On Wednesday, by a 3-2 vote, the SEC approved proposal of the long-anticipated CEO pay ratio disclosure rule (read the press release). The proposed rule, part of the 2010 Dodd-Frank Act, would require a public company to disclose the ratio of compensation between its CEO and the median compensation of all its other employees.

The rule derives from Section 953(b) of the Dodd-Frank Act, and will require a public company to make the following disclosures:

  1. The median of the annual total compensation of all employees, except its CEO;
  2. The annual total compensation of its CEO; and
  3. The ratio of CEO compensation to median employee compensation.

Companies and SEC-watchers were most interested to see what methodology the rule would dictate for calculating median employee compensation. As it turns outs, the SEC will be flexible on this, saying that it would “allow companies to select a methodology that is appropriate to the size and structure of their own businesses and the way they compensate employees.”

The announcement specifically mentions statistical sampling, which, for companies that have sampling expertise, could significantly reduce the costs of compliance. However they decide to calculate these figures, companies will have to disclose their methodology.

Other aspects of the rule include:

  • Calculating “Total Compensation:” median employee compensation will be calculated using the same definition of “total compensation” as used in the executive compensation disclosures. These are found in Item 402(c)(2)(x) of Regulation S-K.
  • Reasonable Estimates Allowed. Companies are allowed to use reasonable estimates to calculate:
    – Annual total compensation of an individual employee;
    – Any element of total compensation; and
    – Annual total compensation of the median employee.
  • What is an “Employee?" All employees of the registrant includes:
    – All employees (including full-time, part-time, temporary, seasonal and non-U.S. employees);
    – Those employed by the company or any of its subsidiaries; and
    – Those employed as of the last day of the company’s prior fiscal year.
    Companies may, but are not required to, include employees (such as new hires) who did not work for the entire year. The rule will not allow inclusion of “full-time equivalent adjustments” for part-time employees.
  • Filings Requiring Disclosure. Companies will have to disclose these amounts on registration statements, proxy and information statements, and any annual reports that already require executive compensation disclosures.
  • Effective for 2015 Proxy Season. The SEC noted that the rule will not go into effect until after the 2014 proxy season. The rule will first undergo a 60-day comment period, and once adopted, would become effective for a company’s first fiscal year starting on or after the effective date of the final rule.