Late last month, the SEC issued new and updated interpretive guidance so that companies can calculate the CEO/worker pay ratio that is required to be published on proxies for the 2018 proxy season. Less than three weeks later, the Trump Treasury Department released a report that, somewhere in its 220 pages, suggested that the pay ratio disclosure be done away with.
Even before this latest turmoil, as a disclosure requirement, this one has had a chequered history. Described as politically motivated even by liberals and Democrats, it has been fought against by corporates, been the subject of several “going nowhere” bills introduced into Congress which sought to cancel the requirement, and probably more comment letters than anything else the SEC has ever tried to introduce either as a result of Dodd-Frank – as in this case – or off its own bat. When Trump was elected, many corporates sighed with relief, thinking ‘he’s anti-regulation, he’ll appoint an SEC chief who’ll cancel this’. But then, Jay Clayton did nothing of the kind and just left it to the Treasury Department.
Here’s where I have that theory.
Back to the guidance, for a moment. The guidance gives companies significant flexibility in developing and applying methodologies to arrive at the required ratio, including in the use of internal records to calculate median employee pay, on the use of a consistently applied compensation measure (CACM), on whether and how to include independent contractors, a choice of three different sampling combinations, 10 different “estimation” methods in addition to choices over whether to use simple random sampling, stratified sampling, cluster sampling, systematic sampling (anyone who wants to know what any of those mean should go to the guidance document itself). And this is in addition to guidance issued last October that dictated when to include certain classes of workers and how to calculate what it calls “consistently applied compensation measure”.
The SEC admits all this flexibility could create a “degree of imprecision” in a company’s pay ratio disclosure. As an understatement, that one has few equals. What it means is that no two ratios are going to be calculated the same. Not only that, the SEC reassures companies that if they use “reasonable estimates, assumptions or methodologies, the pay ratio and related disclosure that results from such use would not provide the basis for Commission enforcement action unless the disclosure was made or reaffirmed without a reasonable basis or was provided other than in good faith.”
In other words, as long as a company does not blatantly misrepresent a CEO/worker pay ratio (and how are you even going to be able to figure that out?) — no one’s going to get into trouble.Now, that’s a plan. Don’t kill the regulation, let it die of statistical sampling. It’s almost as if they appointed a clever corporate lawyer to head the SEC. Oh, wait…
Now, while the whole pay ratio thing just makes journalists gleeful with anticipation – and imagine if you could find a company that wasn’t acting “in good faith” in its statistical sampling – I didn’t think that investors were going to be much bothered.
Figures from ISS’s Global Policy Survey show that only 16% of respondents indicated they are not going to use the new pay ratio disclosure. Nearly three-quarters of investors said they would “either compare the ratios across companies/industry sectors, or assess year-on-year changes in the ratio at an individual company” or both. Most said they would use it as one data point to help make a decision on a Say on Pay vote, while the next largest number said they would use it as background for corporate engagement. A plurality (44%) of non-investors said that the data would not be meaningful, citing “demographic and geographic disparities and the use of part-time or contract workers”. In this instance, the non-investors may have it right.
I said to ISS’s Head of US Research, Marc Goldstein: wouldn’t it be a problem if, either in an engagement situation or where an investor is using the pay ratio as a data point in making a Say on Pay decision a company could turn around and say: you can’t compare us to company X because we calculated our pay ratio differently from them?
“There are going to be legitimate differences among companies in the same sector,” replied Goldstein, “depending on the percentage of the workforce that are employees versus part-timers or contractors, the percentage based in the US versus those based overseas, and the business model, for example, if a company owns stores rather than franchises.
“Goldman Sachs will probably have a pretty good ratio, compared to a bank with a network of branches, with tellers. This means that Bank of America or Citigroup could pay their CEO less but the ratio will be higher. So, for anyone making comparisons you have to be able to understand the differences in the business model and the demographics.”
I asked what ISS had decided to do as a result of the answers in the survey. “In year one, we won’t be able to make comparisons looking at any year on year changes at a given company,” he replied, “and it will also be difficult to make company comparisons because companies file their proxies at different times. We will put the number in our report, but there isn’t very much that we can realistically do with it. In years two and three we will be able to make historical comparisons and peer comparisons, though we’re still receiving input from investors on how they will use the information and I don’t want to commit ISS to doing anything specific.”
This brings up the prospect of even more problems for companies. If the CEO/worker pay ratio goes up year on year, companies are going to want to statistically sample their way out of that headache. I also asked Goldstein if the level of interest in the pay ratio had been a surprise. “The figures from the survey did surprise a little bit; they were a little bit higher than we expected. Part of the reason for asking the question, was to determine where we’re going to put the figure; if it’s going to be used by investors as a data point for voting on say on pay, then we will include it in that writeup. But in terms of our own analysis or vote recommendations, it’s too early to say whether or how we will be using the information.”
Finally, there are potential problems for companies that don’t even involve shareholders, which is communicating the pay ratio to employees.According to a survey by Willis Towers Watson, almost half of respondents (48%) have yet to think about how, or even if, they will communicate the pay ratio to employees. About two-fifths are preparing leadership to respond to employees’ questions, while only 16% are prepping managers to have discussions with employees. Only 14% have created a detailed communication plan to inform employees but a similar number are not planning to say anything.
Did they not prepare because they thought there would be a reprieve at the last minute? If the Treasury’s recommendations are adopted, we may have only a single year of data, which will be worse than useless for investors, but it will be fun for the rest of us. But if the disclosures sticks, it looks like it will become yet another data point in investor governance analysis.