How to prepare for CEO pay ratio reporting

The CEO pay ratio regulations have been introduced to provide a snapshot of the pay gap within organisations, in a move designed to bolster corporate governance and promote transparency in the workplace.

With action being required in 2020 for the current financial year starting in 2019, we are consistently asked, ‘what does a good ratio look like?’ We delve into the detail of what’s expected, examine how these regulations fuel the fairness debate around pay and explain how the narrative will be critical in processing the figures to withstand the first round of scrutiny.

Why has the reporting been introduced?

Concerns that some chief executives’ pay has been out of step with company performance and the fact that it will take the average worker 167 years to earn a FTSE 100 leader’s annual pay has led to greater corporate scrutiny. The new rules apply to companies listed on the London Stock Exchange, an exchange in an EEA member state or the New York Stock Exchange and/or if a company has 250 employees or above. The pay ratio information will need to apply to the group if the listed entity is a parent company, not just the company.

What do the CEO pay ratio regulations require?

The directors’ remuneration report must set out the ratio of the CEO’s total remuneration to the representative employee in the 25^th percentile (lower quartile), median and 75^th percentile (upper quartile) of UK employees’ pay, labeled ‘P25’, ‘P50’ and ‘P75’. This can be completed by three different methods:

1. Calculate the pay and benefits for all UK employees in the relevant financial year to identify ‘P25’, ‘P50’ and ‘P75’;
2. Use the most recent gender pay gap information to identify three UK employees that best represent ‘P25’, ‘P50’ and ‘P75’; or
3. Use pay data readily available that relates to the previous financial year that can identify the three equivalents of ‘P25’, ‘P50’ and ‘P75’.

Employee pay includes the employee’s full-time equivalent pay and benefits. Equally, the CEO’s pay is the total remuneration they receive and must include all elements: salary, fees, benefits, bonuses, share schemes and pension benefits.

How the pay ratio will vary by sector

Some companies will fare better than others based on the ratio being skewed by highly manual roles and high levels of resource, as required in the residential care sector for instance, as opposed to companies with fewer employees who are paid higher salaries, such as in the tech sector. Customers increasingly flag how the reporting regulations are a blunt tool to highlight the differences in pay between chief executives and the rest of the workforce.

However, as E-Reward’s recent analysis highlighted, potential pay ratios can stretch from as low as 9:1 for FTSE 100 companies Autotrader and Segro to 402.2:1 at Tesco. The degree of variation demonstrates the answer we give when employers ask us, ‘what does a good CEO pay ratio look like?’ The ratio will depend on multiple factors, including the wider pay picture across your organisation, the number of employees and the degree to which certain roles are specialist.

The headline median figure is the starting point – more extensive analysis can demonstrate the pay distribution across organisations and give greater insight into the spread of pay data across workforces. More homogenous workforces such as those in retail and care will not experience a large difference in their upper and lower quartile figures. Greater detail can support the objectives of the legislation – to ensure workplaces offer as fair a pay framework as possible.

Developing a picture of pay ratios

The narrative is critical, especially for the starting year where we expect scrutiny to be strong with intense interest in what the ratios say about companies, as it was with the gender pay reporting. Looking to future years, 2020 will set a benchmark to be used as a reference point year on year. Companies will be required to report the same ratios for up to nine financial years preceding the relevant financial year. The table will eventually set out a decade’s worth of pay ratios, making it easy to see at a glance whether progress is being made. This will be accompanied by an explanation of the progress year on year, why the methodology was chosen and clarification around any omissions in relation to certain aspects of pay and benefits.

Transparency is at the heart of the requirements. Behind the regulations is the push to create a more inclusive and open culture within organisations, with equality at its heart. The directors’ report for the financial year will include a statement describing the action taken to:

• Introduce, maintain or develop arrangements to provide employees with matters of concern;
• Consult employees and their representatives when making decisions likely to affect their interests;
• Encourage employee involvement in the company’s performance, such as employee share schemes; and
• Raise awareness of the financial and economic factors affecting the company’s performance.

How to prepare for CEO pay ratio reporting

The process of calculating, presenting and justifying the pay ratios will be a time-consuming exercise that requires careful consideration. Companies could consider doing a test run for the financial year of 2018 to check they have access to the necessary pay data, work out the time it takes to process this and see whether the calculation method they chose is the best option available to them. Any omissions from the pay and benefits can be considered and justified.

The definition of employee used for CEO pay ratio is arguably narrower in scope (requiring a contract of service) than the wider definition used by the gender pay regulations. This requires greater scrutiny for companies basing the calculation on their gender pay gap data. Importantly though, the narrative can be truly planned for in the long-term to manage the impact on employee, public and investor relations when it comes to the reputation of the company.

Responsible reward

CEO pay ratio reporting is encompassed within the idea of responsible reward – a growing trend when it comes to remuneration frameworks. Non-financial measures (covering environmental, social and governance) are integrated with more traditional pay and reward strategies. This is designed to promote accountability to internal and external stakeholders, as responsible reward focuses not just on how much the business makes, but how this money is made.

One thing is for certain – designed to dovetail with the gender pay requirements and the discussions around ethnicity pay reporting, the impetus on equality and fairness when it comes to pay is here to stay.

Get in touch if we can help answer any further questions on what the CEO reporting regulations mean for your business.