This is the second of our blog posts on CEO pay ratio disclosures (see “Reasons to consider expanded Year 2 CEO pay ratio disclosures,” Executive Pay Matters, December 11, 2018). It focuses on the shareholder letter we mentioned in our first post that was sent to Fortune 500 company compensation committees from a group of 48 institutional investors requesting them to disclose more information on workforce compensation practices.
At the outset, we’d like to clarify that we do not agree with the signatories’ position that the pay ratio disclosure itself is “useful for say-on-pay proxy voting decisions regarding the reasonableness of CEO pay levels.” We view the disclosure and the say-on-pay voting decisions as separate items within the proxy, and believe that the Securities and Exchange Commission (SEC) concurred when it permitted companies to include the disclosure outside the Compensation Discussion and Analysis that, in tandem with the tabular disclosures of pay levels, is the subject of say-on-pay voting.
However, Willis Towers Watson strongly advocates for clear communications between companies and their workforces because our data reflect that greater transparency about their talent value proposition helps attract and retain employees. Additionally, even though the SEC has provided guidance that the CEO pay ratio across organizations may not be directly comparable, we believe companies should anticipate more questions about why their pay ratio may differ from that of industry peers.
The shareholder letter focuses on transparent communication of some issues that are relevant to both the mechanics of the pay ratio calculation and how the company manages its employees as a resource. We also believe there is additional financial information that companies may consider mining to help put their pay ratio in perspective for their boards of directors, if not for their shareholders.
When reflecting on all the additional information requested collectively, it seems that how you tell your whole story about your workforce is just as important as what you disclose. We do think it can be beneficial to address the letter’s statement, “… a workforce is an asset to be invested in, not a cost to be minimized…” directly in a brief description about your pay practices. Nonetheless, the shareholder letter requests far more information than needed to provide shareholders insights on these issues, many of which may give employee advocates and unions more information to leverage in negotiations or provide competitors with critical proprietary business information. In many cases it would greatly increase the amount of information collected and the burden on internal systems.
What the shareholder letter requests
The specifics of the suggested supplemental disclosures requested in the shareholder letter are based on the investor signatories’ observations about “best practices” from the 2018 proxy season. These “best practices” and our perspective follow:
|Shareholder Letter Best Practice
||Willis Towers Watson’s Perspective
|1. Identification of the median employee’s job function
||This can provide an opportunity to identify an employee thought to be typical of the company, so doing so may align with messaging to the market and could be useful. Where the median employee is paid at the lower end of the range for that role, disclosing a job function may mislead readers as to that job’s typical pay levels. In other cases, the median employee may be in an atypical or even single incumbent role.
|2. Breakdown of the workforce by job function and/or business unit
||Seems like a large request for many companies as it would require substantially longer disclosures and information frequently not collected as part of the CEO pay ratio calculations. For EU companies, this may also violate the General Data Protection Regulation (GDPR).
|3. Geographic location of the median employee
||While this could be an innocuous disclosure to support identifying a typical employee, we would be concerned employee advocates/unions would use this as a data point for local negotiations.
|4. Country-level breakdown of global employee head count
||Currently, only companies that used the 5% exclusion are required to disclose head count excluded by country. Global clients assembling this information to show their global footprint, which often helps explain why their pay ratio differs from peers, might consider a de minimis cut-off (e.g., countries with less than 10% of the workforce may be listed as “other”) in their disclosure.
|5. A breakdown of full-time vs. part-time employment status
||We would advocate considering this approach when the use of part-time vs. full-time employees (or seasonal and temporary employees) has a material impact on the median pay to help explain why the ratio appeared lower than others in their industry. In instances where this is not the case, we don’t believe this disclosure would be useful.
|6. Use of temporary or seasonal employees
||Same perspective on this issue as in 5 above. In addition, in most cases, seasonal employees are no longer employed at the determination date and thus have no impact on the median pay calculation.
|7. Use (or non-use) of subcontracted workers
||We are concerned that companies would be unfavorably judged against peers if this was disclosed. In addition, these individuals typically are not required to be included in the CEO pay ratio calculation, and this information is not collected to complete the pay ratio calculation.
|8. Tenure and experience of the workforce
||Showing that the company understands its current workforce demographics reflects the company is focused on challenges in keeping employees engaged and motivated. However, since this information is typically not collected for the CEO pay ratio calculation, it could be burdensome to collect and could be subject to data privacy concerns.
|9. Workforce education levels and skill sets
||Could provide more insight to shareholders that a company understands its workforce hiring needs and challenges. However, many organizations do not have this information housed with their payroll information, if they have it at all, and this would be exceedingly burdensome to collect.
|10. The company’s overall compensation philosophy
||Many companies have stated that they pay appropriate levels of compensation for workers in their industry and geographies. It is unclear how much more detail would be helpful.
|11. Employee compensation mix (benefits and incentive)
||This would be consistent with providing more clarity on the total rewards practices for the median employee. It could get complicated for complex organizations that do not have a typical portrait of their rank-and-file. For global organizations this is likely to vary substantially across locations.
We expect that companies’ legal counsel will emphasize how organizations need to be certain they wish to continue to provide these disclosures in later years before making current year disclosures, as we often hear red flags are raised for shareholders when prior year disclosures are cut back. Yet, in concert with some of the disclosures we think are required under the SEC rules, more forthcoming disclosures are already on tap for Year 2. Perhaps companies will embrace doing a bit more where the data is readily available and will provide meaningful information for shareholders.
Then, for companies that decide to include more information, there is the question of where that disclosure should appear. This will be the subject of our next blog post on CEO pay ratio.
Steve Seelig is a senior director specializing in executive compensation in Willis Towers Watson’s Research and Innovation Center, and Rich Luss is a senior director in research, both in Willis Towers Watson’s Arlington office. Jamie Teo is an associate director in talent and rewards, in Willis Towers Watson’s New York office. Email email@example.com, firstname.lastname@example.org email@example.com, or firstname.lastname@example.org.