The SEC Proposes New Pay Ratio Disclosure Rule

In September, the Securities and Exchange Commission proposed the long-awaited “pay ratio” disclosure rule as required by Section 953(b) of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rule would require public companies to disclose a median pay ratio for its chief executives and lower-level employees in shareholder proxy statements. Total compensation would include salary, bonus, stock and option awards, long-term incentive pay, and change in pension value. The proposed disclosure requirements, however, would not apply to emerging growth companies, smaller reporting companies, or foreign private issuers.

Mixed Reactions

In connection with the implementation of the pay ratio disclosure rule, the SEC sought commentary from the public about the proposal. These comments have provided a number of valuable perspectives on the new rule. Anne Simpson, a senior portfolio manager at the California Public Employees’ Retirement System, noted in a public comment that “information around compensation is obviously helpful because financial incentives clearly play a critical role in the recruitment, retention and motivation of employees.” Many argue that these pay disclosures would allow shareholders to understand what drives company and market performance, enabling them to make informed decisions when voting on executive compensation and evaluating the effectiveness of board oversight.

Measurement Flexibility

On the other hand, business groups have commented that the inclusion of part-time workers and employees based in foreign countries makes the calculation painstakingly difficult and needlessly expensive, citing the complex payroll, benefits and pension systems utilized by many companies, and the challenging reconciliation of pay practices between nations. However, as Simpson also points out, the SEC intends to include flexible measurement provisions that would allow companies to use the overall median of the company’s “annual total compensation,” statistical sampling, or any consistently applied compensation measure to determine median pay. That way, a company can choose a method that best fits its business model and budgetary constraints.

Non-Economic Implications

As the SEC highlighted in its economic analysis of the proposed rule, some commenters have suggested that a comparison of executive compensation to employee compensation would allow investors to evaluate employee morale and productivity, as well as provide a measure of a particular company’s investment in human capital. Certain investors weigh these social factors as part of their investment decisions, and strongly value the non-economic benefits associated with them.

The SEC is aware of the potential costs and benefits of the proposed rule, and the agency is currently working to formulate a rule that will comply with the existing executive compensation disclosure regime. An ideal rule will provide flexibility that will help lower the costs of compliance, but will also create a metric that is meaningfully informative to shareholders.

The proposed rule’s 60-day commentary period ended on December 2, 2013. The SEC should reveal whether and when the new rule will take effect in the upcoming weeks.