The Payoff of Pay Ratio Disclosure

“… Morgan, it is said, would never lend money to a business where the boss was paid more than 20 times the wages of the lowliest employee. Anything more, Morgan thought, showed that the boss was only in it for himself and the business was therefore a credit risk.”

By this measure, J.P. Morgan would likely withhold loans from many 21st century U.S. companies. And, within the next several months, we will know with certainty as more U.S.-based public companies disclose, for the first time, the ratio of chief executive officer (CEO) compensation to the median compensation of all other employees (in keeping with the adoption of a final rule by the Securities and Exchange Commission (SEC) as mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act).

Because the SEC rule provides companies with considerable calculation flexibility, the reported ratios are expected to span a wide margin. According to the AFL-CIO Executive Pay Watch, the 2015 average total compensation for S&P 500 CEOs compared to the 2015 average compensation for nonsupervisory employees working in the U.S. was 335:1, while, according to PayScale, the median 2015 cash compensation for 168 of the highest-paid CEOs in the annual Equilar 200 study compared to the compensation of the median employee in those same 168 companies was 71:1.

Beginning in 2017, this pay ratio disclosure will present significant strategic and communication challenges for public companies, as key stakeholders, particularly employees and investors, seek to understand their corporation’s calculation, compensation positioning relative to the market, and current and future reputation implications.

Communications, Investor Relations and Human Resources teams will be expected to address questions, such as:

• How was the compensation of the median employee determined?
• Is compensation for seasonal employees, or contractors, included in the calculation or are only full-time employees included? What about non-U.S. employees in a multinational company headquartered in the U.S.?
• What compensation elements (equity, cash bonuses, overtime pay, etc.) are included in the calculation?
• Why was our company’s ratio significantly higher or lower than other companies of similar size, or other companies in our industry or geography?
• Why is “my” compensation so far below our company’s median employee compensation level?

And, corporate boards and financial community members may consider issues like these:

• Are our compensation practices rewarding desired behaviors and outcomes at our company, including strategic clarity, innovation, thoughtful risk-taking, financial stewardship and long-term performance?
• Are our compensation practices attracting and motivating talent at every level of the organization?
• Is there an “optimal” pay ratio within our industry … or for companies of our size and growth trajectory?
• What changes in compensation policies and practices should the company consider in light of pay ratio disclosure implications?

While much has been previously written about the operational burden and financial costs inherent in implementing this SEC rule as well as the challenges of clearly communicating the disclosure to key stakeholders, in our view, it also offers an excellent opportunity for companies to demonstrate genuine leadership.

In the coming months, corporate leaders who understand the importance of enhancing their brand and reputation will:

• Patiently and transparently communicate information and relevant context about their pay ratio to key stakeholders,
• Take actions that address significant compensation inequities, and
• Leverage their employees’ power and passion in pursuing a greater business purpose.

Through strategic communication and a respectful, rewarding corporate culture, organizations can inspire the commitment and alignment that is essential to elevating long-term performance and reputation.