Despite apprehensions about CEO pay ratio compliance, the process for determining and disclosing the ratio went relatively smoothly for most companies in 2018. The ratio of the CEO’s annual pay to that of the median-paid employee varied by industry and company size, as expected, but overall, ratios were lower than predicted. And shareholder, proxy adviser, employee, and media response was muted.
How will 2019 differ? Most companies should be able to use the same median employee identified by the 2018 selection process, unless a company’s workforce or pay plans significantly changed. But companies should consider providing more context for the ratio, as requested by some investors. And the ratio may get more attention this year — particularly if a company has a year-over-year swing or its ratio is an industry outlier.
Implications of 2018 Disclosures
While there was little fallout from the first year of disclosure, recent developments show shareholders and other stakeholders are using the new data to target pay inequities and glean more information about workforce structure in the US and abroad:
- Late in 2018, a group of pension funds asked Fortune 500 companies to provide more information in 2019 on their workers’ pay and benefits, geographic location, full-time vs. part-time status, education and experience, and jobs broken down by function and business unit.
- Last year, several companies responded to a shareholder proposal from the New York State Common Retirement Fund by agreeing “to reexamine their CEO and executive pay and adopt policies that take into account the compensation of the rest of their workforces.”
- Several state and local initiatives piggybacked on the disclosure — proposing economic penalties on companies with large executive-to-worker pay gaps. Portland, Oregon, was the first jurisdiction to enact legislation imposing a tax on companies with high ratios.
- CEO pay continues to be criticized as too high relative to average worker pay, although comparisons often look at general economic data for employee pay figures rather than company-specific pay levels. For example, the AFL-CIO’s 2018 S&P 500 CEO pay ratio study showed a ratio of 361:1, comparing average CEO pay to average wages of US production and nonsupervisory workers.
- Pay gap disclosure has gone global. For example, starting in 2020, most public companies incorporated in the UK will have to disclose new information on the gap between the CEO’s pay and the median, upper quartile, and lower quartile pay of their UK employees.
Planning for 2019 Disclosures
Most companies did the heavy lifting in 2018 to establish a method for identifying the median employee. But there are still a few issues to tackle for 2019:
- Use the same median employee? A company may use the same median employee for up to three years. However, if changes in the employee’s or the company’s circumstances (such as the employee’s promotion or a company merger) would result in a significant change in the pay ratio disclosure, a company may need to identify a new median employee. If the median employee’s situation has changed, companies may use an employee whose “compensation is substantially similar” to last year’s median employee.
- Provide more context? In light of the institutional investors’ letter seeking information on workforce demographics and pay, companies may want to provide more context for their ratio in 2019. This could be particularly helpful if a company’s ratio differed significantly from its peers or to explain any significant change in the ratio from 2018.
- Monitor proxy adviser reactions. Institutional Shareholder Services (ISS) and Glass Lewis aren’t expected to consider companies’ pay ratios in developing voting recommendations for 2019, but ISS will report both the new ratio and prior ratio — drawing attention to year-over-year volatility at individual companies. The advisers may also question industry outliers.
The median ratio for all companies was 64:1, and the median value for the median-paid employee was $63,900. (We’re not reporting averages because they are distorted by a handful o outliers.)
Ratios, employee pay vary by industry
- Ratios for consumer cyclical and consumer staples companies were the highest (median of 172:1 and 129:1, respectively), while those for financial services and health care companies were the lowest (median of 37:1 and 39:1, respectively).
- Median employee pay for consumer cyclical and consumer staples companies was the lowest (median values of $33,100 and $42,900, respectively), while energy/utilities was the highest (median value of $115,400).
- The generally higher ratios for consumer cyclical and consumer staples companies were a result of lower employee pay (large number of part-time, less-skilled workers) combined with high CEO pay: median CEO pay for the two industries was among the highest ($4.9 million and $5.7 million, respectively).
- Even when CEOs are paid similarly, median employee pay (and resulting ratios) may vary significantly within an industry, depending on a company’s business model, outsourcing of jobs, and location. For example, among consumer cyclical companies, the 75th percentile ratio was 243% of the median, while the 25th percentile ratio was 42% of the median.
Ratios closely correlate with company size, driven largely by CEO pay levels
Median company revenues for the 2,500 companies was approximately $1 billion. As shown in the table below, the median ratio was closely correlated with company size, with CEO pay having a much larger impact on the ratio than employee pay:
- Median ratios ranged from 24:1 at the smallest companies to 251:1 at the largest companies.
- Median CEO pay ranged from about $2 million for the smallest companies to over $17 million for the largest.
- There was no correlation between median employee pay and company size.
Most companies defined their own consistently applied compensation measure (CACM)
To identify the median-paid employee:
- 63% of companies used a customized metric, consisting of base pay or base pay combined with other pay elements; of these, about one-third included equity compensation in determining median pay
- 28% of companies used tax records
- 9% used the summary compensation table definition