The CEO Pay Ratio Rule

Today [August 5, 2015], the Commission takes another step to fulfill its Congressional mandate to provide better disclosure for investors regarding executive compensation at public companies. As required by Section 953(b) of the Dodd-Frank Act, today’s rules would require a public company to disclose the ratio of the total compensation of its chief executive officer (“CEO”) to the median total compensation received by the rest of its employees. The hope, quite simply, is that this information will better equip shareholders to promote accountability for the executive compensation practices of the companies that they own.

The Congressional mandate under Section 953(b) has proven to be one of the most controversial rules that the Commission has been required to undertake under the Dodd-Frank Act. Since Congress first required the Commission to promulgate this rule just over five years ago, the Commission has received over 287,000 comment letters, with over 1,500 individual letters and the rest form letters. The diverse views expressed by these commenters reflect that Congress tasked the Commission with navigating a highly divisive subject—a boon or a bane, depending on one’s perspective. Many of these commenters urged adoption of the pay ratio rule, and cited the benefits from such a disclosure. For example, they pointed to the ability of investors to use CEO-to-worker pay ratios as an additional metric in evaluating and voting on executive compensation matters, including “say-on-pay” votes. Other commenters noted that this disclosure could provide visibility into other hard-to-measure indicators of a company’s long-term health, such as the effectiveness of its corporate governance. At the same time, a number of other commenters expressed general skepticism that pay ratio disclosure would provide any benefits, or otherwise expressed concern with the potential complexities, and associated costs, of complying with this Congressionally-mandated disclosure.

These diverse views reflect that while the CEO-to-worker pay ratio is a seemingly simple requirement—after all, the primary output of today’s rule is just a ratio, like 296:1—getting to the ratio may require some effort. Pursuant to Section 953(b), issuers will need to determine the median employee, by annual total compensation, by considering “all employees of the registrant.” Indeed, Congress did not expressly carve out any categories of employees, whether they are part-time, temporary or seasonal, or employees situated in the U.S. or abroad. For some companies, unless the information for “all employees” is already readily attainable, this could require them to incur costs in creating compatible payroll systems across foreign borders, or across various business areas, in order to extract the necessary data.

In drafting the rule being considered today to fulfill the Dodd-Frank mandate, the Commission and its staff went to great lengths to consider all viewpoints, including how best to stay faithful to the values of the rule, while mitigating the potential challenges faced by issuers in its implementation. The end result provides a thoughtful and reasonable approach to fulfilling the Congressional mandate that permits issuers to have a great deal of flexibility in the methods of compliance with the pay ratio disclosure—and, at the same time, tries to ensure that the resulting disclosure will be useful to investors.

For example, in calculating the CEO-to-worker pay ratio, today’s rule permits issuers to do the following:

• To choose a reasonable method to identify the median employee that is appropriately tailored to their business, including identifying the median employee using statistical sampling or any consistently applied compensation measure (such as payroll records);
• To exclude from the pay ratio calculation a de minimis amount of non-U.S. employees;
• To exempt from the pay ratio calculation non-U.S. employees from certain jurisdictions when foreign privacy laws make it illegal to provide the information necessary to calculate the pay ratio; and
• To calculate the median employee only once every three years, instead of every year, providing certain conditions are met.

These and other discretionary decisions were made to help ameliorate some of the complexities of implementing the statutory mandate while retaining the value of the disclosure to investors.

Ultimately, today’s pay ratio rule should be viewed as a complement to other executive compensation rules mandated by the Dodd-Frank Act that promote corporate accountability and enhance the information available to investors. For example, today’s rules complement the Commission’s recently proposed rules that would require public companies to show the relationship between the executive compensation actually paid and the financial performance of the issuer. Furthermore, today’s rules also provide investors with additional information to inform their Dodd-Frank-mandated “say-on-pay” advisory votes. In this way, today’s rules are intended to promote better shareholder engagement on executive compensation issues.

Conclusion

In conclusion, today’s pay ratio adopting release incorporates many discretionary decisions made by the Commission consistent with the Dodd-Frank statutory mandate. These decisions were designed to facilitate compliance with the rule in a manner that is reasonable and workable for issuers, while still providing for increased transparency and greater accountability in executive compensation matters. For these reasons, I will support today’s rules.

Lastly, I would like to thank the staff from the Division of Corporation Finance, the Division of Economic Research and Analysis, and the Office of the General Counsel for their hard work on this rulemaking. I appreciate the important work you do to protect investors.