CEO pay ratios: The new reporting requirements
25 September 2018
Following hot on the heels of gender pay gap reporting, large listed companies will soon have to publish the ratio of CEO’s pay packages to those of the workforce due to new legislation that takes effect on 1 January 2019. This article looks at the new requirements and the possible implications for payroll practitioners.
With only one year of gender pay gap reporting under our belts, companies – and payroll departments – are already faced with another set of payroll data calculations to prepare and publish: CEO pay ratios.
The high level of executive pay has been the subject of general debate for many years and ‘fat cat’ bosses’ salaries have been criticised in the media from time to time. So it is perhaps surprising that the introduction of legislation requiring companies to disclose the ratio of the Chief Executive Officer’s remuneration to workers’ pay has received so little attention. Nevertheless, the rules take effect in a few months’ time and the ratios have the potential to generate as much debate as gender pay gap figures.
The numbers can be dramatic. Recent research carried out by the CIPD alongside think tank the High Pay Centre discovered the ratio of median FTSE 100 CEO pay to median UK full-time or part-time worker pay was 167:1 in 2017, up from 153:1 in 2016. This means that it would take 167 years for an average worker to earn the amount that an average FTSE 100 leader earns in a single year.
In its Corporate Governance Reform green paper, the government noted the “widespread perception that executive pay has become increasingly disconnected from both the pay of ordinary working people and the underlying long-term performance of companies” and that it contributed to public distrust and shareholder dissatisfaction. It suggested introducing CEO pay ratios and supporting explanations, including context as a way to increase transparency and help shareholders hold boards to account about executive pay.
When do the changes take effect?
The Companies (Miscellaneous Reporting) Regulations 2018 were made in July 2018. The pay ratio changes are due to come into force on 1 January 2019 and would apply from the company’s fiscal year beginning on or after that date.
Which companies are affected?
The regulations apply to quoted companies, as defined by the Companies Act 2006, with more than 250 UK employees.
The legislation specifies that companies determine this headcount by calculating the average of the number of employees for each month of the fiscal year. This applies at group level for companies in a group structure.
UK employees are defined as those employed under a contract of service, except people employed to work wholly or mainly outside the UK. According to guidance from the Department for Business, Energy & Industrial Strategy (BEIS), it is unlikely that contractors or agency workers would be included because they are employed under a contract with a different organisation. Individual contractors and consultants with a personal contract with the company who may contract for services to other companies would not typically be included, either.
The regulations apply directly to England, Scotland and Wales. The Northern Ireland administration has previously agreed that business legislation should be made in the same terms for the whole of the UK.
What are the reporting requirements?
Regulation 17 requires companies within scope to disclose pay ratio information in the annual director’s remuneration report and to account for the results and for any changes over time.
BEIS published guidance in the form of FAQs in June 2018, which sets out the reporting requirements.
The figures must be set out in a table within the annual director’s remuneration report. The figures to report are the CEO’s total pay as a ratio to:
- the 50th percentile (median) employees’ remuneration
- the 25th percentile employees’ remuneration
- the 75th percentile employee’s remuneration.
Eventually, the table will include ratios for the previous 10 years.
Beneath the table of figures, companies must provide supporting information and explanation including:
- the methodology chosen for calculating the ratios
- the reason for any changes in the ratios from the previous year
- for the median ratio (50th percentile), whether the company believes that it is consistent with the company’s general employee pay, reward and progression policies and, if so, why.
How to calculate the figures
The CEO’s remuneration figure must be the latest Single Total Figure of Remuneration (STFR), which is already part of the directors’ report, calculated according to existing regulations. Where there has been a change of CEO during the year, the total pay and benefits paid to each post holder must be taken into account (but not their pay and benefits from other roles held during the year).
The employees’ remuneration uses the full-time equivalent (FTE) remuneration of the company’s UK employees. This should be calculated in the same way as the CEO’s remuneration. If this is not possible, a company can use a different approach but must explain this in the accompanying notes.
The regulations set out three methods for identifying the employee remuneration values for the ratios: A, B and C. The government’s preferred method is option A.
- Option A involves calculating the actual FTE remuneration for all relevant employees for the fiscal year in question. These values are then listed in order from lowest to highest and the values at the three percentile points are identified. To do this, divide the total number of employees by four and count that number of values from the beginning of the list to identify the 25th percentile, count from the end of the list to identify the 75th percentile, and the 50th percentile, or median, is the value at the middle of the list.
If it is not possible to calculate actual FTE remuneration values for the entire workforce (in the group, where necessary), there are two alternative methods that allow the company to identify the employees at the percentile points on an indicative basis using existing data.
- Option B allows the company to use its most recent gender pay gap information.
- Option C allows the company to use any other existing pay data instead of, or in combination with, gender pay gap information.
When Option B or C is used, the actual FTE remuneration for these indicative employees must then be calculated for the fiscal year in question. The supporting information must state the option used, must explain why B or C was used instead of A, and must explain any change from year to year.
To calculate each ratio, divide the CEO’s remuneration by that of the employee at each percentile.
For example, the CEO’s STFR is £3,200,000 and the remuneration of the employees at the 25th, 50th and 75th percentiles are £20,000, £40,000 and £100,000, respectively. Therefore, the ratios to report are 160:1, 80:1 and 32:1. In this example, it would take 160 years for a worker at the 25th percentile to earn the amount that the CEO earns in a single year.
What happens next?
Responsibility for preparing and publishing the director’s remuneration report is likely to be the responsibility of finance or human resources in many organisations. However, because this requirement involves pay data for the whole workforce and not just senior management levels, it is likely that payroll will be involved in data collection and analysis. It may be appropriate to create a team from the departments involved.
After identifying whether they are affected by the new requirements, companies will need to identify where the relevant data is held and decide which method to choose for calculating the ratios. In some respects, this is similar to the data collection and analysis for gender pay gap reporting but it is likely to be over a different timeframe and the pay elements to include may differ.
Each company will need to consider the supplementary information that it publishes carefully, ensuring that the statutory requirements are met while setting out the appropriate context, such as its industry sector, international competition for executive recruitment and so on.
The administrative and regulatory burden on employers continues to grow and, with it, the workload of payroll practitioners. Here, though, is another opportunity for the profession to show its willingness and ability to contribute at a strategic level, and to take the lead on analysis and preparation of data, demonstrating the importance and relevance of payroll activities to ‘good business’.
This article was originally written for Accounting WEB (25 September 2018)