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Calculating the Pay Ratio Rule

A new study shows that CEOs still make gobs more money than the rest of us mere mortals, although Corporate America uses a variety of approaches to demonstrate that point.

ClearBridge Compensation Group analyzed 100 companies in the S&P 500 to see how they complied with the CEO Pay Ratio Disclosure Rule. That’s the requirement under the Dodd-Frank Act that companies report the ratio of total CEO pay compared to pay of the “median” employee. Companies had to start reporting the CEO pay ratio this year.

Among the 100 companies ClearBridge studied, the median CEO pay ratio 208 to 1, or roughly $14 million to $71,000. One-fifth of the companies also disclosed an alternative pay ratio, in addition to the required one. The alternative pay ratio resulted in a median decrease in the ratio of 25 percent decrease. The most common explanation companies gave for providing an alternative figure was to exclude bonuses or other one-time financial awards that could have skewed the numbers on the CEO side of the equation.

pay ratioThe biggest divergence in companies’ approaches to calculating the pay ratio were in how they defined “pay” to identify the median employee salary. That had always been a sticking point for critics who objected to the rule: that the idea of a median employee was too vague and subject to interpretation. (For example, should a company include part-time or contract labor? What about overseas workers who might be paid a reasonable wage in emerging markets, that’s still low by Western living standards? And so forth.)  

Roughly 28 percent used base salary only; 33 percent used cash compensation only; and 39 percent used total compensation. The cash compensation only category consisted of base salary plus annual incentives, and in some cases overtime and commissions.

In the total compensation category, 14 percent were companies using W-2 forms as their basis, and the other 25 percent included base salary, annual incentives, and equity grants. Some companies then added overtime, commissions, allowances, retirement and healthcare benefits, and perks.

The vast majority (94 percent) of companies used their entire workforce as the sample to calculate the median employee, compared to just 6 percent that chose to do statistical sampling.

Pay Ratio Adjustments

A good number of companies took advantage of various exemptions allowed under the Pay Ratio Rule. For example, 44 percent used the de minimis exemption allowing companies to exclude non-U.S.-based employees, with a cap of 5 percent of the total workforce; and 16 percent used the acquired companies exemption, which allows companies to exclude employees of an acquired company if the acquisition took effect in the disclosure year.

No companies claimed the data privacy exemption, which allows them to exclude employees based in jurisdictions that prevent data collection due to privacy laws.

Most companies (57 percent) dealt with new hires that came on board in the middle of the reporting year by annualizing their compensation. Only a small number (4 percent) took advantage of the rule allowing them to substitute the median employee with a similarly compensated employee if their calculations resulted in a median employee whose salary was abnormally high due to a one-time bonus or other award,

ClearBridge, a New York-based consulting firm, chose the 100 companies to roughly mimic the percentages of various industries comprising the S&P 500. Companies included Amazon, Coca-Cola, Exxon Mobil, and JP Morgan Chase. The median FY 2017 revenue for the sample was about $23.7 billion.

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