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With Voluntary Disclosure, Companies Get Ahead of CEO Pay Ratio

April 11, 2016

In August 2015, the SEC passed the Pay Ratio Disclosure rule as a part of Dodd-Frank, which will require them to include a comparison of CEO pay to that of a median employee. Companies are not required to report this information in their proxy statements for two more years, and very few have included this information in any way, shape or form. Moreover, most governance stakeholders do not expect many voluntary disclosures before the rule is mandatory in 2018 proxy statements.

In the meantime, any presentation ahead of the mandate will provide insight into how the CEO pay ratio reflects internal pay equity. As an example, Adam’s Resources and Energy Inc. (AE) disclosed this information according to the SEC’s rule, proactively telling its executive compensation story through this transparency.

Industry-specific complexities and international policies make defining pay for a median employee challenging. As a result, the SEC regulation allows for companies to decide their own methodology for choosing their median worker provided that they disclose this process. Adam’s Resources and Energy Inc. disclosed this methodology in addition to acknowledging their preemptive inclusion and recognition of the rule as a measure of equitability within the company. The entire disclosure from the April 6 proxy filing is below.

Pay Ratio Disclosure Rule

In August 2015 pursuant to a mandate of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd – Frank Act”), the Securities and Exchange Commission adopted a rule requiring annual disclosure of the ratio of the median employee’s annual total compensation to the total annual compensation of the principal executive officer (‟PEO”). The Company’s PEO is Mr. Smith. Registrants must comply with the pay ratio rule for the first fiscal year beginning on or after January 1, 2017. The purpose of the new required disclosure is to provide a measure of the equitability of pay within the organization. The Company believes its compensation philosophy and process yield an equitable result and is presenting such information in advance of the required disclosure date as follows:

Median Employee total annual compensation      $60,052
Mr. Smith (“PEO”) total annual compensation      $400,000
Ratio of PEO to Median Employee Compensation      6.7:1.0

In determining the median employee, a listing was prepared of all employees as of December 31, 2015. Employees on leave of absence were excluded from the list and wages and salaries were annualized for those employees that were not employed for the full year of 2015. The median amount was selected from the annualized list. For simplicity, the value of the Company’s 401(k) plan and medical benefits provided was excluded as all employees including the PEO are offered the exact same benefits and the Company utilizes the Internal Revenue Service safe harbor provision for 401(k) discrimination testing. As of December 31, 2015 the Company employed 809 persons of which 557 are professional truck drivers.

The company’s CEO pay ratio of 6.7:1 is a stark contrast to the statistic at a market level. The ratio of median CEO pay in the S&P 500 to the median U.S. worker hit a peak of nearly 250:1 in 2014, according to Equilar data on executive compensation compared against U.S. Department of Labor Statistics data on the median U.S. worker.

These broader figures don’t tell the whole story, since they include the very highest paid and most successful companies in the United States, and the median worker pay figure represents all workers regardless of company size and revenue. Disclosures like the one highlighted here will go much further to tell the real story of how executive pay compares to worker pay, and whether there are concerns about pay inequality from company to company.

“The new CEO pay ratio is unlikely to materially change Say on Pay voting patterns, but it may influence some investors who consider internal pay equity to be an important factor, or in cases where the ratio is dramatically different than a company’s peers,” said John Beckman, a partner at Hogan Lovells, whose firm contributed independent commentary for Equilar’s annual Governance Outlook research report and the latest issue of C-Suite magazine.

Using the pay ratio to determine “equitable pay” supports an emerging idea that executive compensation should be determined by looking inwards at their employees’ pay rather than comparing pay at peer companies. For example, Israel recently adopted legislation restricting bank and insurance companies’ executive pay at 44 times their lowest workers’ pay. Even though this type of legislation looks distant from the U.S., it will be interesting to how companies present this ratio, define their median employee, and to see any if any other pay ratio disclosure rules arise. And of course, the question remains whether this will influence CEO pay levels at all.

For more information on Equilar’s research and data analysis, please contact Dan Marcec, Director of Content & Marketing Communications at Ryan Villard, research analyst, contributed to this post.

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