A new rule requiring public companies to disclose the pay relationship between chief executives and median employees will serve as lightning rod for public debates about income disparity and executive compensation. The good news for community and smaller regional banks is that their pay ratios will tend to be relatively moderate, allowing them to fly under the radar.
The Securities and Exchange Commission has provided a lengthy lead time for companies to implement the rule, which will begin to be enforced starting in 2018. At a high level, the CEO pay ratio appears to be simple. It involves four basic steps:
- Identify your median employee
- Calculate the total compensation of the median employee
- Calculate the total compensation of the CEO
- Disclose the ratio
However, nothing is as simple as it appears. The SEC's nearly 300-page release on the pay ratio rule provides extensive guidance on each of these steps. For example, companies must identify the median employee from its worldwide workforce of full-time, part-time, seasonal and temporary workers. However, the rule permits companies to identify the median employee from a subset of its worldwide workforce as long as the subset is based on statistical sampling techniques or any other reasonable method.
Employees not based in the U.S. may be excluded from consideration, but these excluded employees may not exceed 5% of a company's worldwide workforce. This accommodation wont impact most community banks, as they generally do not employee workers outside the U.S.
In identifying the median employee among the relevant employee pool, companies may use proxy-equivalent total compensation for each employee or a simple component of compensation like base pay. In addition, a company may use the same median employee for three years as long as there has not been a significant change in the company's employee population or compensation arrangements. However, the median employees total compensation must be recalculated each year.
The rule also explains that the total compensation for the CEO and median employee generally will be calculated in accordance with proxy disclosure rules. However, companies will have the discretion to include or exclude from total compensation the value of perquisites and benefits of less than $10,000, such as an auto allowance. In addition, companies may include in total compensation the value of nondiscriminatory benefits, such as health insurance, which could represent a significant percentage of the median employees total compensation.
The flexibility accorded to companies under the new rule means their pay ratios will be significantly impacted by the methods they use to develop the relevant employee pool, identify the median employee and calculate total compensation. Also impacting pay ratios will likely be the companys industry, business model and size. Unfortunately, this suggests that the CEO pay ratio will be of limited use in allowing interested parties to make true comparisons across companies.
On the upside, community and regional banks should have a relatively easy time calculating the pay ratio and experience limited fallout from the disclosure. Both the difficulty and cost of complying with yet another rule is mitigated by the fact that smaller banks generally do not employ non-U.S.-based employees. In addition, CEO pay levels at the majority of community and regional banks are fairly modest relative to the 300:1 pay ratio at other large firms, as calculated by the Economic Policy Institute in 2013.
Bank boards will undoubtedly review and consider the CEO pay ratio. But its practical import may prove to be limited. Executive compensation programs typically strive to be competitive to attract and retain talent and reflect achievement of defined performance goals. So long as boards and investors are satisfied with the CEO's performance, they may be unlikely to push for change.
Regardless, banks must now decide begin preparing for the implementation of the disclosure rule in 2018. The majority of small banks will be best served by beginning in 2016 to determine the resources they need to comply with rules, develop a compliance plan and test the plan against 2015 and 2016 pay data. This should give most banks sufficient time to identify and correct issues they might encounter in developing the pay ratio.
Susan O'Donnell is a partner at Meridian Compensation Partners, an executive compensation consulting firm in Newton, Mass. Donald Kalfen leads Meridian's technical team.