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Get ready to do some math, in-house counsel, or at least to call up the accounting department. The Securities and Exchange Commission has finally adopted a CEO pay ratio disclosure rule, five years after Dodd-Frank imposed the disclosure mandate.
The new executive pay ratio rule is complicated and, for some companies, sure to be embarrassing. But, the SEC promises, it will help shareholders have a "say on pay" and might delay -- or ignite -- the coming income inequality-inspired revolution everyone from Thomas Piketty to billionaire hedge fund managers are warning about. Here's what in-house counsel need to know.
What You Need to Know
The controversial new rule has been in the works for two years. The SEC received almost 300,000 public comments regarding the rule during that period -- an unusually high level of public engagement. Most of them were supporting the rule, several of them were by influential business groups denouncing it. Coming in at 18,000 words long, the new compensation calculation and disclosure rule isn't easy to digest. Here are some important points:
1. It applies to most public companies, but not "emerging growth" and small companies. Emerging growth businesses are those with less than $1 billion in annual gross revenue.
2. You have some time to prepare. The rule doesn't come into effect until 2017.
3. Companies have leeway in calculating their ratio. Companies can adopt a variety of calculation methods to determine the median employee compensation, including statistical sampling. That median can be calculated based on a single point over a three year period.
4. Compensation is total compensation and includes salary, bonuses, stocks and options, incentive plans and other compensation.
5. The median income will include foreign workers, which could drastically increase the ratio if your CEO is making American-style pay while many of your employees work on Bangalore wages. Cost-of-living adjustments are allowed, but the unadjusted ration must be provided as well.
6. Companies can't easily exclude non-U.S. employees. Keeping foreign employees out of the calculation is allowable in only narrow circumstances, including when another country's data privacy laws make compliance impossible.
7. CEO pay probably won't drop. Perversely, when CEO pay is disclosed, research shows, executive compensation increases, as boards compete for candidates by throwing more money around.
8. The big news could be employee median pay. If employees are upset that executives make 100 times more than them, they also might be surprised to see how their median wage stacks up against competitors.
9. Yes, this will likely result in shareholder conflict. Many predict increased proxy battles and potential lawsuits by shareholder activists.
So consider advising your company to take on some new bookkeepers and number crunchers, as putting together the ratio won't be easy. They might want to think of upping their PR budget as well, to help deal with the aftermath.