required to disclose the ratio of the CEO’s compensation to the compensation of the median employee. We initially provided Capital H blog with our thoughts about the implications of this disclosure requirement in 2013 and prepared an analysis of the inaugural disclosures of 294 S&P 500 companies in July 2018. Our executive compensation consulting team recently updated our analysis to include the additional 153 S&P 500 companies that completed their CEO pay ratio disclosures as of October 4, 2018.

Following is a summary of our findings for the 447 companies that have disclosed their CEO pay ratios and related methodologies, along with some considerations for the second year of the CEO pay ratio disclosure requirement.

Primary takeaways from additional pay ratio disclosures

In general, the updated information and our observations are similar to the original report, as the latest batch of company filings were similar to the earlier disclosures. Here are some of the main takeaways:

  • The CEO pay ratio and the median employee’s compensation cannot be compared across companies, even within similar industries, as each company has its own unique organization structure and/or geographic footprint that leads to the identification of very different median employees and corresponding pay levels.
  • There is large variation in pay ratios across industries, within an industry, and across revenue sizes. There is, however, one clear trend: Typically, the larger the organization, the higher the CEO pay ratio. This is directly related to the level of CEO compensation, which generally increases to reflect the size and complexity of the organization, whereas the median employee’s pay is largely unaffected by company size.
  • Eighty two percent of companies placed the CEO pay ratio disclosure immediately following the termination table. We believe this placement was intended to clearly indicate the CEO pay ratio was not a factor in determining CEO and other executives’ pay levels or the design of the executive compensation program.
  • There was a fairly even distribution in the Consistently Applied Compensation Measure (CACM) used by companies—base pay (21 percent); total cash compensation (30 percent); total direct compensation, which includes equity (21 percent); and W-2 wages (20 percent). Only 8 percent of companies added benefits to the CACM.
  • Twenty two percent of companies analyzed provided background information on the median employee (employment status, geographic location, and/or role), while 15 percent of companies disclosed supplemental ratios. Many companies followed a “less is more” approach to disclosure this year to avoid being seen as defensive, but some additional disclosure could provide meaningful and constructive context for shareholders and other readers.

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Additional insights

Although the majority of our findings remained the same, there were some additional insights gained by including the additional 153 S&P 500 companies:

  • Nine companies disclosed alternative pay ratios that were higher than the Securities and Exchange Commission (SEC)-mandated pay ratio. One was due to a one-time pension adjustment and two were for cost of living adjustments. The other six companies wanted to clarify that their pay ratio was artificially lower than normal as the CEO did not receive an annual bonus or equity award in the current year. These six companies are good examples of companies that are potentially concerned about an increase in their respective pay ratios next year, when bonus and equity awards are once again made to the CEO.
  • Several retailers with January fiscal year-ends were reviewed as part of the 153 additional companies, and the results confirmed prior findings that the consumer discretionary industry has the highest CEO pay ratios and lowest median employee pay. We also found that a higher proportion of these companies offered a description of the median employee (e.g., retail store employee, part-time store associate, restaurant crew employee) to explain lower median employee compensation and higher CEO pay ratio figures.
  • The prevalence of total direct compensation (i.e., the sum of base salary, annual cash bonus, and long-term incentives) used as the CACM increased. This may be attributable to the additional time these companies had to prepare their disclosure and the availability of the data.

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Considerations for 2019 pay ratio disclosures

In addition to the key takeaways mentioned above, we have identified some considerations for companies that will soon be preparing their 2019 CEO pay ratio disclosures.

  • Consider whether to use the same median employee, identify a new comparable median employee from last year, or identify a new median employee. Two key factors that could impact this decision include:
    • Has the median employee left the company or had a material change to compensation?
    • Has there been a material shift in the composition of the workforce or compensation programs (due to acquisitions and divestitures or otherwise)?
  • Proxy advisory firms will disclose the CEO pay ratio in their research reports, but will not factor it into say-on-pay recommendations for the 2019 proxy season.
  • Expect more scrutiny of the 2019 pay ratio than in 2018, now that shareholders, employees, and the media have a baseline to use for comparison purposes.

    • Given the strong economy and tight labor market, there is a likely expectation that median employee compensation will increase over last year.
    • CEO compensation may have increased in 2018 compared to 2017 due to strong stock price performance earlier this year and healthy full year financial results. The rate of increase in CEO compensation in these situations may well eclipse those of the median employee, given the significant performance leverage embedded in the CEO’s pay, which may raise questions about the widening pay gap.
    • Be sure to document all the factors that impact compensation levels for the median employee and the CEO, such as company and individual performance as it relates to incentive payouts or overtime wages for nonexempt employees.

We believe there will be significantly more scrutiny of the CEO pay ratio in 2019 and that the best way to approach the coming year’s disclosure is to be fully transparent regarding the calculation and to enhance disclosure where needed to explain changes from the prior year.

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Get in touch

Michael Kesner is a retired principal and consultant to Deloitte Consulting LLP. He has  more than 35 years' experience working with companies on a wide range of executive compensation and board of director compensation issues.
Edward Sim is a manager in the Compensation Strategies practice of Deloitte Consulting LLP, working with management and compensation committees on all aspects of total rewards, including executive compensation, and corporate governance.
James Kwon is a consultant in the Compensation Strategies practice of Deloitte Consulting LLP, working on executive compensation and board of director compensation matters.

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